Nathan Travell of Milestone Group says oversight risk review is ‘timely
Nathan Travell, product manager, EMEA at Milestone Group, says that with fundamental changes to the way long term savers will take on investment risk across Europe, the time is right for a review of oversight risk in the industry.
Trust is a critical component of any outsourced relationship. However, as the outsourcing model matures, it has become clear that finding the balance where trust and control go hand in hand is the foundation of a successful relationship. A number of European regulatory bodies, such as the CSSF in Luxembourg, the BaFin in Germany and the Central Bank of Ireland have highlighted in recent times that trust alone is no longer enough.
Finding the right level of oversight for outsourced fund accounting is a case in point and the UK provides a good example. In November last year, the UK Financial Conduct Authority (FCA), released its thematic review into asset management following an earlier ‘Dear CEO’ letter that focused on resilience risk: in other words what would happen if the service provider went out of business. Although the consequences would be significant, this scenario is highly unlikely.
In its thematic review however, the FCA focused on something much more likely: what it now refers to as oversight risk. That is the impact of errors in valuation and pricing of funds both on individual investors and on the industry as a whole.
Oversight risk had a more central position in the thematic review, in which the FCA identified four areas for attention: reconciliation between custodian and administrator; pricing and valuation of portfolios and their constituent instruments; corporate actions affecting instruments held; and trade processing quality.
The review is timely. The advent of government-mandated pension auto-enrolment in the UK and the widespread trend of moving from defined benefits to defined contributions across Europe has altered the marketplace in subtle but important ways, in particular the new and larger cohort of end-investors to be protected.
A model in which service providers have taken on responsibility for delivering critical and complex functions, but in reality have been expected to bear sole responsibility for quality, is not fit for purpose in this changing environment.
As a result, a best new practice is emerging. This involves fund managers participating directly in the control framework, providing an effective oversight function that offers a second layer of protection to themselves, and their relevant stakeholders and clients.
The thematic review has fuelled this trend, particularly where fund managers are now expected to have qualified people in place who understand how instruments are valued. These people should also be able to challenge the data coming back from service providers.
The challenge is to secure the right level of oversight. Having the right people in place is one dimension, but it remains an operational challenge. For one thing, firms often engage more than one service provider. With different outsourcing arrangements in place, there will also be different practices, different data sets and different operational procedures to oversee.
Then there are the timeframes involved. If inaccuracies and errors in the NAV calculation are not caught in time, the resulting costs can spiral rapidly. So the pressure is on to review, validate and react to any anomalies within a very short timeframe.