ASIC RG 94 — ASIC Regulatory Guide – RG 94 Unit pricing: Guide to good practice

Page 1 REGULATORY GUIDE 94 Unit pricing: Guide to good practice August 2008 Note 1: In October 2007, ASIC withdrew Regulatory Guide 130 Managed investments: Licensing (RG 130) and Regulatory Guide 164 Licensing: Organisational capacities (RG 164). All references to RG 130 and RG 164 in this guide are historical, as the guides no longer exist. Note 2: In September 2008, ASIC withdrew the guide Breach reporting by AFS licensees (October 2004). Its reference in the guide should be read as ‘Regulatory Guide 78 Breach reporting by AFS licensees and credit licensees (RG 78)’. Note 3: In September 2015, ASIC repealed Class Order [CO 04/1575] Managed investment schemes: unit pricing as part of our bulk repeal process to repeal redundant instruments identified in our sunsetting work. All references to [CO 04/1575] in this guide are historical, as this class order no longer exists. Note 4: In July 2018, ASIC updated and retitled Regulatory Guide 134 Managed investments: Constitutions (RG 134). All references to RG 134 in this guide should be read as ‘Regulatory Guide 134 Funds management: Constitutions (RG 134)’. Note 5: In July 2021, s52(2)(c) of the Superannuation Industry (Supervision) Act 1993 was amended. As a result of the amendment, the reference to ‘the best interests of the beneficiaries’ at section 7.1 should be read as ‘the best financial interests of the beneficiaries’. Note 6: In October 2022, ASIC withdrew Regulatory Guide 165 Licensing: Internal and external dispute resolution (RG 165). All references to RG 165 in this guide should be read as ‘Regulatory Guide 271 Internal dispute resolution (RG 271)’. Note 7: In December 2026, ASIC updated and retitled Regulatory Guide 168 Disclosure: Product Disclosure Statements (and other disclosure obligations) (RG 168). All references to RG 168 in this guide should be read as ‘Regulatory Guide 168 Product Disclosure Statements: Disclosure and other obligations (RG 168)’ and the reference to ‘[RG 168.20]’ is historical. Page 2 Unit pricing Guide to good practice Joint ASIC and APRA guide Updated August 2008 Page 3 –Unit pricing guide to good practice Copyright © Australian Prudential Regulation Authority and Australian Securities & Investments Commission (2008). The material in this publication is copyright. You may download, display, print or reproduce material in this publication in unaltered form, for sale or otherwise, conditional upon acknowledging ownership of content by the Australian Prudential Regulation Authority (APRA) and the Australian Securities & Investments Commission (ASIC), for example: ‘© Australian Prudential Regulation Authority and Australian Securities & Investments Commission. Reproduced with permission.’ Apart from any use as permitted under the Copyright Act 1968, all other rights are reserved. Requests for other uses of the information in this publication should be directed to APRA Public Affairs Unit, GPO Box 9836, Sydney NSW 2001 or Public.Affairs@apra.gov.au and feedback@asic.gov.au Disclaimer While APRA and ASIC have published this publication in good faith based on the facts we are aware of at the time of publication, neither APRA nor ASIC accept any responsibility for the accuracy, completeness or currency of the material included in this publication, and will not be liable for any loss or damage arising out of any use of, or reliance on the material in this publication. This publication is meant to be a general guide and you should form your own views as to its application. Australian Securities & Investments Commission, GPO BOX 9827, Sydney NSW 2001 Australian Prudential Regulation Authority, GPO Box 9836, Sydney NSW 2001 First published: 2005 ISBN: 0-646-45372-6 © ASIC and APRA > August 2008 page 2 Page 4 Unit pricing — guide to good practice What this guide is about APRA/ASIC review of unit pricing practice Both APRA and ASIC have regulatory jurisdiction for aspects of the practice of life companies, superannuation providers and fund managers. After noting concerns about unit pricing practice in these entities in recent years, we undertook a joint review of unit pricing practice from July to December 2004. The review built on the prior work of both regulators, examining instances at more than 40 entities where unit pricing issues have been addressed since 2000. We also visited product issuers and service providers and consulted with industry bodies to obtain current views on unit pricing and outsourcing practice. The review included a survey of aspects of unit pricing, outsourcing and tax practice that was sent to 95 entities. The response rate overall was high at 85%. We received replies from 29 operators of managed investment schemes (93% response rate), 16 life companies (100%) and 36 superannuation funds (80%). The regulators’ fndings in the joint review were by no means all bad news. Substantial evidence was found of entities that had clearly recognised and were managing the risks associated with unit pricing, and where the complexities of operating a unit pricing methodology were approached with care and diligence. For the thousands of unit prices calculated by industry each day, most will be correct, or if found to be in error will be quickly corrected. However, a small number of undetected errors can give rise to problems. In December 2004 we published a joint consultation paper on good practice in unit pricing, based on the fndings of our review. We received 16 detailed submissions in response and have considered those comments in the development of this guide. Our survey process, the development of the consultation paper and the further refnement of parts of this guide were subject to independent review by an external consultant. We would like to acknowledge the contribution of industry participants and industry bodies to the development of both the consultation paper and this guide. © ASIC and APRA > August 2008 page 3 Page 5 Unit pricing — guide to good practice Status of this guide We are not of a view that there is only one preferred way to address unit pricing issues, and we have noted a range of industry conduct that has the characteristics of good practice. This is therefore a guide to ‘good practice’ – not a guide to ‘best practice’ nor a mandatory set of instructions. Some of the material in this guide is a reminder of current legal obligations, while some is a reminder of policy and other guidance we have published. Other material describes good practice as observed among industry participants. Much of the material outlines a common sense approach, building on the obligation to treat unit holders equitably. Many of the matters raised in this guide have come to our attention following recent unit pricing issues. However, the range of matters that product providers need to consider in managing unit pricing is not necessarily limited to, or fully covered by, this guide. We will continue to review aspects of unit pricing practice as part of our ongoing regulatory monitoring. In doing so, we will expect to fnd: sound understanding of good practice in unit pricing demonstrated at all levels of regulated organisations, and a strong commitment to the implementation of effective unit pricing practice. We will also expect that product providers’ unit pricing practices will measure up with the practices described in this guide. There may be unusual circumstances in which alternative practices are