COVID-19, and economic responses in New Zealand and around the world, is continuing to cause record falls (and recoveries) in the markets in which KiwiSaver and other managed funds invest. For example, the US Dow index is down 30% since its all-time high reached last month.
The Financial Markets Authority (FMA) issued a series of announcements yesterday afternoon (19 March 2020) including notification that it was working closely with the Council of Financial Regulators (CoFR), which includes New Zealand’s Treasury, the Reserve Bank, Commerce Commission and the Ministry of Business, Innovation and Employment (MBIE), as well as frontline regulators NZX, Supervisors and Audit bodies, to ensure a co-ordinated response for the industry. The FMA has also published consumer warnings about the risks of investment scams exploiting market conditions and uncertainty caused by the COVID-19 pandemic.
In New Zealand’s market, fund managers are seeing a major spike in transfers from growth to conservative funds, with KiwiSaver reacting more than other managed funds (e.g. unit trusts). Within the turbulence, pro-active fund managers are finding buying opportunities in the equity and debt markets.
Fund managers are considering a range of questions and the implications of COVID-19 related issues under their licence, under product disclosure statements (PDS) and the Disclose Register, governing documents, and statements of investment policy and objectives (SIPOs). They are also responding to a record number of investor enquiries including hardship applications and those seeking advice on the implications of the current market convulsions.
Financial advisers are having to ensure advice is still appropriate in a rapidly changing environment, while counselling clients to resist panic and remain objective.
While the global impact of COVID-19 is extensive and new issues continue to emerge, fund managers should consider the points below.
Business Continuity Plan
Urgently review the business continuity plan you maintain as a requirement of your fund manager’s license against the latest information, and consider whether it is adequate for the current situation. To the extent that it is not, consider whether any reporting requirements are triggered under Financial Markets Conduct Act.
Few envisaged disruptions of the scale of the COVID-19 pandemic at the time they prepared their current plan. The issues currently being considered include:
- the global nature of the pandemic means overseas offices may be affected at the same time;
- there is potential for CBD or country wide lockdowns at some point in the future, meaning “working from home” may be required for the whole enterprise for an extended period;
- the fund managers own business may be impacted alongside many others, and the collective impact may stress infrastructure such as telecommunications;
- service providers and regulators may also be impacted in parallel with the fund manager’s business;
- some regulatory requirements for physical sign-offs or certifications may be difficult when service providers (e.g. auditors and lawyers) are also required to work remotely.
- working remotely for extended periods raises additional health and safety, privacy concerns, and increased cyber-security risks.
Fund managers are working hard to update their plans with multiple scenarios from the optimistic view that this will be a short-term disruption which will fade once current market panic subsides, to the pessimistic view that this is only the beginning of an event the like of which has not been seen before.
Net asset value (NAV) setting and buy/sell spreads
Ensure NAV setting and unit pricing provisions in your governing document are being followed. Consider whether buy/sell spreads or other mechanisms are appropriate to provide fairness between exiting and remaining investors in times of volatility. If the governing document does not provide an appropriate mechanism, agree amendments now with the supervisor/trustee, in the interests of all investors.
High levels of volatility can present challenges in setting the fund’s NAV used for establishing unit prices and other purposes. The timing of valuations can also present challenges. Further issues arise when current prices cannot be obtained, for example, for listed equities for which trading is suspended for an extended period, or fixed interest securities for which market quotes are not available, or only at extended spreads.
Until recently, many New Zealand managed funds have provided for new investments and redemptions in and from their funds to occur based on its NAV. But large flows in and out of funds can raise questions as to whether the costs are adequately addressed by the NAV calculation, and are fair to all relevant parties.
It is vital that the governing document’s current provisions are followed, at any time. Depending on the terms of the existing trust deed, there may be leeway to exercise discretion to recognise the full costs to the fund (and therefore to remaining or new investors) of sales of assets.
