For at least the past decade, within a market where a Fund’s NAV activities are predominantly outsourced, the importance of a robust fund oversight process has been well recognised. Events of the past 18 months and associated market volatility have seen Operational Resilience become an industry buzzword and have shone an even brighter light on oversight processes. Ally this with the increasing complexity associated with a broader investment profile and emerging global regulatory scrutiny and it is easy to see why NAV Oversight and Contingent NAV processes are becoming such a hot topic amongst Australian Asset Owners and Asset Managers alike.
A Renewed Focus on Operational Resilience
Much has been said about the impact of COVID-19 on day-to-day operations over the past 18 months. For the most part, the investment industry has handled the uncertainty and volatility well from an operational perspective. Nevertheless, if there is one thing we should take away from the pandemic it is that anything can happen. As we come out the other side of these seismic events, we are seeing a renewed, more intense focus on operational resilience, with a keen eye on ensuring that processes are less manual and reliant on tactical tools, not prone to key person dependencies, and that appropriate robust contingencies are in place.
The most visible component of a Fund’s daily, or weekly, processes are the Unit Prices or in some instances in the Superannuation segment, a Crediting Rate, that is released to members and investors alike. It is also an area where small incremental errors or omissions can have large repercussions. As such, the focus is turning to the resilience, or appropriateness, of current NAV Oversight arrangements, and ensuring the continued provision of a Funds NAV under various “what if” scenarios has become a real concern.
Global Regulatory Scrutiny
Globally, regulatory pressure for NAV Oversight has been evident for quite some time. Regulators in the US, Canada, and across Europe have made it clear, outsourcing fund accounting and associated activities such as Unit Pricing, does not absolve funds of their fiduciary duty to distribute timely and accurate NAV and Unit Prices. In addition to the mechanics of day-to-day operations, there has been a rising tide of expectations relating to thoroughness and transparency with which such outsourced functions are monitored and supervised. Demand is rising for greater visibility and focus on the need for Fund boards to demonstrate active oversight and commitment to fund investors and members’ interests.
A clear example was provided by the UK’s Financial Conduct Authority (FCA) in their 2017 review of outsourced practices which highlighted instances where funds had as little as 30 minutes to check the NAV’s provided by their service provider ahead of releasing prices to the market, with many essential checks not being carried out due to time constraints. While their comments that “In the absence of adequate oversight, valuations errors could occur and investors in the fund could miss out on returns they should have received” were Asset Manager focussed the sentiment for Asset Owners and their members remain valid. The risk inherent in such tight windows and manual processes is evident. Further still in an industry with portability and choice, where members can transact or rollover their superannuation accounts on a more frequent basis, is there a reliance on the valuation to be timely and correct.
Closer to home, while regulators have yet to be prescriptive on Oversight, the guidance on outsourcing is clear: while a process may be outsourced, the risks and responsibility for the business activity are borne by the RSE.
In addition, Superannuation Funds are actively considering the impact of the Financial Accountability Regime (FAR) which has shone a light on individual executive accountability. For leaders who become ‘Accountable Persons’ under the extended regime, the importance of good governance and record keeping will only increase. A large part of this consideration is focussing on those outsourced relationships that often represent and provide for a significant portion of a Fund’s operations. FAR spells out that obligations include taking “reasonable steps to prevent matters arising that would negatively impact the organisation’s 'prudential standing' or ‘prudential reputation”. As such, Superannuation funds will need to test whether they currently have a sufficient and robust oversight program in place, as well as full transparency of outsourced activities.
Furthermore, APRA have recently released an insights article titled: 'Improving cyber resilience: the role that boards have to play' which highlights the fact that cyber attackers are increasingly targeting financial organisations’ suppliers or service providers to find that weak link into the organisation. APRA encourages boards to play a more active role in challenging management’s assumptions regarding the effectiveness of service provider information security controls by asking questions such as “What controls are in place to protect our business and minimise customer impact when the information security of one (or more) of our suppliers is compromised?”. There can be no doubt that having an independent NAV Oversight process allied with Contingent NAV arrangements will go a long way towards answering this question.
The Modern Investment Landscape
A combination of the growth in fund size, the trend towards the insourcing of investment management, today’s low-interest-rate environment, and heightened awareness and comparability of fund returns have pushed many Superannuation funds towards more complex assets. Recent years have seen increased investment in unlisted assets and for many, this has stretched to global alternative assets. These investments are typically complex, often have limitations in terms of availability of frequent and accurate valuation information, and can be difficult to manage on legacy platforms that often only cater for listed assets well, all of which adds risk to the total NAV calculation process. As funds continue to seek exposure to alternative asset classes, so too does the need to develop better methodologies and processes to ensure that they are dealing appropriately with the inherent risk of these investments and how the valuations are derived, recorded, and utilised within a NAV which is used to strike a unit price. Having an automated oversight process that provides for data that is often independent of the Fund’s custodian is a crucial part of mitigating the risk associated with investment complexity. For example, Investment teams that invest in these assets are closest to their valuations, and being able to incorporate that perspective into a real-time NAV review is key.
In addition to the challenges that present themselves with alternative assets, firms also have to free up personnel to manage these activities, giving rise to an increased focus on the replacement of resource-heavy tactical solutions with more contemporary, efficient, and standardised NAV oversight and unit pricing solutions. Automating the oversight process can in fact free up key staff to focus on value-add activities thus further improving and mitigating the risk of holding these complex alternative investments.
An Evolving Oversight Approach
Taking the above considerations together, it is clear to see why NAV oversight has evolved into a critical daily function for Superannuation funds and Asset Managers alike. However, for many, oversight resources are stretched thin and there simply is not enough time in the short window before NAVs and Unit Prices are distributed to perform a complete set of checks across the fund’s hierarchy both “top-down” and “bottom-up” to ensure their accuracy.
Furthermore, the oversight process often relies heavily on user tools and manual processes that, while they may have served funds well in the past, are prone to user error or discontinuity, which increases the chances that at some point NAV errors are going to go undetected. Additionally, the use of such tools makes it exceptionally difficult to maintain the kind of audit records required to facilitate the generation of a “contingent NAV” in the case of a service provider outage or other such risk event, such as experienced during the pandemic when a number of offshore centres went offline due to unforeseen illness and lockdowns.
This is why oversight technology is critical, as we have discovered over the past 5 years and learned from the Asset Management perspective. The industry challenge can be solved in a cost-effective and digitalised way, where Oversight is recognised as a key production process and is automated and enhanced. This is not about replicating what the administrator is doing for a fund – this is about being able to independently value and assemble an expected NAV in real-time, ready to be used for oversight or to shift into a Back-Up NAV when required.
About Milestone Group
At Milestone Group we have the global perspective, local market engagement, and business mandate to work with the investment industry on exactly this type of issue. Since 2011, our pControl™ Oversight Solution has been strengthening oversight functions of leading funds globally. Since 2015 we have innovated and developed a powerful backup NAV capability, enabling organisations to both demonstrate and put in place an effective contingency plan to deal with the possibility of a limited or sustained service provider outage. Our pControl™ Backup NAV is fully integrated with the automated pControl™ Oversight capability leading to an accurate, high confidence, and low-cost solution for outsourced functions.
For more information:
- Visit us at milestonegroup.com/solutions/oversight
- Access the Factsheet | pControl™ Oversight and Backup NAV Solution
- Contact us to discuss your requirements in more detail