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Articles and opinion

In an article first published by Financial Regulation International, Rosalyn Breedy argues that the regulatory system cannot work by relying on the regulator to monitor and oversee every authorised fund in the UK. The UK investment industry was estimated at £9.1 trillion in 2018. What is required now is a wholesale review of whether the current regulatory regime and government approach is fit for purpose for the next decade and beyond. 

Regulatory overview

The UK Financial Services regulatory framework for investment funds is divided into two. First, there is an authorised funds regime whereby the authorised fund must be established in the UK and take one of three legal forms: authorised contractual scheme, authorised unit trust and investment company with variable capital.

The authorised fund must be classified based on a marketing strategy, as one of the following:

  • An undertaking for collective investment in transferable securities scheme (UCITS);
  • A non-UCITS retail scheme (NURS); or
  • A qualified investor scheme (QIS).

In order to have a fund authorised, customers need to complete a detailed application form, pay a fee and provide supporting documents.

For a fund of alternative investments, that is, a NURS or its sub-fund, details of the due diligence process are required, including written procedures, resources delegated functions, confirmation that the depositary is satisfied with the process, and any detailed due diligence undertaken in respect of target schemes.

The authorised funds regime, which is prescriptive in nature, derives in the main from the EU UCITS regime and works by setting rules for the fund to comply with and by authorising the fund key participants, investment manager, depositary (holder of the assets) and the trustee or authorised corporate director, who are themselves subject to prudential capital requirements, to comply with business conduct rules including reporting any breaches.

Once the fund is authorised it is the responsibility of the authorised fund participants to ensure compliance with the regulatory rules, and the auditors to report to investors on fund controls and accounting.

The second regime is for alternative investment funds and that relies on the UK implementation of the EU Alternative Investment Fund Manager’s regime, which relies on the authorisation of the alternative investment fund participants, the alternative investment fund manager and depositary. However, the alternative investment funds themselves are not authorised. Instead, a lower level of investor protection is delivered by a process of information disclosure, reporting on risk, and restrictions on marketing to professional investors or investors by virtue of wealth or sophistication, who fall within certain exemptions of the UK Financial Services and Markets regime.

Finally, the product governance rules under the Markets in Financial Instruments Directive II (MiFID II), in addition to guidelines issued by the European Securities and Markets Authority (ESMA) from 3 January 2018, require manufacturers and distributors of financial products and services to put in place robust processes for the design of financial products and services, the identification of target investors and the ongoing monitoring of financial distribution. MiFID II also introduced new product intervention powers for national competent authorities such as the Financial Conduct Authority (FCA), ESMA and the European Banking Authority (EBA).

The FCA plays one role alongside the managers, depositaries, trustees, auditors and (where funds are either recognised or permitted via a passport) other regulators.


Neil Woodford built one of the strongest investment performance records in the UK working for Perpetual (which was later taken over by US firm Invesco, one of the world’s largest money managers, in 2000).

Savers who invested £1,000 with him in 1988 saw £25,000 growth in their pots over 25 years. Woodford was also a regular in the personal finance pages and was awarded a CBE.

Invesco recognised that Perpetual wanted to grow other products, but it has been reported that Woodford’s bonuses were skewed into attracting investment into his fund and that, of course, was driven by the fund’s performance.

Around 2010, Woodford started to invest in small private companies which potentially offered a pathway to exponential growth at a much greater level (and a different type) of risk than Woodford, who had built his track record by taking conviction positions on very large companies, was used to managing.

His $252 million investment in US biomass company Xyleco was for less than 7%, which valued the company at more than $352 billion. The company’s board included former US secretary of state George Schulz and former energy secretary Steven Chu. However, the company only held a collection of scientific patents, which concerned Invesco, and it is has been reported that Invesco then formed an internal risk committee to review private company investments.

Between 2008 and 2012, the FCA noticed that three Invesco funds (two of which were managed by Woodford) had taken on excessive risk and too much debt, resulting in losses of £5 million for clients. The FCA conducted a regulatory investigation resulting in a fine of £18.6 million for failings in fund management. It found that Invesco Perpetual had not complied with investment limits which were designed to protect consumers by limiting their exposure to risk. In addition, the firm did not clearly inform investors or explain the associated risks of its use of derivatives which introduced leverage into the funds, although the firm was allowed to use derivatives in this way. The extent of the losses was £5 million, and prompt compensation was paid to investors. 

Woodford felt constrained by Invesco and left to start his own management firm, Woodford Investment Management and Equity Income Fund, with Craig Newman, head of retail funds, who had marketed Woodford’s funds. They were joined by Nick Hamilton, formerly head of global equity product at Invesco, and Gray Smith, a former Mishcon De Reya lawyer who advised on the FCA investigation.