appropriate. In such cases, we expect that product providers will have a reasonable and documented justifcation for adopting alternative practices. Scope of this guide APRA and ASIC have developed this guide to help product providers understand and comply with their unit pricing obligations. The guide may also help entities considering whether to unitise their products. The guide does not specifcally address crediting rate practices, which are another way of attributing investment returns from a pool of assets to members of the pool. However, some of the issues raised and practices outlined in this guide are also relevant to crediting rate practices. Chapter 1 outlines strategic unit pricing issues to be considered by the board and senior management. Chapter 2 identifes good practice principles that should underpin the unit pricing practice of all product providers. © ASIC and APRA > August 2008 page 4 Page 6 Unit pricing — guide to good practice The body of the guide (Chapters 4 to 6) describes the application of the good practice principles in relation to a range of important management, technical and consumer matters. Each section of these chapters outlines a particular unit pricing issue and concludes with guidance on good practice. Key terms used in the guide are defned in Chapter 8 at the end of the guide. Updates to this guide We will consider updating this guide from time to time. If you would like to comment on matters discussed in the guide, please send your comments to both: Review of Unit Pricing Guide APRA ASIC GPO Box 9836, Sydney NSW 2001 GPO BOX 9827, Sydney NSW 2001 or email: unitpricingguide@apra.gov.au unitpricingguide@asic.gov.au © ASIC and APRA > August 2008 page 5 Page 7 Unit pricing — guide to good practice In this guide, references to laws, including regulations and sections of acts, are references to those laws as at the date of this guide. This page has otherwise been intentionally left blank © ASIC and APRA > August 2008 page 6 Page 8 –Unit pricing guide to good practice Contents page 1 Strategic unit pricing issues for the board and senior management 8 2 Good practice principles for unit pricing 14 3 Pooled investments – unit pricing and crediting rates 18 4 Management issues 21 4.1 Effective risk management culture 21 4.2 Unit pricing issues common to many products 30 4.3 Additional unit pricing issues for products with complex structures 38 4.4 Managing diversity in systems and products 41 4.5 Managing change 44 4.6 Outsourcing unit pricing functions 48 5 Technical issues 56 5.1 Determining asset values 56 5.2 Determining tax treatments 63 5.3 Determining the use of reserves 72 5.4 Applying accounting standards 76 6 Consumer issues 80 6.1 Providing information about unit pricing 80 6.2 Managing complaints 87 6.3 Managing errors and compensation 90 7 Obligations relevant to unit pricing 99 8 Key terms 102 © ASIC and APRA > August 2008 page 7 Page 9 Unit pricing — guide to good practice Strategic unit pricing issues for the board and senior management 1 1 Strategic unit pricing issues for the board and senior management Focus on unit pricing issues Unit prices are often calculated in a high-speed, high-pressure environment. Your organisation may calculate and publish many hundreds of unit prices every day. Even if you only calculate a smaller number of unit prices weekly or monthly, you still face considerable pressure to obtain timely, if less frequent, information and to ensure consistency and accuracy in your operations. You need to consider the following strategic unit pricing issues to ensure that your organisation measures up to industry good practice. We discuss these issues in more detail in the remainder of this guide and outline good practice in relation to them. Errors in unit pricing can be costly When large errors arise they tend to be very large indeed. There have been instances of errors costing more than $10 million in compensation. The associated costs of rectifcation can also be substantial, as can the consequences of reputational damage or publicity. As a senior manager or member of the board, it is therefore important to get unit pricing right. Give unit pricing a high profle and resources To avoid costly errors ensure that unit pricing in your organisation has a high profle and adequate resources. In each budget cycle you need to consider the resources required for unit pricing and ensure they are at the appropriate level. You also need to determine the appropriate level of board and senior management involvement in unit pricing issues, including endorsement of policies and the implementation of a unit pricing policy framework. Comply with your legal obligations At all times you are subject to a wide range of duties. In particular, in all cases you need to act honestly, diligently and impartially and in the best interests of all unit holders. © ASIC and APRA > August 2008 page 8 Page 10 Unit pricing — guide to good practice Strategic unit pricing issues for the board and senior management 1 Build an effective risk management culture You need to build an effective risk management culture in your organisation from the top down. The board and senior management set the tone and approach. Your attitude to risk management is the major determinant of the likelihood and impact of unit pricing errors. Signifcant errors have arisen, and have continued undetected, where the approach to risk management has been inadequate. You also need to demonstrate your commitment to risk management. This may be done by setting policy, monitoring performance and leading risk management committees. In such ways your staff and professional advisers are more likely to see risk management as a high priority for your organisation. Your risk management systems should include controls, monitoring and reporting, so that unit pricing errors are avoided or quickly identifed. The more effective your risk management systems, the more likely it is that errors will be avoided or quickly identifed. The sooner an error is detected and resolved, the lower the potential cost and reputational damage to your organisation. You need to support and encourage staff and professional advisers to report issues, incidents and exceptions. Establish a policy framework You need to take responsibility for developing and implementing a unit pricing policy framework for your organisation. Your policy framework needs to cover all of the management, technical and consumer issues identifed in this guide. It should also include policy and procedures for managing any unit pricing errors that arise and for addressing rectifcation and compensation issues. Implement the policy framework in such a way that your unit pricing policies are discussed, understood and applied consistently throughout your organisation. Implementation should include regular monitoring to ensure that your policies are updated as required. © ASIC and APRA > August 2008 page 9 Page 11 Unit pricing — guide to good practice Strategic unit pricing issues for the board and senior management 1 Maintain robust systems and processes You need to have reliable unit pricing systems, procedures and controls in place, as well as business continuity and disaster recovery plans. Where possible, avoid manual systems and upgrade your old information technology systems. Old systems require signifcantly greater controls and maintenance, as well as viable interfaces with up- to-date systems. You also risk loss of critical knowledge