Problems identified with custody arrangements

New Zealand fund managers may have issues with the consistency and independence of their custody arrangements, the Financial Markets Authority has found.

Sunday, December 15th 2019, 9:23PM

It has released the results of a thematic review conducted by PwC of the custody arrangements of managed investment schemes.

In 2017, the International Monetary Fund published its review of the New Zealand financial sector, which recommended considering separate licensing and direct supervision of custodians of managed investment schemes.

The FMA said it had also received reports of inconsistent practices by different custodians and involving different types of assets.

Supervisors are responsible for funds’ custody, holding and safeguarding assets and keeping accurate records. They may appoint another independent person as custodian.

The review found supervisors were often delegating custody administration tasks back to fund managers, such as record-keeping. Although the legislation requires the custodian to ensure that accurate records are kept, rather than requiring the custodian to keep all records itself, the FMA said this practice weakened the separation of functions and duties.

Liam Mason, FMA director of regulation, said: “Custodians perform key functions in safeguarding investors’ assets. They provide an additional layer of protection for investors from risks such as human error, fraud and manager insolvency.

“We were pleased to find the vast majority of assets under management were being held in custody appropriately. However, we have identified potential weaknesses in the way custodians and supervisors have implemented certain provisions of the legislation. We will engage with the industry to clarify and reinforce our expectations and we’ll continue to assess if further legal reform is required to license custodians.”

The review also found that, because a large proportion of managed fund assets were in wholesale funds, where custody was not regulated, supervisors would need to ensure they did due diligence on the custodial arrangements of the wholesale funds.

"We recognise that some of the issues identified have arisen out of business practicality and are meant to minimise the costs of custodial arrangements where the market generally considers the likelihood of risk crystallisation to be low," the FMA said.

"These factors need to be balanced against the clear expectation in the legislation about segregation of functions and duties. We will engage with supervisors and MIS managers to understand concerns and clarify our expectations in this area."

Supervisors are licensed by the FMA but custodians are not. In 2017, the IMF recommended that custodians be licensed by the FMA. The FMA said there was more supervisors could do to implement sufficient controls and oversight of custody arrangements within the current legislation but would assess its options after engaging with the industry.

Tags: FMA funds management