Adopting NAV Oversight and Resiliency Practices Helps Drive Significant Benefits
Adopting NAV Oversight and Resiliency Practices Helps Drive Significant Benefits
November 2023
Two leaders in the financial services industry — Christine Waldron, Global Head of Fund Services at BNY Mellon and Marian Azer, Global Head of Product, Milestone Group — sit down to share their views on trends in the industry and discuss how Net Asset Value (NAV) oversight and operational resilience are evolving as core elements of industry infrastructure.
Q: Over the past several years, the role and expectations of oversight as a key control function to monitor and ensure the availability and accuracy of NAVs released to the market has gained significant attention. What is driving this need for NAV oversight and resilience?
Waldron: As outsourcing has increased in the investment management industry, regulators around the globe continue to promote the requirement for asset managers to take ownership of NAV accuracy via effective oversight of service providers. The relationships between asset managers and their service providers can be complex and regulators are reinforcing the need for oversight of their outsourced fund operations, such as accounting and administration. In addition, regulators have extended their thinking on operational resilience and have now applied that principle to outsourced arrangements and the need for contingency plans in the event of a service provider outage.
For example, in the United Kingdom, the Financial Conduct Authority1, and in the United States, the Securities and Exchange Commission2 recently proposed oversight requirements for certain outsourced services. Both regulators have reinforced the need to have sound business continuity plans in place and they’ve emphasized that firms should have appropriate oversight for their outsourced fund operations. We’ve even seen fines issued for lack of oversight in certain jurisdictions.
Azer: I think there has been a realization that the industry can further industrialize the NAV process to match the regulatory attention and trustee expectations that have evolved with market developments. The pressure for asset managers to ensure accurate NAVs through effective and timely oversight reflects the fact that they have always had the primary responsibility for NAV accuracy and that they should be working closely with their third-party providers to this end.
Similarly, there has been a heightened awareness to new risks that could lead to service disruptions, such as the emergence of cyberattacks, which have different characteristics than the previously considered threats. The focus used to be on power failures, natural disasters or acts of terrorism and the like. As a result of these new threats, asset managers and asset owners are examining back-up arrangements across their supply chains in the event of a disruption or outage of business-critical functions such as NAV production. The approach to a potential disruption has evolved from examining suppliers’ business continuity arrangements, to having their own reliable back-up NAV to ensure operational continuity if and when these challenging circumstances arise.
Q. What benefits can clients gain from adopting modern NAV oversight and resilience practices?
Azer: In just a few words, a more comprehensive, timely risk management capability to protect their firm and their investors, with greater efficiency, transparency and auditability. A modern oversight approach means having reliable and repeatable processes for detecting a wider range of anomalies and accelerating the remediation of exceptions, ideally before NAV release. With an effective back-up NAV, this heightened level of resilience can help avoid business disruption in the event of a service provider outage.
The approach is also strengthening relationships between asset managers and their fund accounting agents as they are more visibly aligned in preventing and detecting NAV errors. Asset managers and asset owners are generally embracing the opportunity to demonstrate a more robust oversight process and the ability to collaborate with suppliers to remediate issues more quickly, generating increased confidence across the full spectrum of stakeholders.
Waldron: Regardless of whether you’re performing fund accounting in house or through a third-party administrator, the bottom line is that you can’t delegate the responsibility for NAV accuracy, timeliness, or resiliency. Service providers are contracted to deliver precise and timely NAVs to the investment industry, but firms need to actively monitor outcomes and look to ensure adequate levels of investor protection and equity and client service via an effective oversight process. As noted, commitment to effective oversight can also foster a tighter and more collaborative relationship with service providers.
One of the benefits of an effective NAV oversight function is that it provides not only the details of any anomaly that needs to be investigated, but also the related contextual data and full history of actions that allow asset managers and their service providers to address issues quickly. The approach leads to better communication all around — from asset managers to clients, as well as between asset managers and their service providers.
Q. Okay, then what’s the foundation for an effective and robust NAV oversight and backup NAV solution? How does this happen?
