The three key themes driving interest in NAV oversight and contingent arrangements
The importance of a robust fund oversight process has come into focus for at least the past decade — a time when net asset value (NAV) activities for many asset managers have moved to an outsourced model. Over this period, operational resilience has become an industry buzzword, with more attention now being devoted to oversight processes. Ally this with 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 among asset managers as well as asset owners.
A renewed focus on operational resilience
Much has been said about the impact of COVID-19 on day-to-day operations. The investment industry by and large managed the uncertainty and market volatility well from an operational perspective. Nevertheless, the pandemic underscored that an unexpected event could occur at any time. As we emerge from 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 NAVs/unit prices released to investors. It is also an area where small incremental errors or omissions can have large repercussions. As such, the focus for many institutions is turning to both the resilience or appropriateness of current NAV oversight arrangements and ensuring the continued provision of a funds NAV under various “what if” scenarios.
Global regulatory scrutiny
Globally, regulatory pressure for NAV oversight has been evident for some time. Regulators in the US, Canada, Australia and across Europe have made it clear that outsourcing fund accounting and associated activities such as the production of the NAV, does not absolve funds of their fiduciary duty to distribute timely and accurate NAVs/unit prices to their investors. 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. There is a rising demand for greater visibility and focus on the need for boards and their executive teams to demonstrate active oversight and commitment to investors.
A clear example was provided by the UK’s Financial Conduct Authority (FCA) in its 2017 review of outsourced practices which highlighted instances where funds had as little as 30 minutes to check the NAVs/unit prices provided by their service provider before market release. Many essential checks were not being carried out due to time constraints. Clearly highlighting the importance of a robust oversight process, the FCA observed, “In the absence of adequate oversight, valuations errors could occur and investors in the fund could miss out on returns they should have received.”
The Monetary Authority of Singapore (MAS) has long been proactive when it comes to operational resilience. Having first introduced business continuity guidelines in 2003, MAS continues to expand and refine its approach. In late 2022, MAS released its business continuity management guidelines which clearly articulate that organisations should have “plans in place to address any unforeseen disruption, failure or termination of third-party arrangements to minimise the impact of adverse events on the continuity of its critical business services.” MAS specifically identifies trustee services, including fund administration and valuation, as “critical business services.”
A similar intensification of focus on operational resilience can be seen in the SPM OR-2 circular from The Hong Kong Monetary Authority (HKMA), and a circular from the Securities and Futures Commission (SFC) to intermediaries. The circulars stress the establishment of comprehensive frameworks for overseeing service providers and maintaining critical business operations during market stress.
There can be no doubt that having an independent NAV oversight process, allied with contingent NAV arrangements goes a long way towards ensuring best practice and business continuity, protecting investors while also helping with concerns from regulators.
The modern investment landscape
Recently assets such as infrastructure, real estate, and private equity have moved from a niche to a core portfolio holding for funds globally. 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 — all of which adds risk to the NAV calculation process.
As funds continue to seek exposure to alternative asset classes, there is a growing need for better methodologies and processes. Having these in place ensures that funds deal appropriately with the inherent risk of these investments and how they are incorporated into the NAV. An automated oversight process that provides 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.
An evolving oversight approach
It is clear to see why NAV oversight has evolved into a critical daily function. However, oversight resources are often stretched thin for many businesses. There is not enough time in the short window before NAVs/unit prices are distributed to perform a complete set of checks across the fund’s hierarchy, both “top-down” and “bottom-up” to ensure accuracy.
Furthermore, the oversight process often relies heavily on user tools and manual processes. While they may have served funds well in the past, these processes are prone to user error or discontinuity, increasing the chance of errors going undetected. Additionally, such tools make it difficult to maintain the kind of independent process required to facilitate a “contingent NAV” in the case of a service provider outage or other such risk event.
As a result, oversight and contingent NAV technology is critical. The industry challenge can be solved in a cost-effective and digitalised way, where oversight is recognised as a key automated production process. Leveraging technology ensures that oversight processes are robust, reliable, and capable of handling potential disruptions efficiently. By integrating automated oversight processes, funds can better manage risks, improve operational efficiency and maintain operational resilience in an increasingly complex investment environment.
Please click here to know more about how Milestone Group can support your oversight operations, through its pControl™ Oversight solution.
