This is because the fund ends up with a higher proportion of more illiquid stocks, which puts the remaining investors at a huge disadvantage.
If they want to cash out, the fund manager would then have to sell off stocks, often at a heavy discount.
The FCA added: “This approach [of assuming the most liquid assets would be sold first] provides a distorted view of real portfolio liquidity and makes stress tests less effective in comparison to a more conservative pro-rata approach to modelling, where a proportionate ‘slice’ of every asset comprising the portfolio is contemplated to accommodate the redemption.”
The FCA also said in the good practice guide that there must be a willingness to challenge investment managers about their funds’ liquidity and the composition of portfolio transactions undertaken to meet investor redemptions.
Elizabeth Budd, partner at Pinsent Masons, says: "The review of ACDs was triggered to a certain extent by commercial dynamics. The commercial reality of a large portfolio manager who was creating significant revenue for the ACD meant that it could be difficult for the ACDs to be as rigorous in their regulatory obligations as the FCA expected.
"The FCA became quite concerned by this conflict of interest because they considered that the delegate [investment manager] seemed to have more power than the ACD who, from a regulatory perspective, was the entity in charge.
"The tension between the regulatory position and the commercial still exists. If you‘ve got a company whose sole business is to provide what is essentially a service to a portfolio management entity, that commercial dynamic could influence how things operate on the ground.
"However, the fact that the FCA has focused on this tension or conflict of interest has meant that ACDs are much more conscious about their obligations and more robust in their negotiations using the regulatory environment to support their position."
Yealand's Jackson says the publication of liquidity management good practices for independent and internal ACDs provides a basis for the FCA's expectations, which ACDs are able to factor into their framework.
He adds: "We have been very vocal about supporting the introduction of minimum contractual requirements between independent ACDs and investment managers.
"Although we acknowledge great strides have already and continue to be made in this part of the industry, since the ‘Woodford’ fund suspension, to enhance the oversight and challenge of investment managers by independent ACDs, prescriptive requirements would make it clear and consistent to all applicable firms what their and the independent ACDs' roles and responsibilities are. Our concern is that there remain too many inconsistent approaches."