If the governing document does not adequately cover the issues, it may be possible to amend it with the approval of the supervisor trustee, to appropriately regulate the position. If the position worsens (which we hope it will not) there are useful precedents from the global financial crisis (GFC) a decade ago as to how governing documents may provide, for example, for “side-pockets” for illiquid assets or deferral of redemptions.
Statements of investment policy and objectives (SIPOs)
Assess the materiality of any limit breaks under the SIPO and report promptly to your supervisor.
One of the innovations under the Financial Markets Conduct Act was giving SIPOs a formal status and creating consequences for asset class limit breaks.
Limit breaks can arise passively, (e.g.e.g. when falling equity prices result in a balanced fund being overweight fixed interest), as well as actively (e.ge.g. when a manager chooses to hold more cash than envisaged under the SIPO).
Fund managers are checking carefully the wording of their SIPOs to see what leeway there is to respond to the current market conditions. Some were drafted (with the benefit of insights gained during the global financial crisis) to allow discretion within wide ranges, while indicating a target. Others set tightly defined limits of the proportion of the fund that can be held in specified asset class. The two types of provision have different implications for what calls the fund manager can make.
Material limit breaks are required to be reported to the supervisor. The assessment of materiality must consider both the nature or type of investments that can be made and the proportion of each type of asset.
Consider additional risk disclosure is required either in the PDS or on disclose.
Financial Markets Conduct Regulations require a risk indicator diagram showing, on a scale of 1 to 7, a ranking for the managed fund calculated based on a standard deviation calculated from the weekly returns of the fund over the last five years. The regulations do not envisage adjustment, unless the investment policy has changed significantly. The fact that the ranking determined under the regulations may not reflect the forward-looking position does not allow it to be changed, but some may consider a warning note appropriate.
PDSs must also include a description of circumstances that exist, or are likely to arise, that significantly increase the risk to the returns for investors in the scheme or fund, other than those already reflected in the risk indicator. Most PDS already identify equity market volatility but this too should be reviewed.
Managers may also want to look at their existing disclosure of other material matters (outside the PDS) on the Disclose Register.
Ensure any financial advice given is well founded and within the fund manager’s capability, and where appropriate refer the customer back to their financial adviser.
The FMA Chief Executive has said: “KiwiSaver providers should be providing general (class) advice to members at this time.”
While that sentiment is understandable, fund managers should take great care giving financial advice. They must ensure that any financial advice given is compliant with the requirements of the Financial Advisers Act. They will usually not be aware of an individual investor’s overall financial situation or goals, but they must ensure that the investor does not assume or expect that they have taken those into account. Specifically, they are unlikely to be aware of the investor’s risk appetite, or investment horizon.
Given the uncertainty created by COVID-19, it may be appropriate to refer investors back to their own financial adviser, or to online tools for assessing risk appetite such as Sorted.org.nz.
The regulatory compliance environment
Actively engage with MBIE, FMA and other regulators, either directly or via industry groups, to ensure they understand the challenges being faced, including from the regulatory reform agenda.
Various government reform initiatives are underway or proposed, for example, the financial adviser regime (under the Financial Services Legislation Amendment Act) due to take effect on 29 June 2020, and the Conduct of Financial Institutions Bill, and thematic reviews by regulators. The COVID-19 pandemic means that some fund managers may not have capacity to adequately address those initiatives, or that it is not appropriate, for example, to require staff to attend large training workshops.
The FMA has already shown understanding of those concerns. In yesterday’s announcements it confirmed a delay on its planned thematic review on liquidity for managed investment schemes to ensure fund managers can continue to focus on the issues at hand. The FMA was also considering deferral or reduction of other monitoring activity such as audit quality reviews for audit firms, NZX’s Obligations Review and other planned proactive and thematic monitoring activity and information gathering.
Similarly, the FMA and NZX have announced their intention to give NZX-listed firms, Financial Markets Conduct Act reporting entities and auditors more time to publish their audited annual financial statements.
However, fund managers should communicate their resource constraints to other government agencies, such as MBIE, so that they can prioritise initiatives they are responsible against the requirements to respond to COVID-19.
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