By Allen Cohen
Outsourcing has many potential benefits – cost savings, scalability, and greater operational efficiency to name a few. But, with this outsourcing trend comes the need to support and oversee these sometimes-complex relationships.
While asset managers can outsource important aspects of their fund operations, they cannot delegate the responsibility for accuracy and resiliency. Service providers must deliver accurate and timely NAVs to the investment industry as asset managers monitor their providers and protect investors. The staff of the Securities and Exchange Commission2 in the U.S. and the Financial Conduct Authority3 in the UK have reinforced the need to have sound business continuity plans (BCPs) in place, and to consider having appropriate oversight in place regarding their outsourced fund operations. Business continuity planning is not only a regulatory issue; insufficient oversight and the lack of resiliency plans may expose funds to potential reputational risk, loss of competitiveness, and financial loss. The recent COVID-19 crisis has led to a renewed consideration of the sufficiency of such plans.
Regulators have encouraged asset managers to examine their own, as well as their critical service providers’ BCPs, assessing how natural disasters, acts of terrorism, hardware or software failures, or the unavailability of key personnel due to pandemics would impact them. Organizations with more robust planning have a greater chance to maintain operational continuity if and when these challenging circumstances arise.
Asset managers need to consider a number of questions to help ensure that fund NAVs are available to the industry even if the primary calculation approach fails. These include:
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. Despite best efforts, errors in NAV calculations can occur. Even if NAV calculations are accurate 99.9% of the time, a 0.1% error rate can cause considerable headaches. In today’s operating environment, with market volatility causing the inflow of massive amounts of data, pricing exceptions and instances of fair valuing are increasing substantially.
When market volatility and uncertainty further intensify valuation challenges, manual approaches to determining and instructing the fair market value of an investment can add significant risk and complexity. Asset managers and fund valuation committees work closely with their service providers to determine the tolerances that drive when exceptions requiring further review are generated. Validations can be set at the instrument level and can allow certain variations from day to day. Frequently, for instruments such as equities or bonds, daily variations exceeding the norm flag exceptions and require investigation. As we navigate the uncertainty of a post pandemic economy, it is highly possible that the number of exceptions requiring further review and validation will increase, making the robust oversight of day-to-day operational continuity even more important to help ensure NAV accuracy.
Our recent survey of global asset managers reveals that 88% are likely to look to outsource components of operational oversight in the next 3 to 5 years. Regardless of the approach taken to perform this oversight, there are several key principles that should be considered.
Combined in the right way, these principles demonstrate a robust framework that can provide fund boards, risk committees, regulators and investors with the comfort of knowing oversight over the NAV process is in place, while helping to drive greater transparency, efficiency and risk management for asset managers and asset owners.
As the outsourcing trend continues, and our economies re-open post COVID-19, we can expect there to be a continued focus by asset managers on oversight and operational resilience, making sure that they are well-positioned to continue their operations through any future crises.
12020 BNY Mellon survey of 200 global asset managers
2IM Guidance Update, June 2016
3Building operational resilience: impact tolerances for important business services and feedback to DP18/04, December 2019
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