Last Wednesday, the FSA met with senior managers of
25 major OEIC and Unit Trust mangers and expressed concerns that UK
fund managers may have been managing funds in a manner that has
enabled market professionals to profit at the expense of buy and
hold retail customers, thus resulting in detriment to
consumers. The FSA cited late trading and market
timing as examples of activities which might be
included. It has asked fund managers to provide
it with specific information on these types of activities by 24
Market timing is more generally
referred to in the UK as arbitrage and is not a precisely defined
term, but generally refers to a trading strategy involving frequent
purchases and sales of units or shares in open-ended funds with the
intention of anticipating changes in market
prices. Such frequent trading, whilst not in
itself illegal, is viewed as poor practice, as it causes dilution
in the fund, by compelling the fund manager to retain a higher
level of liquidity than is desirable, or to buy and sell holdings
more frequently than may be desirable, thereby incurring costs,
such as broker commissions and market spreads.
Market timing or arbitrage can occur where an
investor is aware that the security prices upon which a fund's
dealing price is calculated do not take account of the most
recently available market information. An
example would be when a fund is priced using closing prices from a
market which closed for trading materially prior to the fund
valuation point (for example, a UK unit trust which is invested
into US stocks, valuing at 9 a.m. UK time and using US market
closing prices, from 9.30 p.m. the previous day), during which
time, a significant event has occurred that arbitrageurs believe
will impact prices when the market reopens.
Fund managers would be in breach of the FSA's rules
and principles if they actively encourage market timing activity,
or if they knowingly or negligently allow the funds they manage to
be used in this way. The FSA has stated that it
would be very concerned indeed if it were to find that fund
managers were providing market professionals with advantageous
pricing to facilitate market timing, or with information that has
enabled them to assess how price movements have affected the
securities in fund portfolios.
Late Trading involves collusion between fund
managers and market professionals to circumvent the fund's internal
procedures on the timing of trades and would be viewed by the FSA
as a clear breach of its Collective Investment Schemes
rules. There are safeguards against late trading
in the UK, but the FSA has indicated that it wishes to investigate
whether late trading is a feature of the UK market.
Systems and controls are a subsidiary
concern of the FSA in its investigation of these
issues. The FSA has said that even where fund
managers do not actively facilitate market timing activity, they
could nevertheless still be in breach of the FSA's principles if
such activity is being carried on elsewhere in their firm, but
their systems and controls are not adequate to alert them to
it. The FSA will follow up any case where it
finds a firm's arrangements to be deficient.
What the FSA
The FSA has asked fund managers to provide it with
specific information on these issues. It is
expecting CEOs to be personally involved in, and to take direct
responsibility for, ensuring that there is a proper review of past
trading practices in their firm. CEOs are to be
required to explain to the FSA precisely what reviews have been
carried out in their firms, what was found and what remedial action
was taken. Non-executive directors must be kept
fully informed of the progress of the review and asked to
participate in ensuring its adequacy and the firm's response.
What should firms
The FSA expects to be informed if there is
any reason to believe that anyone in the firm has been involved in
market timing activity or late trading.
Firms should also inform the FSA if reviews
showed up any weaknesses in systems and controls.
The FSA further requires to be informed if a
firm has been approached by market professionals, suggesting that
the firm assist them in market timing
activities. In this case, the FSA would also
like the name(s) of the counterparties involved.
The FSA requires the industry as a whole to
come up with systems and alternative revaluation arrangements that
reduce - or eliminate – the scope for these types of
Is there any risk of enforcement
action being taken?
The simple answer is yes. The
FSA has said that any evidence of late trading, market timing or
shortcomings in systems and controls could result in enforcement
action being taken.
If you believe that your firm has been involved in
late trading or market timing activity, or there have been
deficiencies in your systems and controls, how you present the
information to the FSA will be determinative.
Information should be presented in the proper context, with full
details of all steps taken to mitigate any
risks. Where problems have been discovered as
part of the review required by the FSA, full details should be
given of any remedial action taken, including any steps taken to
avoid financial loss to customers.
For further information, or to discuss how we could
help you, please contact Charlotte Hill at [email protected]