Fund managers are failing to disclose the expected level of leverage in their funds related to the use of derivatives and in some cases are not even explaining in general terms the associated risks, the Financial Conduct Authority has found.
The regulator has published an supervisory update revealing the results of a review of 19 firms which found that investors were failing to receive adequate information about leverage in open-ended Ucits funds that use derivatives to gain exposure to markets.
In many cases it found that investors are not receiving adequate information in key investor information, annual report and prospectus documents, with only 11 of the sampled funds describing the risk of leverage in their prospectus.
Only five of the funds disclosed the expected leverage level. The actual level of leverage was disclosed in the annual report of only one fund and only two key investor information documents provided clear descriptions of the risk associated with leverage.
While the review focussed on leverage disclosure, the FCA warned that other risks associated with derivative use means firms should:
• consider their disclosure of derivative risks to ensure they are clear, fair and not misleading;
• ensure investors are clearly informed of important risks; and
• decide whether leverage represents a material risk to the fund and if so, whether it should be disclosed in the KIID.
The City watchdog also found in its review that the majority of firms do not submit details of their derivative risk management process to it.
The update also focused on valuation and liquidity oversight, warning that poorly performed assessments have the potential to cause considerable harm to investors.
It particularly pointed to property valuation as difficult, because a market price is often not available. “The time it takes to sell a property and the lack of demand in some market conditions can make physical property a particularly illiquid asset,” it states.
An FCA review of seven funds and three depositaries centred on direct property funds, finding that all trustee and depositaries relied on a single standing independent valuer.
One trustee/depositary compared changes in property valuations to changes in a relevant benchmark, while another did not perform additional checks on valuations, which is being followed up by the regulator’s supervision team.
The regulator cautioned that trustees and depositaries are required to take reasonable care to ensure that all scheme property is appropriately managed, including some form of check of valuations such as comparing valuations against a relevant benchmark or checking a sample of valuations.
Monitoring of liquidity also varied greatly across property funds in the review, with one firm gathering detailed monthly information on liquidity, while another performed no liquidity monitoring at all.
peter.walker@ft.com
