The European Securities and Markets Authority said that investment funds should make use of side pockets to solve problems with liquidity and protect their investors from the effects of the war in Ukraine.
The accounting technique would protect investors from distressed securities linked to Russia whether they want to redeem their shares or stay invested in the fund, the EU body said in a statement.
Side pockets allow fund managers to structure their fund's investments to separate Russian, Ukrainian and Belorussian investments from the rest of their portfolio if they cannot be sold outright. The technique would also prevent funds from suspending all stock subscriptions and redemptions out of necessity and protect other investors from the risk that affected assets would hit the value of the overall fund, the regulator said.
The agency said the practice would make the rest of the fund's assets easy to convert into cash and allow investors to sell their shares at little cost, while protecting other investors because the fund would not be forced to sell their assets at or below market price.
The technique also would prevent new investors from buying shares in the illiquid assets at very low prices, which would have allowed them to take part of any future profits from investors who stay in the fund.
But ESMA noted that simply writing off the assets might be a better solution than side pockets. Some assets might not become liquid or more valuable in the future, making it a waste of money to have created the side pocket. The technique is also a problem for some fund distribution platforms, ESMA said.
Funds should still consider suspended subscription or redemption of shares if they encounter problems with liquidity and not follow a "one-size-fits-all approach" by writing down all illiquid assets as zero-value, the regulator said.
Funds could also consider liquidating or writing off all of their assets if they cannot trade because of the Russian invasion of Ukraine, the regulator said.
In the U.K., the Financial Conduct Authority has called for funds to weigh in on proposals in April that would allow funds affected by the invasion to use side pockets, eliminating the risk of breaking sanctions for investors.
The proposals were raised in March after Western governments hit Russia and Belarus with a wave of sanctions for the invasion of Ukraine. Belarus was targeted as it is a close ally of President Vladimir Putin's government.
--Additional reporting by Najiyya Budaly. Editing by Ed Harris.
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