Outsourcing trends that drive focus on NAV oversight and contingency

Over the past decade the investment management industry has seen a growing trend of firms choosing to outsource key operations such as fund accounting and administration, with some managers having practical business reasons to diversify their books of business with multiple service providers. It appears this trend will continue, and in fact, in a recent survey conducted by BNY Mellon, 90% of respondents state that if they were to explore or expand their outsourcing relationships in the next three years it would be in the back office area.

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 Commission in the U.S. and the Financial Conduct Authority 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.

Organisations with more robust planning have a greater chance to maintain operational continuity if and when these challenging circumstances arise.

Attaining NAV resiliency

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:

• Is the calculation of a back-up NAV sufficiently insulated from the processes and infrastructure used to produce and disseminate the primary NAV?
• What is the strength of the provider’s BCP? Are its teams able to perform their tasks remotely, ensuring continuity when BCPs are enacted?
• To strengthen platform resiliency, is the solution platform fully independent of the primary NAV calculations?
• Is the back-up NAV derived from data sourced independently from the primary accounting platform?

Oversight as a best practice

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.

Key principles of oversight

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.

Efficient: The process should be efficient. Leveraging automation provides consistent processes to help ensure exceptions are reviewed and handled correctly on T prior to NAV dissemination and can help firms achieve operational scale and an easily repeatable process.

Independent: The creation of a NAV that can be calculated independently from the primary accounting system using independent data sources is imperative. In addition, controls and operational processes should be fully independent from the primary accounting function both from a technology and people perspective. This independently calculated NAV can then be used for a detailed comparison analysis with the primary NAV to identify and address any anomalies.

Transparent and Auditable: To support audit and regulator inspection, a full audit trail of controls performed, analysis and investigation made and flagging of exceptions is relevant. And, for those using multiple providers, aggregation of fund accounting data across service providers to deliver cross-provider validation and oversight should be strongly considered.

Accurate and Timely: The accuracy and timeliness of NAVs is of significant importance. As already mentioned, firms will want to consider a contingent NAV strategy as part of their BCP to ensure that fund NAVs are available to the industry even if the primary calculation approach fails.

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.

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