Waldron: It’s all about independence of the oversight process and insulation of the backup NAV from the primary NAV production process. It is imperative that a NAV error can be detected and remediated prior to NAV release, and that a backup NAV can be issued to the market during an outage of a primary NAV production process or provider. The back-up NAV therefore should be an independent calculation sufficiently isolated from the processes and infrastructure used to determine and disseminate the primary NAV. This ensures that if a service provider goes down —due to power failures, political unrest, terrorist or cyberattacks or any of the other factors we mentioned previously — the NAV can still be released so that asset managers can meet their obligations to investors and regulators.
Azer: It’s also about efficient technology to underpin that independence. The need for a back-up NAV is only one side of the coin. The independent verification of daily NAVs and portfolio valuations across providers is the other. Today’s explosion of data and the market’s volatility are increasing pricing exceptions and instances of fair valuing, so an independent verification of NAV calculations reduces risk. Whether it be through software or a service offering, the best practice approach is based on independent, evidence-based, repeatable workflows that demonstrate oversight for outsourced fund operations. It’s important to have a separate, independent verification of daily NAVs and portfolio valuations across providers.
Waldron: That’s a great point, despite best efforts, errors in NAV calculations can occur. Even if NAV calculations are correct 99.9% of the time, a 0.1% error rate can cause considerable headaches. Asset managers and fund valuation committees would do best to work closely with their service providers to determine both their tolerances and when exceptions requiring further review should be generated. With volatile market conditions, the number of exceptions requiring further review can increase, which makes the robust oversight and automated exception handling even more important to help ensure NAV accuracy.
Q. What should clients consider to help attain NAV resiliency and effective oversight?
Azer: Asset managers could consider several questions when thinking about NAV oversight and resiliency to help ensure that fund NAVs are available to the industry even if the primary calculation approach fails, including:
- Does your oversight function support NAV error detection and same day remediation prior to release to the street?
- Does it use an independent methodology to compute an accurate NAV without replicating fund accounting?
- Does it support automated comparison analysis with primary NAV pack to ensure timely detection of NAV anomalies?
- Does the back-up NAV utilize data sources and infrastructure sufficiently independent from those used to produce the primary NAV?
Q. What key principles should be considered regardless of the approach a client takes?
Waldron: To summarize, the principles that we believe should be considered include:
- Independence: The controls and operational processes should be fully independent of fund accounting agent staff, data and infrastructure.
- Efficiency: A high degree of automation is implicit in an effective oversight solution and even more important for a backup NAV solution. This will help establish efficient, timely and repeatable processes that are evidence based.
- Transparency: Across one or more fund accounting agents - the ability to provide a standardized process and assembly of data enabling audit and regulator inspection of full audit trails of validations and controls performed, analyses and investigations made, and exceptions flagged and resolved.
- Accuracy and Timeliness: Ensuring that a solution can meet the prescribed accuracy and timeliness requirements for NAVs is fundamental to the selection of a modern oversight and backup NAV solution.
- Granularity: A detailed approach for the process including bottom-up checks and granular data is required to identify and remediate anomalies under daily time pressures.
These straightforward principles have proven remarkably valuable in informing debate and design of effective oversight and backup NAV solutions that seek to reassure fund boards, risk committees, regulators, and investors, while helping to drive all the previously mentioned benefits — greater transparency, efficiency, timeliness and risk management.
Q. What do you see on the horizon for NAV oversight and resiliency?
Waldron: With that sustained focus, it is likely that firms will look to solution providers who can supply them with open, flexible digital solutions, whether that be software or a service offering, that can help solve the problems associated with the rising complexity and volume of data that must be digested to accurately perform oversight and protect them from potential reputational risk, loss of competitiveness and financial loss.
Azer: As the outsourcing trend and market volatility and uncertainty continue, we can expect there to be increased focus on automation of oversight and operational resilience, more generally so that asset managers are well-positioned to continue their operations through any future operational challenges, with an eye on cyber risk, in particular. We are also seeing increased focus on intelligent analysis and prediction of anomalies, as well as exceptions being auto cleared using intelligent technologies.
- "Operational Resilience," FCA.org.uk, Financial Conduct Authority, March 3, 2024, https://www.fca.org.uk/firms/operational-resilience
- "Press Release: SEC Proposes New Oversight Requirements for Certain Services Outsourced by Investment Advisers," SEC.gov, U.S. Securities and Exchange Commission, Oct. 26, 2022, https://www.sec.gov/news/press-release/2022-194