In a rare intervention, France’s financial regulator has forced H2O Asset Management to suspend a series of its funds because of their exposure to illiquid debt.
The move by the AMF late last week came more than a year after the Financial Times first revealed that London-based H2O, which for years posted some of the most consistently high returns in European fund management, had substantial investments in hard-to-sell assets, with uncertainties over their valuations.
The AMF has never taken such draconian action against a fund manager the size of H2O, which managed nearly €22bn of assets at the end of June. Below the FT examines how the saga reached this point.
What are H2O’s illiquid investments?
H2O’s investments in private debt and unlisted shares are all linked to one man: Lars Windhorst.
The German financier, who is an investor in Hertha Berlin football club, owns a network of mostly private companies backed by thinly traded bonds. But some institutional investors have blanched at the 43-year-old’s turbulent history.
Last year, the FT reported that H2O had no such qualms, however, revealing that the asset manager owned well over €1bn of hard-to-sell bonds linked to the entrepreneur. They were held across funds that allowed retail investors to withdraw their money daily.
Despite the furore, H2O’s chief executive Bruno Crastes stuck by Mr Windhorst, describing him as “very talented”.
Why has the regulator stepped in now?
While H2O weathered last year’s storm, the asset manager has come under renewed pressure after several of its flagship funds lost more than 50 per cent of their value during the March turmoil triggered by the pandemic.
The losses were not related to its investments in private debt, but the collapse in the value of its funds made it harder for the asset manager to comply with EU rules governing open-ended funds, which place a 10 per cent cap on illiquid assets.
To solve this issue, H2O struck a deal with Mr Windhorst at the end of April to buy back his businesses’ illiquid stocks and bonds. Yet months later the deal remains incomplete. H2O said the AMF’s intervention was “motivated by valuation uncertainties” around these investments.
The fund manager marked down the value of these bonds severely last year, and KPMG, the auditor of several H2O funds, subsequently flagged the “uncertainty” around these “valuation methods”.
While the French regulator supervises many of H2O’s funds, given the asset manager is based in London, the group falls under the purview of the British markets watchdog. The Financial Conduct Authority told the FT that it had been “working closely” with the AMF and other overseas regulators, and remained “in regular discussions” with H2O.
What is the status of Windhorst’s buyback?
The agreement looked like it could end the questions over the illiquid investments that have dogged H2O. Yet last week the asset manager described progress on the deal as “very partial”.
One reason for this is the sheer scale of the transactions required. A new investment vehicle set up by Mr Windhorst will purchase about €2bn of securities for about €1bn, according to people familiar with the deal.
“You can’t settle over €2bn of bonds in one week,” one person involved in the buyback told the FT.
The financier is also relying on others to help fund the buyback. The new vehicle investment vehicle — Evergreen Funding — is backed with a €1.25bn bond that carries a hefty 12.5 per cent annual interest rate. Mr Windhorst has tapped his sprawling network of contacts and business associates to drum up funds.
They include Ulrich Marseille, a German entrepreneur and former business partner of US president Donald Trump, according to people familiar with the matter. Mr Marseille did not respond to a request for comment.
Mr Marseille is also a former legal adversary of Mr Windhorst, having pursued the then young entrepreneur through the courts for the best part of a decade over repayment of a loan in the 2000s.
Has H2O ‘gated’ its funds?
Mr Crastes vowed last year that he would “never gate” the firm’s funds, drawing a sharp contrast with other asset managers exposed to illiquid assets, such as the UK’s Woodford Investment Management or Switzerland’s GAM.
Last week, the French regulator asked H2O to “suspend all subscriptions and redemptions” on three of its funds. H2O decided to freeze withdrawals on four additional open-ended funds, saying it was in the “best interests” of their investors.
The AMF has only used these powers once before. In contrast, that 2014 case concerned a small asset management company, where the funds were all owned by members of a single family.
However, H2O has said that, technically speaking, it has not gated its funds.
“H2O has taken the approach of using a sidepocket, which is an entirely different tool to gating under the French framework for liquidity risk management,” the asset manager told the FT.
Under French law, gating refers to a specific mechanism used to manage a rush of redemption requests. Instead, H2O has temporarily halted its funds, while it creates new vehicles to hold the private bonds, a process it says should take about four weeks.
While investors cannot access their money for at least a month, in legal terms H2O has not gated these funds.
What does the regulator’s intervention mean for Natixis?
The AMF’s move comes at a turbulent time for Natixis, H2O’s parent company, which last month replaced its chief executive after a two-year term marked by doubts over the bank’s business model and risk management.
H2O was previously the star performer in Natixis’ stable of asset management affiliates, which have their own independent management and risk control processes.
Jean Raby, the head of asset management at Natixis, vouched for the quality of the Windhorst-linked bonds last year, assuring investors that they were “quite diversified”. And while Natixis launched an internal audit into the matter, it has refused to make its findings public.
The bank has said it supported the actions taken by H2O over its funds, while stating that the regulator’s action had “no financial impact on Natixis”.
Not everyone agrees. Matthew Clark, an equity analyst at Mediobanca, said: “I do not share their confidence.”
He estimated that H2O contributed about a fifth of the group’s underlying earnings and argued that the latest troubles could have a reputational impact on Natixis’ broader asset management business.
However, other analysts, including at Jefferies and UBS, have maintained “buy” ratings on Natixis shares, believing that if H2O successfully separates its illiquid investments into new funds, it could be positive for the French lender.