and skills as old systems become obsolete. Your unit pricing systems and procedures need to be well designed and well understood, and should be reviewed periodically. End-to-end process maps and end-to-end maps of unit pricing controls may be useful, particularly when developed by the people involved in unit pricing functions. Your systems and procedures should include measures to minimise the likelihood of unit pricing errors. This includes applying reliable cross-checks to data before it is used in calculations and reviewing valuation methodologies. Design effective reports for monitoring You need to ensure you receive appropriate and timely information on unit pricing issues. The reports you receive should focus on key unit pricing measures and show the cumulative impact of unit pricing issues arising in different parts of your organisation. If you are not kept adequately informed then you cannot manage the risks. Establish clear delegations and accountabilities You need to ensure responsibility for each function in your organisation is allocated to a designated person. Depending on the nature and scale of your operations, the range of functions impacting on unit pricing will probably include: Product development Marketing Unit pricing operations © ASIC and APRA > August 2008 page 10 Page 12 Unit pricing — guide to good practice Strategic unit pricing issues for the board and senior management 1 Information technology Tax Accounting Legal Compliance Risk management Outsourcing management Internal audit. Your end-to-end process map should completely describe all business activities that can impact on unit pricing. Manage complexity and diversity If you choose to offer complex products or a diverse range of products, or if you operate with diverse systems, then you must ensure that you appropriately manage all aspects of your operations. Some unit pricing issues are common to most products. However, unitised products are numerous and diverse. A single provider may administer many different unitised products offering a variety of investment choices. Many products and investment choices may no longer be actively marketed to new investors, yet they still need to be administered. Some unitised products invest in other unitised products. Multilayered products and the use of performance fees add complexity to unit pricing decisions and management. Diversity in information technology systems and in product range constrains simplifcation and standardisation. Extra layers of complexity require greater commitment to implementing effective systems and procedures and greater attention to risk management. Manage change effectively Many unit pricing errors arise as a consequence of change. Some change occurs in the external environment, while other change is driven by the board and senior management implementing strategic direction, such as takeovers, downsizing or relocation. Other change, such as changes in policy, investment strategy, fees or product documentation, comes about during normal business operations. © ASIC and APRA > August 2008 page 11 Page 13 Unit pricing — guide to good practice Strategic unit pricing issues for the board and senior management 1 Change that might appear initially to be unrelated to unit pricing may signifcantly affect the unit pricing function. You need to attend to risk management during periods of change, particularly where there is more than one change or where change arises frequently. Where possible, schedule the implementation of change to avoid reporting and other peak periods, when business workloads may affect the success of the change program. You should also implement project management policies, planning and reporting systems to approve, monitor and control change. You need to assess the effect of proposed change on unit pricing and need to involve unit pricing staff as early as possible. You are responsible for outsourced functions While you can outsource some of your functions, remember that you cannot outsource your responsibility for those functions. You need to decide which functions will be outsourced and be satisfed that all aspects of the end-to-end unit pricing process are addressed in outsourcing arrangements. The outsourcing agreement must include arrangements for service levels, reporting, determining the extent of liability, dispute resolution, error and complaint management, business continuity and disaster recovery and termination of the agreement. You need to build and maintain effective working relationships with service providers, maintain appropriate knowledge and build and maintain appropriate monitoring systems. Meet periodically with service providers to understand the effect any proposed strategic change will have on unit pricing functions. Be prepared to manage errors and compensation Regardless of the quality of your systems and controls, unit pricing errors may occur – you need to be ready to deal with them. When an error has been identifed, all your attention needs to be directed to limiting damage and addressing the loss to investors. At that stage it is too late to be establishing general processes to deal with errors. © ASIC and APRA > August 2008 page 12 Page 14 Unit pricing — guide to good practice Strategic unit pricing issues for the board and senior management 1 You need rectifcation and compensation procedures in place so that they can be applied promptly. These should be applied consistently and in good faith so that current or former unit holders are not disadvantaged. You should also give priority to preventing recurrence of the error. Communicate with the regulators as soon as possible after you detect a unit pricing error. Independent review by external experts is likely to be important in helping you quantify errors and rectify your systems and may help you to avoid errors in the future. © ASIC and APRA > August 2008 page 13 Page 15 Unit pricing — guide to good practice Good practice principles for unit pricing 2 2 Good practice principles for unit pricing The following good practice principles should underpin the unit pricing practice of all product providers. In Chapters 4 to 6 of this guide we consider the application of these principles in relation to a range of management, technical and consumer issues. We will consider ‘substance over form’ when examining particular instances of conduct. 2.1 Unit pricing policies and practice must be consistent with the governing documents for each product Your policies and practices need to be consistent with the governing documents for each product and your PDS or offer documents. Some unit pricing errors have arisen because the calculation methodology did not match statements in the product’s governing documents, rather than because the unit pricing methodology was intrinsically faulty. Examples of these include errors in asset valuation and transaction cost methodologies and errors in fee and tax treatments. To the extent that implementation of good practice is currently constrained by the governing documents, you need to update the governing documents where possible and, as the opportunity arises, align them with good practice. Governing documents for new products need to be written to take account of guidance for good practice in unit pricing. 