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NAV Oversight and Backup NAV Challenges? You are Not Alone.

Milestone Group

By

08/11/2018

Established outsourced relationships and more recent outsourcing initiatives are driving renewed interest in addressing the sometimes complex operational challenges of supporting and overseeing these relationships. If some of these developments and challenges sound familiar, you are not alone.

While the motivations for outsourcing back office functions continue to evolve, the challenges of successfully operating an outsourced or hybrid model persist. The intentions of early outsourcing deals often revolved around achieving cost reductions, access to centers of excellence and the avoidance of significant technology investments.

More recently, these motivations have shifted a degree or two and tend to be driven by a corporate sense of core and non-core activities, as well as the desire to avoid major refurbishment projects of internal operating models and related technology.

In one sense this shift is profound, as there are now multiple examples of fund managers knowingly increasing operating costs as a consequence of outsourcing, which may seem both counterintuitive and directly at odds with two decades of marketing by fund administrators.

The latter is an interesting discussion as it points to a dichotomy of efficiency and scalability that exists at a custody level but is not necessarily present at the fund administration level.

 

Fund Managers are presented with Increasing Challenges & Expectations

Irrespective of the validity and long-term value of this newer outsourcing trend, the industry and individual fund managers are presented with an increasingly tangible set of challenges and regulatory expectations of effectively managing operating models with one or more external parties undertaking mission critical
activities such as fund valuation and striking a NAV.

In addition to the mechanics of day to day operations there has been a rising tide of expectations relating to thoroughness and transparency with which such outsourced functions are monitored and supervised, with much more visibility and focus on the need for fund boards to demonstrate active oversight and commitment to fund members’ interests.

For many firms with outsourced relationships, particularly where the relationship is in its early stages, it is not uncommon to feel a loss of control over the quality of daily NAV production and related data.

In other situations, fund managers with long standing outsourcing arrangements share either their experience or fear of periodic interruptions to the timely and accurate delivery of NAVs.

The scenario is one where a fund manager receives a call late in the day to advise them that NAVs are going to be delivered “later than usual” by their service provider.

Adding to some of these anxieties are the residual effects of the 2015 accounting system failure at a major service provider that prevented them from getting client NAVs out the door across dozens of fund complexes over multiple days.

 

Recent adversity is driving the need for NAV oversight as a critical daily function

As is often the case, this moment of adversity has contributed to shaping and accelerating the recognition and push for industrialization of a professional oversight function. NAV oversight has evolved into a critical daily function for treasury and fund administration teams. But for many, oversight resources are stretched thin, and there is not enough time in the short window before NAVs are distributed to perform a complete set of checks across all funds and classes to ensure their accuracy.

Further, the oversight process often relies heavily on spreadsheets and manual processes that are prone to user error or discontinuity, which translates into a high likelihood that some NAV errors are going to go undetected.

For example, in 2016, one fund manager had a NAV error go undetected for months before being identified during a routine audit, resulting in millions of dollars in restitution to the fund and several more millions of dollars in fines by the regulator.

 

Regulators have raised the bar on acceptable market practice in relation to oversight

Regulators in both the US and Canada have made it clear, outsourcing fund accounting does not absolve the fund managers of their fiduciary duty to distribute timely and accurate NAVs.

These events have collectively caused the industry and its regulators to ‘raise the bar’ on acceptable market practice in relation to oversight, and this has gone further to set the expectation that fund boards should have a business continuity plan in place to insure against a future service provider outage or failure. This
could be onerous if managers continue to rely on home grown solutions that often leverage existing middle office systems that were not intended for this purpose, surrounded with cumbersome and fragile spreadsheet-based or semi-manual solutions.

Some fund administrators are offering their clients add-on services to provide protection against a failure of their primary accounting system, but their clients are struggling to understand the logic and value behind this approach as resilience was a primary factor in their original business case.

 

Oversight & Insurance against service outages should be independent of service provider’s infrastructure

This sentiment was clearly born out in a recent Milestone Group survey of outsourced fund managers where 78% of participants feel that the oversight process should be independent of their service provider(s). The role of shadow accounting, recreating accounting books and records either internally or with a second service provider, is also generally discounted as too costly, and likely to wipe out the cost savings that drove a firm to outsource in the first place.

Still on the cost theme, a common concern shared by many in the industry relates to freeing up operational budget to strengthen oversight and contingent NAV capabilities given fierce competition for available budgets.

Among industry peers there is a common lament:

“I realize that my current oversight process is not great, but it appears to be working… for now at least”

The sentiment is that if nothing or little has gone wrong for a period of time, then there is a prima facie case that risk of an oversight
failure is being effectively managed.

It is therefore not a surprise that initiatives to fortify oversight and contingent NAV capabilities often follow an actual loss event, near miss or regulatory directive.

 

So how will this play out?

Fortunately, there is an organization whose business is to anticipate and contribute to the effective resolution of such industry challenges. At Milestone Group we have the global perspective, local market engagement and business mandate to work with the investment industry on exactly this type of issue. Since 2011, our pControl Oversight solution has been strengthening oversight functions of leading fund managers globally. In 2015 we engaged with the US market to respond to a more urgent demand for an accurate and cost effective contingent NAV capability.

As a result, Milestone Group is now deploying a new and powerful backup NAV capability, enabling organizations to demonstrate an effective contingency plan to deal with the possibility of a limited or sustained service provider outage. It is fully integrated with the automated pControl Oversight capability leading to an accurate, high confidence and lowcost solution for outsourced functions. It can also be deployed independently for organizations with in-house fund accounting systems or administrators seeking to fortify fund accounting infrastructure.

As pioneers and global leaders of industrialized, commercially available oversight and backup NAV capabilities we are here to say, you are not alone…

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