What are the latest issues affecting fund managers?
One area topping the agenda at the moment is how the industry deals with oversight of outsourced functions. As the model for outsourced fund accounting matures, it has become clear that success depends on having an effective mechanism to ensure outsourced functions are properly monitored. At Milestone Group, we have been tackling the issue for some time, but now increasing awareness and regulatory scrutiny are bringing it to the fore.
Outsourcing is nothing new, so why is this a particular issue now?
The concept of outsourcing certain aspects of fund accounting has been around for some time, but the concept of ‘oversight’ has only really been on the agenda as outsourcing models have matured, particularly in more recent years.
Forward-thinking fund managers, asset owners and trustees have largely led the way in strengthening their processes and controls, but it is still fairly early days in fully recognising the discipline. The reason it is now a wider issue and becoming a concern for many more firms is that regulation appears to be catching up on this issue.
In November 2013, the UK Financial Conduct Authority (FCA) released its thematic review into asset management, which homed in on oversight risk: the impact of errors in valuation and pricing of funds both on individual investors and on the industry as a whole.
What was wrong with the old model of working and how is it changing?
A model in which service providers have taken on responsibility for delivering critical and complex functions, but in reality have been expected to bear sole responsibility for quality, is not fit for purpose in today’s complex world.
As a result, a new best practice is emerging. This involves fund managers participating directly in the control framework, providing an effective oversight function that offers a second layer of protection to themselves, and their relevant stakeholders and clients.
What challenges do fund managers and service providers need to address?
The challenge is to secure the right level of oversight. The FCA thematic review highlighted that fund managers are expected to have qualified people in place who understand how instruments are valued. These people should also be able to challenge the data coming back from service providers.
Having the right people in place is one dimension, but it’s still an operational challenge. For one thing, firms often engage more than one service provider. With different outsourcing arrangements in place, there will also be different practices, different data sets and different operational procedures to oversee.
Then there are the timeframes involved. If inaccuracies and errors in the net asset value (NAV) calculation are not caught in time, the resulting costs can spiral rapidly. So the pressure is on to review, validate and react to any anomalies within a very short timeframe.
There is a careful balance to be struck. Too little oversight potentially exposes asset managers to significant reputational damage, funds outflows and potential fines. At the other end of the spectrum, ‘shadowing’ or duplicating outsourced functions is inefficient and so dilutes or negates the benefits from the outsourcing business case.
How have your clients been responding to the challenges?
The basic trick is to treat fund oversight as a core business process, subject to the same operational control principles as any other critical function. This includes automating the process to eliminate undue administrative burdens. Our clients are finding that the best way to achieve this is to give the individuals charged with oversight the right tools in the form of modern and sophisticated fund oversight technology.
The system needs to be able to independently verify the ‘actual’ NAV and unit price values provided by the outsourced partner, and compare them to an independently predicted or ‘expected’ NAV or unit price. A sophisticated benchmarking capability to allow for comparison against multiple indices for accurate analysis of mixed portfolios and complex products is also essential.
Critically, the system also requires robust data management capabilities that support collecting and combining multiple service providers and data streams, with the ability to recognise, validate, and present the relevant fund valuation data, while monitoring service-level agreement performance and outlier exceptions.
How has this recent trend affected your business?
Helping firms manage oversight has been a big focus for us since 2012, and our oversight solution has contributed to our strong growth over the last two years.
We’re seeing interest continuing to expand, particularly as regulatory scrutiny into fund administration practices accelerates awareness of this critical function, and shows no sign of waning. The FCA in the UK has already declared its intentions and we see regulators in other jurisdictions globally moving down the same path.
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