2.2 Sound unit pricing policies should be implemented consistently and kept up-to-date Policies Your unit pricing policies need to seek to achieve equity between unit holders. You need to develop soundly based policies that cover the range of reasonably foreseeable circumstances, including sudden changes in the environment. You must explain any relevant methodologies and assumptions, and why the assumptions are appropriate and reasonable. This includes explanation of the use of judgement and estimates. © ASIC and APRA > August 2008 page 14 Page 16 Unit pricing — guide to good practice Good practice principles for unit pricing 2 You need to specify delegation levels for decisions and approvals. Where unit pricing functions are outsourced, you remain responsible for the policies adopted. Maintain a register of key service provider policies and review those policies periodically. Procedures You need to develop procedures to ensure that your unit pricing policies are implemented consistently, including in circumstances where the policies require the exercise of judgement. Your procedures should be developed by operational unit pricing staff in consultation with staff from other relevant functional areas. You need to monitor and report internally on the use of these procedures. Review You need to review your policies and procedures periodically, and update them in line with changed circumstances – for example, changes in market conditions, legislation or strategic direction. Documentation Documenting policy and procedures promotes effciency and consistency and assists in managing risk. Documenting your policies and procedures will also help you demonstrate, both internally and to the regulators, that your approach and your systems are soundly based and appropriate. Remember that documentation does not replace individual vigilance. 2.3 Adjustments to unit price, if based on sound policy, are not errors In considering whether compensation is required when you make an adjustment to a unit price, it is essential to consider whether the unit price being adjusted was developed in accordance with soundly based and appropriate policies that were applied consistently. For example, where estimates included in a unit price need adjustment as the actual amounts become known, or where a reasonable policy is nonetheless reviewed from time to time and updated, neither the unit price before the change, nor the unit price after the change, is incorrect for the purpose of deciding whether compensation is required. © ASIC and APRA > August 2008 page 15 Page 17 Unit pricing — guide to good practice Good practice principles for unit pricing 2 Where such a change is to be made to a unit price, the change should be made as soon as possible. Such change should not be implemented gradually over a period of time. It is important to note that compensation does need to be considered where policy has been or is inappropriate or where the application of policy has been or is defcient. 2.4 Judgement may be applied to develop estimates in some circumstances You should not use estimates where actual values are available. However, we recognise that in some cases there is no alternative but to use estimates – for example, in relation to some aspects of tax provisioning. Your estimation policies, like your other policies, should seek to provide equity to unit holders and potential unit holders. Your development and use of estimates needs to be consistent with the legal obligations that apply to you, the rules that govern the operation of the product and relevant policies. If you are using estimates, you should develop these on the most sound and reasonable basis available at the time. You need to be able to justify why the use of an estimate is appropriate in the circumstances and that the estimated value is reasonable. You need to adjust amounts initially estimated as soon as information on the actual position becomes available. You should also test estimates periodically for robustness using actual data. 2.5 Information for unit holders should be accessible, timely and useful You are subject to a range of obligations to provide information. For example, there are specifc obligations to provide PDSs and periodic statements to unit holders. You may also provide information to unit holders to meet other obligations, or voluntarily. Where there is no specifc obligation on you to provide information, but you decide it is consistent with your broader obligations to do so, we expect that you will make this information available in an appropriate form. Depending on the circumstances, you may use channels such as websites, call centres or correspondence, or include information in documents provided under statutory obligations. © ASIC and APRA > August 2008 page 16 Page 18 Unit pricing — guide to good practice Good practice principles for unit pricing 2 Information must be expressed in terms that unit holders will understand. The Good Disclosure Principles in ASIC Regulatory Guide 168 Disclosure: Product Disclosure Statements (and other disclosure obligations) [RG 168] provide a useful checklist: 1. Disclosure should be timely 2. Disclosure should be relevant and complete 3. Disclosure should promote product understanding 4. Disclosure should promote comparison 5. Disclosure should highlight important information 6. Disclosure should have regard to consumer needs. © ASIC and APRA > August 2008 page 17 Page 19 Unit pricing — guide to good practice Pooled investments — unit pricing and crediting rates 3 3 Pooled investments – unit pricing and crediting rates People may choose to invest directly in assets such as shares or bonds. Alternatively, they may choose to invest in products where their money is pooled with the money of other people. The investment assets acquired with this pooled money are managed on behalf of all the investors. Unitisation is a way to equitably attribute a share of the value of pooled products to investors. Products that may be unitised include superannuation, life insurance and managed funds. To enable people to enter or exit a unitised fund, the price per unit is determined based on the number of units issued and the value of fund investments at the time the price is calculated. Unit prices are generally calculated daily, weekly or monthly. The elements of a unit price calculation are shown in Figure 1 below. Figure 1: Basic unit price calculation Unit price calculation system • Calculate assets • Calculate liabilities • Calculate net assets • Divide by number of units and take account of transaction costs to determine unit price Another method to attribute a share of the value of pooled products is the use of a crediting rate. An amount is credited to each person’s account based on the overall rate of return on investments and the amount invested by each person in the fund. A crediting rate is generally calculated monthly, quarterly or annually. Unitisation provides a more direct link to movements in asset values, investment income and transaction costs, as unit prices are calculated at, or closer to, the time unit holders acquire or dispose of products. Unit pricing avoids transferring investment returns between entering, leaving and ongoing unit holders (generations of unit holders). That is, unitisation may be perceived as providing more transparency and resulting in more equitable treatment of benefciaries and fund members. © ASIC and APRA > August 2008 page 18 Page 20 Unit pricing — guide to good practice Pooled investments — unit pricing and crediting rates 3 However, calculation of unit prices can involve signifcant administrative effort, and the costs of establishing and operating an effcient unit pricing system may be prohibitive for certain types of fund. Unit prices also fuctuate with changes in asset values and investment returns. Where unit prices are calculated frequently there is often greater volatility in the unit price. Returns appear more volatile than for funds using crediting rates. A number of the issues covered in this guide are relevant to both the unit pricing and crediting rate environments. While this guide focuses on unit pricing issues and practices, the following sections in particular are also relevant for entities using crediting rates: 4.1 Effective risk management culture 4.5 Managing change 4.6 Outsourcing unit pricing functions 5.1 Determining asset values 5.2 Determining tax treatments 5.3 Determining the use of reserves 5.4 Applying accounting standards. 