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Preventing the “huge consequences” of NAV oversight error

Funds technologyShortcomings in net asset value oversight are a risk to the industry, and heightened regulation is making proper oversight essential, experts on a recent Funds Europe webinar said.

Publishing high-quality net asset values (NAVs) and ensuring solid oversight has become critically important., Technological developments and a transition away from manual processes in NAV production point the way forward, while laggards may face financial and reputational risks, industry experts have said.

Speaking on a Funds Europe webinar called ‘NAV oversight and contingency: a global perspective’ on November 30, and held in association with Linedata, panellists discussed a range of influences that impact the approaches taken by fund firms to NAV oversight.

David Barry, head of hedge funds at fund administrator Apex Group, told the webinar that the impact of getting a NAV wrong for a central administrator has “huge consequences” for all stakeholders within the fund.

First, the business may have to compensate an investor for the error, which will most likely lead to client loss, he said. But most importantly for Barry, the reputational damage such a mistake can cause is more damaging than the financial hit.

Barry added that the issue is particularly potent from a European investment manager’s perspective, as under European regulations, fund managers are ultimately responsible for the valuation of the fund.

He continued: “If for some reason we don't do oversight, or the administrator gets it all wrong, and we missed a trade or wrongly priced a portfolio, it could lead to investment managers making wrong investment decisions or investing off of incorrect risk measurements and exposure levels, or even hedging incorrectly.”

Matt Grinnell, global product manager - fund oversight at Linedata, echoed Barry’s sentiment on reputational damage, adding that the “worst thing is seeing your name in the headlines for some sort of breach of fiduciary duty where the NAV is incorrect.”

He said that in a worst-case scenario, the NAV error is not caught immediately, pointing out an instance where such a mistake went undetected for a year.

Changing habits
A reliance on legacy technology, such as spreadsheets, is hampering the industry, Grinnell said. Research found that 49% of asset managers are using spreadsheet checks to provide NAV oversight, but as newer tools are becoming mainstreamed, that number is expected to fall.

Yet a reliance on spreadsheets is still widespread, and is done “out of habit,” Grinnell said, with layers of complexity added as funds and organisations grow, with the approach being perpetuated indefinitely, “because that’s all firms know,” he added.

This process is “not very robust”, he explained, and can be prone to “operational breakdowns” or negative comments from auditors, who prefer to see the process automated. Additionally, using software such as Microsoft Excel means that a fund administrator is “probably not doing all the tests that they should,” resulting in a poor audit trail, Grinnell said.

However, the shift to work-from-home and cloud-based solutions is accelerating the uptake of technology within the space.

Research by Funds Europe, in association with Linedata, found that an overwhelming number of asset managers use some form of alternative NAV for oversight purposes, yet too few of them use systematic oversight approaches or have back-up NAV capabilities – something technological solutions may help in addressing.

But the industry is being serviced by an ever-growing suite of cloud-enabled platforms that is affording fund administrators the ability to properly conduct oversight procedures, Nicolas Hennebert, partner of asset management at Deloitte Luxembourg, said.

Covid catalyst
The pandemic spurred the uptake of technology across society, and in the fund administration space, this manifested in the need to provide information “in real time” to clients, Barry said.

“Clients naturally seek reassurance from their service providers that they're still going to be able to maintain their service levels, and deliver them in a timely manner, and it actually led to managers wanting data and more information in real time,” he said.

Grinnell added that while there are many NAV-technology providers, “not all are created equal.” This means that the decision on which service to use is jointly dependant on the products providers currently offer, as well as how well they can stay on top of the technological curve.

“NAV oversight isn’t a one-and-done type of thing,” Grinnell said. “It’s a continuous pattern of activity, and you want to make sure that the vendor is always keeping pace with the times.

“You need to have the tools that are a little bit more flexible, can handle a lot of different data points, and really allow you to analyse your data the way you want. It’s a bit of a challenge, but you need to keep on top of it and always look down the road with what’s coming next.”

Regulatory demands
Beyond technology, a key driver of change within the space is heightening regulation across Europe, Hennebert said, with “more and more oversight” being sought by regulators. He added that failing to get an accurate NAV is one issue, but “failing to comply with regulatory requirements will see your licence taken away”’.

And whilst regulators from across the globe are implementing new requirements, Hennebert said there is “flexibility” in how local jurisdictions are drafting the rules, meaning that there is a large amount of international crossover, allowing for easier collaboration and more cross-border understanding.

The panellists agreed that trying to anticipate every change linked to NAV oversight was extremely hard, especially with requirements changing on an annual basis.

The best way to mitigate this risk, Grinnell said, is by “thinking long-term” over the best approach and ensuring that NAV oversight is given the attention it requires.

The ‘NAV Oversight and Contingency: A Global Perspective' webinar in association with Linedata is available to watch here.

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