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(March-2003) The errors of our unitised ways
The number of unitised investment products continues to grow in Australia, and increasingly, in Asia. This growth is mainly in response to consumer and distributor demand for a wider range of investment options and it may well be accelerated with the potential introduction of ‘choice-of-fund’ legislation.
However, anecdotal evidence suggests that the frequency of errors and variety of problems arising with unitised products is high. A review of the financial press and regulatory web sites supports the conclusion that unit pricing and related errors, particularly performance related, are by no means rare or insignificant. In 2001, the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) conducted a number of joint visits to financial institutions as part of an APRA review of unit pricing in the super industry.
The theory of unitised products is simple — consumers acquire units at a unit price based on the net asset value of the assets divided by number of units on issue. Behind this conceptual simplicity lies a range of implementation and administration risks for operators of managed funds, unit trusts or unit-linked products. These risks are independent of the inherent investment risks, disclosure and reporting, and distributor issues.
Successful administration of a unitised product depends on implementing a reliable unit pricing mechanism. Pricing covers topics such as the treatment of income tax and franking credits, allowance for deferred capital gains tax, distributions, forward versus backward unit pricing, buy-sell margins, pricing frequency and so on. However, the long-term success of a unitised product also critically depends on other key factors including clarity of administration processes, quality of staff and their training, product design, robustness of systems, timeliness of processing, quality of investment information, and unit registry control.
The risk of failure in the overall administration and management chain is highest at its weakest link. From a consumer or distribution perspective, the cause of a failure is typically of little interest. The issue is simply that the product provider had a failure. This is particularly relevant when some crucial functions have been outsourced.
Those who are used to periodic (perhaps annual) interest crediting rate declarations need to make significant cultural shifts when they introduce or convert to unitised products. The time period applicable to unitised products is the length of the unit pricing cycle, be it daily or weekly. In principle, once a unit pricing period is completed, all transactions relating to it should be quarantined. For example, this implies no backdating should occur. The changes driven by unitising are pervasive. Care and planning are needed to ensure all impacts are reviewed to ensure effective and efficient administration.
In a perfect world, once a product has been properly implemented, accurate unit pricing from an integrated administration and investment reporting system might be expected. The reality is that no administration procedure can be perfect and mistakes will occur in an environment with nested data feeds, daily unit pricing regimes, and perhaps hundreds of products to price. While prevention is better than cure, operational risk controls need to be established to trap, cap and then correct errors when — not if — they occur.
Correcting errors requires ensuring unit holders ultimately are in a position where they are not disadvantaged. The cost and complexity of this can be significant. A clear methodology is required, as any correction must be confidently explained and justified.
Issues of how material the problem is and equity between groups of investors need to be considered. Industry standards provide a basis for assessing materiality, but interpretation in particular circumstances may be required. Errors may have different impacts on individual investors depending on whether they are buying or selling units. The key criteria for assessing the impact of errors are the value changes of the investments and these may not be revealed by an examination of unit prices alone. Corrections made at a fund level, in contrast to being specifically targeted at affected investors in the fund, may be unnecessarily expensive and may generate windfall gains for investors not impacted by the error.
When compensating investors, many issues need to be considered to ensure the correction is successfully implemented. Not only do amounts need to be determined, they need to be correctly attributed for both continuing and exited investors. Consequential issues, such as investor communications, annual statements and performance reporting, also need to be addressed.
Unitised products are an established growth area, and offer consumers valuable benefits, but the industry is faced with the ‘backroom’ challenge of ensuring that the products are, and are seen to be, properly and safely administered.
— Jules Gribble is a director of AskIT! Consulting. www.askit.com.au
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