H2O and the saga of its illiquid bonds

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In a uncommon intervention, France’s monetary regulator has pressured H2O Asset Administration to droop a collection of its funds due to their publicity to illiquid debt.

The transfer by the AMF late final week got here greater than a 12 months after the Monetary Instances first revealed that London-based H2O, which for years posted a few of the most persistently excessive returns in European fund administration, had substantial investments in hard-to-sell belongings, with uncertainties over their valuations.

The AMF has by no means taken such draconian motion in opposition to a fund supervisor the dimensions of H2O, which managed almost €22bn of belongings on the finish of June. Beneath the FT examines how the saga reached this level.

What are H2O’s illiquid investments?

H2O’s investments in non-public debt and unlisted shares are all linked to at least one man: Lars Windhorst.

The German financier, who’s an investor in Hertha Berlin soccer membership, owns a community of principally non-public corporations backed by thinly traded bonds. However some institutional traders have blanched on the 43-year-old’s turbulent historical past.

Final 12 months, the FT reported that H2O had no such qualms, nevertheless, revealing that the asset supervisor owned effectively over €1bn of hard-to-sell bonds linked to the entrepreneur. They have been held throughout funds that allowed retail traders to withdraw their cash every day.

Regardless of the furore, H2O’s chief govt Bruno Crastes caught by Mr Windhorst, describing him as “very proficient”.

Why has the regulator stepped in now?

Whereas H2O weathered final 12 months’s storm, the asset supervisor has come underneath renewed stress after a number of of its flagship funds misplaced greater than 50 per cent of their worth in the course of the March turmoil triggered by the pandemic.

The losses weren’t associated to its investments in non-public debt, however the collapse within the worth of its funds made it more durable for the asset supervisor to adjust to EU guidelines governing open-ended funds, which place a 10 per cent cap on illiquid belongings.

To resolve this concern, H2O struck a take care of Mr Windhorst on the finish of April to purchase again his companies’ illiquid shares and bonds. But months later the deal stays incomplete. H2O mentioned the AMF’s intervention was “motivated by valuation uncertainties” round these investments.

The fund supervisor marked down the worth of those bonds severely final 12 months, and KPMG, the auditor of a number of H2O funds, subsequently flagged the “uncertainty” round these “valuation strategies”.

Whereas the French regulator supervises lots of H2O’s funds, given the asset supervisor is predicated in London, the group falls underneath the purview of the British markets watchdog. The Monetary Conduct Authority informed the FT that it had been “working carefully” with the AMF and different abroad regulators, and remained “in common discussions” with H2O.

What’s the standing of Windhorst’s buyback?

The settlement appeared prefer it might finish the questions over the illiquid investments which have dogged H2O. But final week the asset supervisor described progress on the deal as “very partial”.

One motive for that is the sheer scale of the transactions required. A brand new funding automobile arrange by Mr Windhorst will buy about €2bn of securities for about €1bn, based on individuals conversant in the deal.

“You may’t settle over €2bn of bonds in a single week,” one particular person concerned within the buyback informed the FT.

The financier can also be counting on others to assist fund the buyback. The brand new automobile funding automobile — Evergreen Funding — is backed with a €1.25bn bond that carries a hefty 12.5 per cent annual rate of interest. Mr Windhorst has tapped his sprawling community of contacts and enterprise associates to drum up funds.

They embrace Ulrich Marseille, a German entrepreneur and former enterprise associate of US president Donald Trump, based on individuals conversant in the matter. Mr Marseille didn’t reply to a request for remark.

Mr Marseille can also be a former authorized adversary of Mr Windhorst, having pursued the then younger entrepreneur by the courts for the most effective a part of a decade over compensation of a mortgage within the 2000s.

Has H2O ‘gated’ its funds?

Mr Crastes vowed final 12 months that he would “by no means gate” the agency’s funds, drawing a pointy distinction with different asset managers uncovered to illiquid belongings, such because the UK’s Woodford Funding Administration or Switzerland’s GAM.

Final week, the French regulator requested H2O to “droop all subscriptions and redemptions” on three of its funds. H2O determined to freeze withdrawals on 4 extra open-ended funds, saying it was within the “finest pursuits” of their traders.

The AMF has solely used these powers as soon as earlier than. In distinction, that 2014 case involved a small asset administration firm, the place the funds have been all owned by members of a single household.

Nonetheless, H2O has mentioned that, technically talking, it has not gated its funds.

“H2O has taken the method of utilizing a sidepocket, which is a completely totally different device to gating underneath the French framework for liquidity danger administration,” the asset supervisor informed the FT.

Underneath French legislation, gating refers to a particular mechanism used to handle a rush of redemption requests. As a substitute, H2O has briefly halted its funds, whereas it creates new autos to carry the non-public bonds, a course of it says ought to take about 4 weeks.

Whereas traders can’t entry their cash for not less than a month, in authorized phrases H2O has not gated these funds.

What does the regulator’s intervention imply for Natixis?

The AMF’s transfer comes at a turbulent time for Natixis, H2O’s dad or mum firm, which final month changed its chief govt after a two-year time period marked by doubts over the financial institution’s enterprise mannequin and danger administration.

H2O was beforehand the star performer in Natixis’ steady of asset administration associates, which have their very own impartial administration and danger management processes.

Jean Raby, the pinnacle of asset administration at Natixis, vouched for the standard of the Windhorst-linked bonds final 12 months, assuring traders that they have been “fairly diversified”. And whereas Natixis launched an inner audit into the matter, it has refused to make its findings public.

The financial institution has mentioned it supported the actions taken by H2O over its funds, whereas stating that the regulator’s motion had “no monetary influence on Natixis”.

Not everybody agrees. Matthew Clark, an fairness analyst at Mediobanca, mentioned: “I don’t share their confidence.”

He estimated that H2O contributed a couple of fifth of the group’s underlying earnings and argued that the newest troubles might have a reputational influence on Natixis’ broader asset administration enterprise.

Nonetheless, different analysts, together with at Jefferies and UBS, have maintained “purchase” rankings on Natixis shares, believing that if H2O efficiently separates its illiquid investments into new funds, it might be optimistic for the French lender.

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