FCA consults on new ‘side pocket’ rules for UK investment funds

Side pockets would give authorised fund managers the option to separate investments that are subject to financial sanctions relating to Russia by the United Kingdom, other G7 countries and the European Union that are difficult to value or sell from their fund’s other core investments.

The FCA said its decision to consult on the measures was prompted by the “challenges” faced by fund managers in the context of suspensions and extensive global sanctions affecting Russian and Belarusian assets. The short consultation period closes on Monday 16 May 2022.

Side pockets could allow new investors to enter a fund without being exposed to Russian assets and enable existing investors to redeem the rest of their investment, while illiquid Russian assets remain separated. Assets held in a side pocket would be marked to zero in many cases, although existing investors would retain the rights to any eventual value.

Side pockets would give authorised fund managers the ability to separate affected investments from the fund’s other scheme property. Existing classes of shares would cease to include the value of affected investments and a new share would be created whose value would be based on the value of affected investments. The existing unitholders at the time the side pocket is created would receive units in the side pocket class. The FCA’s intention is to permit new investors to enter the fund the exposure to the affected investments; existing investors to sell the shares which relate to assets that are not affected investments; and funds potentially to be able to end their current suspension of dealing.

The regulator’s side proposals would be limited to assets that are illiquid as a result of the Russian invasion of Ukraine, and their use by authorised fund managers would be optional. Managers would be required to make sure that assets are valued fairly and accurately and that subscriptions and redemptions take place at a fair price.

Investment funds expert Elizabeth Budd of Pinsent Masons described the proposals as “quite extraordinary in the context of authorised funds”.

“The FCA’s proposed focussed use of side pockets for UK UCITS to address the impact of the Ukraine conflict on such funds is helpful in providing greater certainty, and follows on from announcements from European regulators including the CSSF in Luxembourg which will permit them subject to meeting certain criteria. The Central Bank of Ireland is currently considering the position for Ireland,” she said.

“The introduction of side pockets without amending the FCA’s COLL Rulebook would most likely be a fundamental change requiring a shareholder vote, or at the very least a 60-day advance notification. The proposals potentially permit the authorised fund manager, provided it meets certain quite detailed conditions, to treat the introduction of a side pocket as a significant change without the need to give 60 days’ notice. This would allow managers to implement relatively quickly once the regime comes in,” she said.