Ignites recently reported that the number of fund companies reporting net asset value errors increased by 29% in 2022 compared to 2021, with 129 of those funds requiring NAV restatements. Turnover and complexity were primarily pointed to as the causes, compounded by higher market volatility yielding errors more material than in times of lower volatility. But the lurking problem behind what the article raises is repeated failures of the NAV control environment.
The functionalized nature of today's accounting models, coupled with an increased focus on automation, has resulted in expertise being siloed within individual processing teams. As a result, this has presented greater challenges for fund administrators to provide a proper balance of transparency and controls to the team responsible for final NAV validation.
Considering these challenges and the increasing number of errors, now is an excellent time to check in with your provider about their control environment.
- Ensure your provider’s controls address potential risk areas, with extra focus around manual or complex processes. Review their procedures describing how exceptions get resolved correctly and on time. Ensure controls aren’t so broad that they may be flooding your service team with false exceptions.
- Verify their procedures to second-source prices. Where securities do not have more than one source, how are the prices validated?
- Understand their NAV sign-off process, including what is reviewed and how. Ask your provider about any contingent NAV service offering, to see if it could add value with a layer of substantiation to the verification process.
- Review how data inputs are validated for accuracy prior to flowing into automated calculations.
- Ensure you know the escalation process through which your provider will raise unresolved exceptions and reconciliation breaks both internally and to you. Consider if the escalation process currently in place (particularly around materiality thresholds and escalation timing) is still acceptable in today’s environment.
- Ensure you’re using a practical set of KPIs to assess the provider’s performance. If your KPIs were created years ago, it’s prudent to revisit them to ensure the right areas are being measured. (And if you’re not utilizing KPIs, it is time to consider it!)
Now is also the time to review the NAV oversight procedures that the team at your shop is performing on the provider-produced NAVs. It’s important to strike a balance in which your team is not “verifying by replicating”, i.e., re-doing the provider’s work to ensure it was done correctly. Instead, ensure an efficient and effective exception-based approach is being taken to confirm the various components of the NAV. Also, look at when the checks are performed – are any cursory checks done the same day to catch errors before the NAV is published, or are all reviews performed the next morning (or later)?
Assessing the scope and requirements for optimizing controls and oversight can be daunting. Reach out today for a discussion on how Olmstead can help you revitalize your control environment.