6.3 Managing errors and compensation. Whichever method is chosen – unit pricing or crediting rates – providers of superannuation and life products and managed investment schemes must ensure that their practices provide fair and reasonable outcomes for all benefciaries and members. Figure 2 below outlines key elements and relationships in the unit pricing calculation cycle. While Figure 1 focuses on the unit pricing calculation itself, Figure 2 illustrates the complexity of the overall unit pricing function, and shows, in the bottom left-hand corner of the diagram, the unit pricing calculation in this context. © ASIC and APRA > August 2008 page 19 Page 21 Unit pricing — guide to good practice Pooled investments — unit pricing and crediting rates 3 Figure 2: Key elements of the unit pricing cycle Unit holder/ contributor Send payment and application form or redemption request to product provider Risk management arrangements Check application and Buy and sell fundpayment, or redemption Transfer and Transfer and assets withinrequest and redemption reconcile assets reconcile assets investment mandate Bank and Investment Units issued to unit holders, or payment made for units redeemed, based on: • unit price at date of application or redemption request • entry/exit fees • purchase/sale of fund assets Publish price Website of product provider Unit registry (member records) Records of unit holders and number of units they each hold in the fund Check unit price against Check market/other performance number benchmarks of units in fund Unit price calculation system • Calculate assets • Calculate liabilities • Calculate net assets • Divide by number of units and take account of transaction costs to determine unit price custody managers Check asset values before transfer to unit pricing system Check tax and account data before transfer to unit pricing system Fund assets Data feeds – foreign Listed equity, fund, yield security prices Market traded derivatives prices Data feeds – domestic Listed equity, fund, yield security prices Market traded derivatives prices Corporate action records Dividends and dividend reinvestment Share splits, rights issues, buybacks Valuations Property Infrastructure Unlisted equity OTC derivatives Fund of funds/sub-fund arrangements No. and price of units Fund manager Unit prices Fund managers No. and price of units Fund manager Investment tax information FITB, CGT, imputation credits, foreign tax credits Investment accounting information Assets – investments, income and distributions Liabilities – management and performance fees, tax, expenses, interest Some product providers may confgure the elements differently. Some may use additional elements. All providers should undertake reconciliations – for example, reconciling bank records and investment accounting records. A product provider may choose to outsource some of the above functions. Nevertheless, the product provider remains responsible for proper performance of outsourced functions and should retain the capacity to monitor and supervise service providers. There are many interdependent elements in a unit pricing system. Where change is made to some elements, care should be taken to ensure that the system as a whole continues to operate effectively. © ASIC and APRA > August 2008 page 20 Page 22 Unit pricing — guide to good practice Management issues 4 4 Management issues Chapter 4 outlines a range of important management issues in unit pricing and includes guidance on good practice. The good practice guidance is presented as boxed text at the end of each section. 4.1 Effective risk management culture Risk in unit priced products Unit pricing, like other business activities, involves risk. The number of steps in the unit pricing process and the complexity of the associated functions make the risk of pricing errors one of the most signifcant non-market risks faced by investors in unitised products. Unit pricing errors do not appear to follow a normal distribution. There are many trivial errors. However, when larger errors do arise, they tend to be very large indeed – there have been instances of errors greater than $10 million. The associated costs of rectifcation can also be substantial. Unit pricing may receive little ongoing review or attention until a major problem is identifed. Responses to our unit pricing survey indicated that risks arise from: the timeframes in which unit prices need to be calculated tax issues, including reconciliations of deferred and current tax, and determination of values for current tax, deferred tax liabilities, and deferred tax assets lack of integration of information technology systems, and the need for manual workarounds the need to manage the relationship with the service provider where functions are outsourced legacy products and services – for life companies and some managed investment schemes, and the need for timely provision of information by external product providers. Role of the board and senior management in establishing risk management culture The board and senior management set the tone and approach. If they demonstrate commitment – for example, by setting policy and monitoring performance and by leadership of risk management committees – high priority is more likely to be given to risk management throughout the organisation. © ASIC and APRA > August 2008 page 21 Page 23 Unit pricing — guide to good practice Management issues 4 However, if the board and senior management indicate that risk management is of subsidiary importance, this attitude will also be refected throughout the organisation. We have seen signifcant errors arise, and continue undetected, where an organisation’s approach to risk management was inadequate. In the worst cases, there was even failure to identify the risk that errors might occur, or staff were disadvantaged or penalised for reporting problems. Unit pricing errors occur most frequently in an environment of management indifference to the unit pricing function or to risk management generally. Attitude to risk management Managers and operational staff directly involved in day-to-day unit pricing play a vital role in drawing key unit pricing issues to the attention of senior management and the board. The effectiveness of an organisation’s risk management culture can infuence the probability and impact of unit pricing errors more strongly than: the nature of the product – for example, life insurance, superannuation or a managed investment scheme the type of product provider – for example, life company, bank subsidiary, superannuation trustee, conglomerate, or the ownership structure or the size of the product provider. The