CMS - Focusing on Funds – Impact of Coronavirus Outbreak on Fund Managers

This Focusing on Funds briefing is to assist fund managers and investors in the wake of the disruption caused by the novel Coronavirus (Covid-19) outbreak.

In addition to observing investor transparency and regulatory requirements, fund managers will need to be reviewing the terms of their fund documents, banking arrangements and underlying asset activity to monitor risk during this period and to plan ahead.

In this briefing we consider:

• the impact on valuations;
• impact on audit reporting;
• investor transparency;
• UK Government announcements; and
• UK and EU regulatory considerations.

Impact on valuations

Valuing portfolio companies and other inherently illiquid assets, such as commercial property, is increasingly challenging given current levels of market volatility, leading some valuers to include ‘material valuation uncertainty’ statements in their reporting and advice.

Such qualified valuations may impact on a number of funds terms including redemption provisions, pricing, the calculation of management fees, distribution waterfalls and clawbacks. It is at such times that review of fund constitutional documents is very important, to ensure continuing compliance.

On 18 March, the UK Financial Conduct Authority (“FCA”) published a statement on property fund suspensions resulting from the outbreak of Covid-19 noting that it understands that certain standing independent valuers have determined that there is currently material uncertainty over the value of commercial real estate (“CRE”). In this situation, it is not possible to establish a fair and reasonable valuation of CRE funds. As a result, some managers of open-ended CRE funds have temporarily suspended dealing in units of those funds and others may follow for the same reason. Managers of open-ended funds can use suspensions in line with their obligations under applicable regulations. In these circumstances, suspension is likely to be in the best interests of fund investors.

Impact on audit reporting

We are noticing that auditors are increasingly withholding their audit opinions, citing the current uncertain economic environment and difficulties in obtaining sufficient audit evidence as reasons. In response, the Financial Reporting Council has published guidance for auditors where audit engagements are affected by Covid-19. The guidance includes (i) advising auditors to consider and seek to agree what work can be undertaken remotely, flagging areas where confirmation of certain matters is contingent on being physically present at a later stage; and (ii) auditors considering whether there are other ways for them to obtain audit evidence, including employing greater use of technology after assessing the sufficiency and appropriateness of the audit evidence produced.

Investor transparency

As the situation continues, and with the long-term impact of the outbreak still to be determined, we have noticed that investors are increasingly requesting additional information and reporting about their portfolio. Fund managers may consider being pro-active in this regard, notifying investors on the manner in which funds and portfolio assets are dealing with issues arising out of Covid-19’s impact on operations. Investors may inquire about impacts on portfolio performance, fund strategy (including the impact on pipeline deals), general banking compliance and cash-flow. Fund managers may wish to agree timings for extensions to reporting periods whilst still achieving a balance.

UK Government announcements

Numerous measures have been announced. The Bank of England’s Monetary Policy Committee voted to reduce the Bank Rate by 15 basis points to 0.1%.

The UK Government has announced a range of “unprecedented measures for, unprecedented times” to assist businesses and shore up the UK economy. These include the following (with links to the underlying sources):

• a three-month moratorium on lease forfeiture for non-payment of rents and other charges arising under commercial leases (in addition to a similar moratorium on residential leases). This applies to all commercial property, regardless of the extent to which occupiers have seen their businesses affected by the virus, until at least 30 June 2020;
• the Prudential Regulatory Authority has urged banks to treat covenant breaches arising from Covid 19-related stress differently from “borrower-specific” covenant breaches and to consider waiving them or not imposing “new charges or restrictions”;
• a new Covid-19 Corporate Financing Facility to support corporates that have been affected by a short-term funding squeeze owing to Covid-19 related disruption;
• implementation of new insolvency measures at the earliest opportunity, such measures will include a time-limited moratorium from creditor action where UK companies are undergoing a restructuring process and a temporary suspension of the wrongful trading rules to remove the threat of personal liability for UK company directors during the pandemic. It is intended that the new measures will be applied retroactively from 1 March 2020.
• for certain small businesses meeting certain criteria, the Coronavirus Business Interruption Loan Scheme will be available, delivered by the British Business Bank, enabling businesses to apply for a loan of up to £5 million, with the UK Government covering up to 80% of losses without fees and interest payments for 12 months;
• the next payment of quarterly VAT is being deferred to on or before 31 March 2021; and
• a Business Rates Retail Discount of 100% applies for 2020/21 to properties used for the majority of retail, leisure and hospitality businesses.

A relaxation of corporation tax filing deadlines has not yet been announced. Where it is not going to be possible for a business to meet its tax compliance obligations, it may consider applying for relief under the Time to Pay regime (which applies to corporation tax, VAT and PAYE).

Regulatory

Reporting: Firms may experience difficulties in submitting their regulatory data. They are still expected to demonstrate an effective level of operational resilience in their approach to dealing with difficulties during this time. Firms will still need to maintain appropriate records and submit the required data as soon as possible as submissions should not be unnecessarily delayed.

However, as well as the standard reporting, AIFMs will need to consider whether the impact of COVID-19 on the risk profile, liquidity management or investment strategy of each of their AIFs will trigger additional reporting to either the FCA or investors.

The FCA have, however, recognised the challenges that firms are facing as a result of both operational challenges and global volatility. Although the FCA expect firms to uphold the best interests of their investors, they are likely to take a less strict supervisory approach during this time to certain operational procedures, including reporting and the holding of meetings.

The FCA published a webpage on 17 March containing information for firms on the coronavirus outbreak. The FCA expects firms to provide strong support and service to customers and to manage their financial resilience and actively manage their liquidity. The FCA asks firms to report to it immediately if they believe they will be in difficulty.

SM&CR: Firms do not need to have a single senior manager responsible for their coronavirus response. They should allocate these responsibilities in the way which best enables them to manage the risks they face.

European response

The European Securities and Markets Authority (“ESMA”) published recommended actions by financial market participants in the wake of the Covid-19 outbreak. Recommendations include a specific request to asset managers to continue to apply the requirements on risk management and react accordingly. ESMA noted in its publication that it will continue to monitor developments in the market, in coordination with National Competent Authorities, and is prepared to use its powers to ensure the orderly functioning of markets, financial stability and investor protection.

Further updates

This is a fast-changing topic and we will be publishing further updates and briefings which can be found on Law-Now and on our additional dedicated Covid-19 Insight page.