Woodford was authorised by the FCA, as no evidence had been found as part of its investigation into the Invesco fund rule breaches sanctions against individuals. A number of large clients, including Kent County Council, followed Woodford as well as investors from intermediaries such as St James Place and Hargreaves Lansdown.

Some investors went directly into the fund and others into managed accounts.

In 2014, Woodford had £5 billion under management. In its first year, Equity Income Fund returned 20%. It was reported that Hargreaves Lansdown struck a deal whereby it agreed to promote Equity Income fund as a “best buy” in return for discounted fees.

In 2015, Woodford started Patient Capital to back small companies with exponential growth. It attracted £800 million at launch.

However, in 2017 fund performance started to decline, and the funds were hit by a series of investment mark downs.

The institutional clients started to withdraw their investments and to meet redemptions Woodford had to sell the fund stakes in the more liquid larger investments. This meant that Equity Investment Fund was soon breaching its regulatory defi ned limit of having no more than 10% of the fund’s asset in unquoted companies. It was at this point the FCA asked the fi rm’s administrator to provide a monthly update on liquidity. This would have been the correct time for the FCA to have taken this action.

Woodford then listed some of the fund’s private company stakes on the Guernsey Stock Exchange to meet the liquidity requirement. This is a recognised stock exchange for FCA purposes but small, so would have a lower rate of transactions and liquidity. This meant that the stakes were quoted for the purpose of FCA rules which would mean that the 10% unquoted limit would not be breached.

While this is permitted by the rules it didn’t address the core issue of lack of liquidity in the face of the number of redemptions.

In May 2019, Kent County Council tried to redeem its £263 million investment (then 7% of the Equity Income Fund) and there was not suffi cient cash for this leading to the indefinite suspension of the fund.

The issues

Fund and product governance

The problem was that the investment strategy came under stress when the institutional investors left as this forced Woodford to sell the liquid stakes.

In the author’s view, the question is not so much, “was the FCA asleep at the wheel?“ but “shouldn’t the rules have required Woodford to stop all redemptions much earlier at the first significant request for investor redemptions?”. That would have enabled an orderly and potentially longer-term wind-down and it may have been better for investors to have received more capital albeit later. A secondary market could have been put in place for investors who required immediate liquidity.

Also, would this have happened if the governance rules introduced in 2019 requiring fund management board to appoint at least two independent directors had been introduced earlier?

Similarly, had the MiFID II product governance requirements been introduced prior to January 2018, would all these retail investors be invested in funds which do not meet their liquidity requirements?

Is there a need for a more prescribed product offering?

The bigger issue is that the UK regulatory regime still allows for a great deal of autonomy and relies on “buyer beware” in the delivery of financial services which, while good for creativity and choice may not be adequate in 2020 and beyond.

It is not the approach taken by regulatory regimes, such as Singapore Monetary Authority, where (contrary to popular belief) fund structures and rules are more prescriptive.

Should retail investment funds be regulated like medicines whereby outcomes and side effects are clearly labelled?

While there has been a rise in the ratings of funds on social media. This is no method of protecting investors as positive rankings can be manipulated.

Relying on other participants, such as fund platforms, to mediate investor access can be problematic where platforms are not regulated to provide investment advice. Very few investors can tell the difference between a “best buy” and an investment recommendation.

Is there a need for financial education for all?

There are 51 million adults in the UK, of which six million receive financial advice. 

There are 10.6 million people aged between 50 and 65 who have not retired yet and, of these, two-thirds have

not saved enough for retirement. Median pension pots for defi ned contribution schemes are £14,000 and £17,000, albeit there are multiple pots. 

According to the OECD/INFE International Survey of Adult Financial Literacy Competencies(2), the UK is 15th in the ranking against the 29 other countries that took part in the survey, just above Thailand and Albania, below the average for OECD countries, and well below France, Norway and Austria.

The industry has found it difficult to provide advice cheaply, so maybe the question should be changed to “shouldn’t a government that requires individuals to take responsibility for their retirement, also provide that they are educated to be financially literate?”.

There is clearly a need for a review to be undertaken to accommodate consumer needs, the roles of online information, intermediaries, rules and regulator.



  1. Background information is mostly sourced from Walker, O and Smith, P, “Neil Woodford: the inside story of his rise and dramatic fall”, Financial Times, 18 October 2019, https://www.ft.com/content/2f077ae2-f19e-11e9-bfa4-b25f11f42901.
  2. https://www.oecd.org/finance/oecd-infe-survey-adult-financial-literacy-competencies.htm.


The article can also be read on the Financial Regulation International website, by clicking here.