effectiveness of risk management in the unit pricing function can indicate the effectiveness of risk management in the organisation as a whole. Organisations with unit pricing problems often fail to address other operational risks. Identifying the source of unit pricing errors Seeking the immediate cause of a unit pricing error may not identify the actual source. Symptoms may be addressed without identifying underlying sources. If piecemeal solutions are implemented, an organisation may continually incur costs of rework, investigation and compensation. Frequently the problem is a failure to appropriately consider and manage risks such as: diffculties in asset valuation ineffective product management lack of an effective control environment © ASIC and APRA > August 2008 page 22 Page 24 Unit pricing — guide to good practice Management issues 4 lack of an appropriate policy framework for fees, tax, asset valuation and other elements of unit pricing failure in information technology systems failure to manage outsourced services low priority given to unit pricing resourcing, including the number and seniority of unit pricing staff staff morale and productivity issues, including inadequate training ineffective project or transition management, and pressure to increase competitive advantage by reducing the time to market for new products. Key considerations for managing risks in unit pricing In building an effective risk management culture in your organisation you need to consider: How can systems and procedures be built and maintained to eliminate or reduce errors? When designing your systems and procedures, you should particularly focus on minimising large errors. You also need to consider other issues, including the matters covered in this guide, as relevant to your organisation. How can errors be detected as soon as possible? Effective detection controls are fundamental. A major determinant of the impact of a unit pricing incident is the time taken to identify the error. How can the time taken to address errors be minimised? A key element of proactive risk management is effective planning, which includes the establishment and periodic review of procedures to quarantine, quantify and rectify errors as soon as they have been identifed. There is a risk that skilled unit pricing staff will be taken from business as usual to fx unit pricing problems. This may create even more exposure to unit pricing problems. The risk to ongoing business operations needs to be managed. How can independent review be achieved? Internal and external reviews need to be taken seriously, and recommendations considered and implemented. An organisation’s failure or refusal to implement recommendations is a clear indication of a poor attitude to risk management. Early identifcation of errors followed by thorough investigation and rectifcation action can signifcantly limit the impact of problems in unit pricing systems or procedures. Systematic analysis of customer complaints © ASIC and APRA > August 2008 page 23 Page 25 Unit pricing — guide to good practice Management issues 4 and feedback may help to identify problems quickly. For more information see section 6.2, ‘Managing complaints’. In the risk management plans provided to APRA as a part of the superannuation licensing process, superannuation trustees need to identify, monitor and manage risks such as those inherent in unit pricing. Similarly, entities applying to ASIC for an Australian fnancial services (AFS) licence need to address such issues in their risk management plans. Accountability to unit holders Unit holders expect exposure to the risk that investments may perform poorly. However, unit holders should not be exposed to the risk of administrative error. You are responsible for managing the risk of administrative error whether you invest directly in the market or through other product providers (for example, by investing in managed investment schemes). You should select product providers who themselves manage administrative risks effectively. In particular, you need to be wary of accepting limitations on service provider liability. Unit holders reasonably expect that, regardless of where an error occurs in an investment chain, the initial product provider will take responsibility for managing risk, and for explaining and correcting the results of any errors. Guide to good practice in effective risk management Build and maintain an effective risk management culture The need for an effective risk management culture is a constant theme of this guide. The board and senior management cannot be expected to understand every process at a detailed level. Nevertheless, they should have suffcient understanding of business processes, including unit pricing, to plan for and manage risks appropriately. Depending on the nature, scale and complexity of the business, your risk management systems and procedures are likely to include: clear delegations and accountabilities © ASIC and APRA > August 2008 page 24 Page 26 Unit pricing — guide to good practice Management issues 4 Guide to good practice in effective risk management (cont.) formal identifcation, assessment and rating of risks formal identifcation of mitigating factors, with assessment and rating of their effectiveness monitoring controls embedded in unit pricing processes – for example, measurement of movements outside acceptable ranges, tracking of prices against benchmarks, and the use of key risk indicators to measure and monitor operational performance and to control quality assessment and rating of the residual risk after mitigation assessment of proposed changes in business activity that affect unit pricing formal procedures to report on the above matters. Reports need to provide integrated information to the board and senior management about the effectiveness of risk management and about emerging issues. Effective reporting allows the organisation to learn about risk management. The systems themselves cannot solve problems, however they do tell management what is important. Reports need to address: exceptions (what is not working as expected) movements outside agreed tolerance levels (a number, a dollar amount, and measure of impact) reassessment of measures – changes to ratings need to be reported and explained, and regular identifcation and reporting of new risks consideration of the number of service providers. Information may be received by the product provider at different times and in many different formats. The greater the number of systems, the greater the number of controls required to ensure that all relevant information is obtained and integrated into the reports. Ideally the number of service providers would be kept to a minimum senior management involvement in compliance and risk management. For example, this may include leadership of risk management and compliance committees and regular reporting to the board on risk issues © ASIC and APRA > August 2008 page 25 Page 27 Unit pricing — guide to good practice Management issues 4 Guide to good practice in effective risk management (cont.) the presence of a risk management unit and/or a compliance unit that monitors and advises on risk mitigation across the organisation the use of independent review, which may include internal and external audit, and the use of external consultants. In particular, your risk management for unit pricing should include: board and senior management attention – the lower the profle of unit pricing, the higher the risk that errors will arise or continue undetected attention to resourcing in each budget cycle for unit pricing staff, information technology systems and policy and procedures. The strength of the risk management culture is refected in the priority the board and senior management give to resources for unit pricing support and encouragement for staff to report incidents and exceptions. According to Australian Standard AS 3806–1998 Compliance programs (paragraph 3.3.8): ‘Staff should be encouraged to respond and report breaches of the law and other incidents of non-compliance, and to see reporting as a positive and non-threatening action.’ We expect entities to establish a similar environment for reporting on risk management implementation of operational procedures such as reconciliations in each pricing cycle. Inconsistencies may indicate errors and should be investigated and resolved as soon as possible reporting of operational losses due to poor risk management procedures to track errors and their resolution periodic centralised review of incident and exception logs to identify systemic problems for further attention involvement of unit pricing staff in the design of information technology testing for changes to unit pricing systems. © ASIC and APRA > August 2008 page 26 Page 28 Unit pricing — guide to good practice Management issues 4 Guide to good practice in effective risk management (cont.) These lists are not intended to be exhaustive. As product providers, you are responsible for ensuring that you identify, measure, mitigate and manage your business risks. For further guidance see: Australian and New Zealand Standard AS/NZS 4360:2004 Risk management ASIC Regulatory Guide 164 Licensing: Organisational capacities [RG 164], if you are an AFS licensee ASIC Regulatory Guide 132 Managed investments: Compliance plans [RG 132], if you are a responsible entity or other provider of managed investments, including IDPS, MDA and custodial services APRA Superannuation Guidance Note SGN 120.1 Risk Management, if you are the trustee of a superannuation fund. Training Everyone participating in unit pricing needs to understand the end-to-end unit pricing process and how their own responsibilities ft into that process. Errors should not arise because ‘things fall between the cracks’. Training is essential to build understanding of all the elements of unit pricing and to implement procedures effectively. Some industry participants have commented that the development of process maps by unit pricing staff is an effective training tool. While policy may be developed separately from operational areas, procedures refecting that policy should be developed in consultation with unit pricing staff. This may also be an effective training tool. Document policies and procedures Documenting your policies and procedures promotes effciency and consistency, and also assists in risk management by: reducing reliance on key individuals © ASIC and APRA > August 2008 page 27 Page 29 Unit pricing — guide to good practice Management issues 4 Guide to good practice in effective risk management (cont.) describing checks and tests, clear paths for investigation of errors and reporting/escalation procedures providing clear instructions for complaints management, disaster recovery and business continuity. This reduces the risk of ‘spur of the moment’ decisions providing clarity about the authority to exercise discretion providing clarity about requirements for review and high-level decisions providing clarity about the meanings of terms. For example, tolerance thresholds may be specifed rather than referring to ‘material amounts’ outlining each step/process, its purpose and the recipients of each output in the process. You should develop and use checklists for this describing the evidence of review, such as signed printouts, required for each step/process, and assisting product or systems migration, where required. However, documentation does not replace individual vigilance. To be effective, your documentation should be succinct and relevant. Documentation will be simpler to manage where you achieve alignment between your governing documents and your policies and procedures – for example, regarding cut-off times for transactions. Your documentation should be periodically reviewed and updated. While this can be time-consuming, resources need to be allocated to it. You should review and update your documents when there are changes in: your organisation the external environment, or your systems or products. © ASIC and APRA > August 2008 page 28 Page 30 Unit pricing — guide to good practice Management issues 4 Guide to good practice in effective risk management (cont.) Independent review and investigation Regular independent review of the inputs and outputs of unit pricing, as well as the related systems, procedures, methodologies and controls, can signifcantly reduce the risk of error. These reviews should both check accuracy and consider whether the related processes continue to be relevant. Reviews can be undertaken by parties who are not directly involved in the unit pricing function – for example, internal audit, the compliance unit, the risk management unit, external auditors, actuaries or other external advisers. The use of such independent review is generally regarded as good practice. For example, IFSA Standard 5.00 Operational capabilities specifes that scheme operators should have appropriate compliance or independent audit functions to ensure that control systems operate effectively. Our unit pricing survey found that where product providers have audits conducted for unit pricing functions, the focus is on member registry, fund accounting, asset valuation, and fee, tax and unit price calculations. However, member registry and tax calculation functions are audited less frequently. While external audits are generally conducted half-yearly or annually, internal audits tend to be based on the organisation’s assessment of risk. Remember that the compliance plans of registered managed investment schemes must be externally audited every fnancial year (under s601HG of the Corporations Act 2001), and the risk management plans and risk management strategies of superannuation funds must be audited annually (under s113(3)(c) of the Superannuation Industry (Supervision) Act 1993). © ASIC and APRA > August 2008 page 29 Page 31 Unit pricing — guide to good practice Management issues 4 4.2 Unit pricing issues common to many products Forward pricing or historic pricing Many product providers use forward pricing to calculate unit prices. With forward pricing, applications to buy or sell units are processed using a price calculated and published after the applications have been received. For example, the end of day price is used for applications received during that day. The use of forward pricing may be limited by governing documents. Old information technology systems or the design of registry systems may also pose a challenge to the use of forward pricing. An alternative is to use backward or historic pricing. This enables purchases and sales of units using a price calculated before applications have been received – for example, yesterday’s price is used for applications received today. In this case the most recent market movements are not refected in the price. Where historic pricing is used there is potential for arbitrage – that is, unit holders can buy or sell units to take advantage