Jon Trinder, senior product manager, Linedata
In 2015, a software outage at a leading global fund administrator prevented about 1,200 mutual funds and ETFs from being accurately priced for over a week during a period of exceptional market turbulence.
Such events have highlighted the legal, financial, and reputational risk faced by Asset Managers that outsource their NAV production.
As regulators increase scrutiny of operational resilience and Business Continuity Plans, the market has been flooded with vendor solutions claiming to enable Asset Managers to conduct their own Contingent NAV calculations.
Not all solutions are created equal, however, so it’s important to educate yourself in order to select the right fit for your business.
If you’ve outsourced NAV production, ask yourself the following questions:
1. Does our fund administrator regularly miss its price delivery deadline? 2. Could missed deadlines threaten our access to distribution platforms? 3. Do we need to validate our administrator’s NAV calculations? 4. Has our administrator had downtime issues that could affect our business continuity? 5. Could our administrator’s pricing errors damage our reputation or cost us money? 6. Does our Board require a robust Business Continuity Plan to ensure timely and accurate NAV production and distribution? 7. Do we need to demonstrate effective third-party oversight to regulators and auditors?
Entrusting your fund’s NAV calculation to a third party without having a suitable alternative NAV solution can expose you to several forms of risk. Compliance risk: Firms increasingly have a regulatory mandate to ensure accurate, up-to-date NAV calculation – even if they outsource NAV production to a third party.
In Europe, UCITS and AIFMD mandate that Asset Managers must implement Business Continuity Plans. They also specify that Managers cannot delegate the responsibility for releasing timely and accurate NAVs, even if they delegate actual NAV production.
In the UK, the FCA Senior Managers Regime in effect means that Senior Managers can be held personally liable for NAV calculation breaches if the FCA determines that they failed to conduct adequate due diligence or take reasonable preventative measures.
In the US, the SEC has proposed (but not yet implemented) a new rule to the US ’40 Act making it a requirement to have Business Continuity Plans in place for critical systems and service providers.
Reputational risk: Access to fund distribution platforms helps drive the asset management business. Managers whose NAV values are consistently late or inaccurate face potential exclusion from distribution channels. Even if their platform access isn’t affected, the reputational cost of calculation failures can hurt investor confidence, with damaging results.
Financial risk: Many factors, including the potential cost of failure, go into evaluating the business case for alternative NAV calculation solutions
You should consider the: • Cost of running a manual solution and the risk (and potential cost) of manual error • Cost of implementing and running multiple solutions versus a single automated solution • Cost of building and maintaining an in-house automated solution • Cost of high frequency / low impact and low frequency / high impact events • Impact of breaches on distribution and reputation • Added value of improved quality checks
Broadly speaking, there are four main solution categories for alternative NAV calculation.
1. Spreadsheets: Cheap, yet time-consuming to maintain and potentially inaccurate, spreadsheets increasingly present an unacceptable level of operational risk.
2. Benchmark NAV: Also known as Indicative or Backup NAV, Benchmark NAV solutions calculate an estimated NAV using algorithms. Although attractive for their relative simplicity, they may be less accurate than Contingent and Shadow NAV solutions.
3. Contingent NAV: These solutions take prior NAV positions, add new transactions, and independently revalue the holdings. They help you hold your Administrator to account and provide a reliable starting point for investigating variances with the official NAV. And, they let you issue the NAV if outages affect the broader market.
4. Shadow NAV: Maintaining a duplicate book of records is labor-intensive and costly. Few Asset Managers aside from hedge funds need to do this, given current regulatory requirements.
If you decide you need a Benchmark or Contingent NAV solution, keep these five considerations in mind:
1. Accuracy. If you issue a price, you assume legal responsibility for its accuracy and will need to compensate investors or the fund for errors. With accuracy ranges from 10-250bp, algorithmic solutions are less accurate than Contingent NAV solutions, which have demonstrated accuracy within 3 bps.
2. Effort to run. More granularity does not necessarily mean more effort to run. There are fully automated solutions on the market. Look at total cost of ownership, including the staff time required for manual intervention.
3. Value added. Does the solution simply provide an indicative NAV, or does it allow you to hold your Administrator to account by alerting you to specific items that need challenging? Does it enable you to issue the NAV in an emergency?
4. Independence. Some TPAs offer complimentary alternative NAV calculation systems. While seemingly cost-effective, such solutions might represent an inherent conflict of interest, particularly if disputes arise over accuracy or potential liabilities. If you use multiple Administrators, you will need a solution that can consolidate and compare data between vendors. Or you will have to run multiple solutions, increasing cost and effort.
5. Ease of switchover. Contingent NAV solutions should let you seamlessly issue a NAV should the need arise, rather than needing to perform oversight checks on estimated numbers and then reimporting data to calculate an accurate NAV.
Clearly, Asset Managers face an abundance of choice when it comes to selecting Benchmark or Contingent NAV solutions. Reputations take years to build but can be destroyed in a matter of moments.
Having robust contingency measures in place is critical. Be sure you are protected legally, financially and reputationally in case of unforeseen events.
Whether you’re considering a Benchmark NAV, a fully outsourced Shadow NAV solution or something in between, Linedata can help. Get in touch to learn more.