of the difference between yesterday’s price and the subsequent shift in market value. When this happens, a few transacting unit holders beneft to the detriment of all ongoing unit holders. Fund documents may state that forward prices will be used, whereas we have seen cases where both forward and historic prices were used in practice. In 2004 ASIC reviewed the investment practices of 70 managed investment scheme operators in Australia following regulatory action regarding market timing and late trading behaviour in the United States. The review found that 84% used forward pricing exclusively while 9% used some backward pricing. Many pieces of information are used to calculate one unit price As shown in Figure 2, ‘Key elements of the unit pricing cycle’, data is drawn from many sources to calculate a unit price. For example, information about security and derivative values, foreign exchange rates, or tax benefts and fees might be included in a price. There is a risk of error where data is not checked. For example, commercial data feeds for listed equity and derivative prices may include stale prices, zero amounts, or daily movements outside the usually accepted tolerances. We have also seen incorrect foreign exchange and fee rates applied. © ASIC and APRA > August 2008 page 30 Page 32 Unit pricing — guide to good practice Management issues 4 There is also a risk of error when the information used to calculate a unit price is not timely. External product providers may be slow to provide the prices of units in unlisted managed investment schemes. Providers vary in their ability to provide prices, depending on their technology and systems. The wrong data fles may be sent, or data fles with the wrong date may be used in unit pricing calculations. Manual operations increase the possibility of error. Prices may be provided by facsimile, rather than electronically, requiring manual entry. Transaction costs When unit holders enter or exit an open-ended fund, investment assets are bought or sold to support the change in number of units on issue. The acquisition or disposal of these assets incurs transaction costs such as brokerage fees. These transaction costs will vary depending on the type and volume of assets transacted. A fund investing in international equities will incur different transaction costs from a fund investing in domestic fxed interest securities. Funds with high volumes of transactions may be able to negotiate lower brokerage fee rates. In some cases – for example, when a person invests in a fund by transferring equities into the fund (‘in specie’ transfer) – transaction costs are not charged by the product provider because brokerage costs have not been incurred. There are a number of ways that transaction costs have been allocated – for example, using: the mid-price as a single price for both sales and purchases. Transaction costs for unit holders entering and leaving the fund are paid by the fund and so subsidised by all existing unit holders. The impact on the fund becomes greater as more units are bought and sold a buy-sell spread, where two prices are applied, calculated from the mid-price plus or minus an allowance for transaction costs. The higher price is paid by people entering the fund. The lower price is received by people exiting the fund the net buyer/seller method, where a single price is used for both applications and redemptions. Whether the price is above or below the mid-price depends on whether there are more buyers or sellers: when the overall size of the fund is increasing – a net buyer position – transaction costs are added to the unit price. In effect the underlying assets associated with the units of exiting unit holders are sold to the new unit holders when the overall size of the fund is decreasing – a net seller position – transaction costs are subtracted from the unit price. © ASIC and APRA > August 2008 page 31 Page 33 Unit pricing — guide to good practice Management issues 4 We have seen unit pricing errors arise where uncertainty about the methodology has resulted in inconsistent calculation of transaction costs or inappropriate application of transaction costs. Backdating – processing applications other than on the date of receipt The practice of backdating – that is, processing applications to acquire or sell units after the date of receipt – may increase the risk of error. For example, the wrong date of receipt may be recorded or the price for the wrong date may be applied. Errors may occur particularly when there are long delays before processing or where many applications accumulate. Fund documents, including the PDS, may specify rules about the price to be applied when units are issued or redeemed and the timeframe in which applications will be processed. Unprocessed money (money paid to a product provider to acquire a fnancial product, where the product has not yet been issued) must be held in trust for the person who paid the money in a designated account until the units are issued: see s1017E of the Corporations Act 2001. Manual systems and workarounds Some entities use computer spreadsheets to calculate and record pricing data or unit prices. Some entities, particularly after takeovers or mergers, join disparate unit pricing computer systems by using temporary manual systems that are not well documented or maintained, but which become entrenched over time. Short-term computer fxes and manual workarounds have been a signifcant cause of unit pricing errors. We have seen double counting of fees and the use of incorrect rates or incorrect formulae for fees. Guide to good practice in relation to common issues Forward pricing or historic pricing Forward pricing is preferred to historic pricing. You should take steps to move to forward pricing, where possible. When moving to forward pricing, it is important to consider the matters discussed in section 4.5, ‘Managing change’. © ASIC and APRA > August 2008 page 32 Page 34 Unit pricing — guide to good practice Management issues 4 Guide to good practice in relation to common issues (cont.) Where historic pricing is used, controls should be in place to avoid arbitrage. Some controls that may assist are: introducing fees for frequent switching, or a disclosed period of delay to make arbitrage uneconomic monitoring and investigating switching activity by investors, and conducting market volatility tests so that unit transactions are suspended if markets move by more than a pre-determined amount. This needs to be supported by clauses in the documents setting out fund operating rules that permit suspension and recalculation of unit prices during periods of extreme market volatility. Where unit prices are calculated less frequently than daily, the use of forward pricing will mean that applications are accumulated in the period leading up to the calculation of the price, and processed as soon as possible after calculating the price. Batching If you use batching, you should process applications and redemptions at the same time you strike the unit price. In our view this is good practice. We encourage you to: batch and process on the day, or the day after, the price is calculated, and make reasonable efforts to ensure that any return earned on unprocessed funds is attributed to the investor. If batching is not possible, a less preferred option is to accumulate applications in the period before the price is struck, and process those applications in the period after the price is struck.