The Australian Prudential Regulation Authority (APRA) and Australian Securities and Investments Commission (ASIC) today released a consultation paper seeking industry comment on proposed guidance for good practice in unit pricing.

The release of this consultation paper follows a joint review of unit pricing practice in life companies, superannuation providers and fund managers conducted by the regulators from July to December 2004.

Both ASIC and APRA have raised concerns about unit pricing practices in these entities in recent years. There have been several instances of unit pricing errors involving compensation of more than $10 million and affecting many thousands of investors.

The joint review has found that particular attention must be paid to:

• establishing an effective risk management culture;
• developing and consistently applying appropriate unit pricing policies;
• maintaining robust systems, processes and interfaces to cope with the necessary volume and frequency of unit pricing activity and the diversity, complexity and variability of product designs and fund structures;
• aligning unit pricing practices with statements in related documents;
• taking responsibility for all unit pricing functions, even when those functions are outsourced;
• timely and reasonable allowance for the value of all assets and liabilities attributable to unit holders, including non-market assets and future tax assets and liabilities;
• reconciling values used in unit pricing with those reported in published accounts;
• complying with obligations to prevent unit pricing errors, treat unit holders equitably, and to act in the best interests of unit holders as a whole; and
• accepting the obligation to compensate all unit holders in an equitable fashion when material errors are identified.

ASIC and APRA are seeking comment on the proposals from a wide range of industry participants including unit pricing practitioners, senior managers, service providers, and professional advisers including actuaries, lawyers, auditors, accountants and other consultants.

APRA Deputy Chairman, Mr Ross Jones, said that when the final guidance is issued in 2005, ASIC and APRA will expect increased understanding of good practice in unit pricing to be demonstrated at all levels of regulated organisations.

'We will also expect increased commitment to the implementation of effective unit pricing practice', he said. 'While this guidance is only one tool in the regulatory framework, it will set a benchmark for expectations about appropriate practice across the industry.'

ASIC Executive Director of Financial Services Regulation, Mr Ian Johnston, said that ASIC and APRA are working to develop a joint regulatory approach to assist industry participants to understand and meet their obligations in a consistent manner. 'ASIC and APRA have not formed a view that there is one preferred way to calculate unit prices. Rather, the regulators have identified a range of practice with the characteristics of good practice.'

Comments are requested by Friday 18 February 2005.

The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry.APRA is funded largely by the industries that it supervises. It was established on 1 July 1998.APRA currently supervises institutions holding approximately $2.0 trillion in assets for 20 million Australian depositors, policyholders and superannuation fund members.

1. Unit prices may be calculated under intense pressure

   Unit prices are often calculated in a high-speed, high-pressure environment. A manager of retail financial asset funds may calculate and publish many hundreds of unit prices every business day.

   The range of unitised products available in the market is numerous and diverse. Even a single provider may administer many different unitised products offering a variety of investment choices. Many of these products and investment choices may no longer be actively marketed to new investors, and yet they still have to be administered. Certain investment choices may involve investment in other funds, either within the same provider or elsewhere, which are themselves also unitised.

   All of this complexity adds to the pressure on achieving accurate unit pricing.

   The same pressure may not be present for other entities, for example with wholesale funds or superannuation schemes, where there are fewer products or where pricing is less frequent.

   Proposed guidance: Whatever the circumstances, product providers should implement reliable systems, procedures, controls and business continuity plans.
   
   

2. Unit pricing errors tend to be systemic

   Errors in unit pricing systems may be undetected for long periods. There have been cases where preventable small errors in the calculation of fees, tax or transaction costs have accumulated over several years, ultimately affecting many thousands of unit holders.

   Proposed guidance: Product providers should check data and valuation methodologies before data is used in unit pricing calculations. Product providers should obtain independent review of calculation methodologies. Product providers should manage old information technology systems effectively and ensure viable interfaces between old and new systems.
   
   

3. Effective risk management processes are essential

   The less complex the systems and the more effective the checking and reconciliation procedures, the more likely it is that errors will be avoided, or quickly identified.

   Proposed guidance: Effective risk management should ensure unit pricing systems and procedures are well designed and well understood, and should involve periodic independent reviews of those systems and procedures.

   End-to-end process maps are a tool to assist risk management, and may be particularly useful if developed by the unit pricing team.

   Attention to risk management is particularly important during times of change.
   
   

4. Unit pricing practice needs to be consistent with statements in related documents

   Some errors have arisen, not because a unit pricing calculation method has been intrinsically faulty, but because the calculation method has not matched statements by the product provider about that method. Errors have arisen, for example, regarding asset valuation and transaction cost methodologies and regarding fee and tax treatments.

   Proposed guidance: Product providers must ensure that unit pricing practice is consistent with the statements made about that practice in the life insurance policy, managed investment scheme constitution, superannuation trust deed, scheme compliance plan and the product disclosure statement.
   

5. Unit pricing entities must comply with their obligations

   Product providers must comply with a range of obligations. For example, product providers have obligations to prevent unit pricing errors and to treat unit holders equitably. Product providers also have a duty to act in the best interests of unit holders as a whole. In meeting these obligations, and in the conduct of their business in relation to unit pricing it is likely that product providers will need to exercise judgement.

   Proposed guidance: Product providers should use soundly-based processes when forming such judgements. Where assumptions are used in exercising judgement, those assumptions should be reasonable. Processes and assumptions, and the bases for those assumptions need to be documented.
   
   

6. Unit pricing entities are responsible for outsourced functions

   Whether product providers perform functions in-house, or outsource unit pricing functions to a service provider, product providers remain responsible for the performance of those functions.

   Proposed guidance: To monitor the provision of services by another entity, product providers should build and maintain an effective working relationship with the service provider, maintain appropriate knowledge, and build and maintain appropriate monitoring systems.

7. Unit pricing policies should be applied consistently and kept up to date

   Many facets of business operations affect unit pricing, including product development, tax, accounting, information technology, legal, marketing and risk management. During the joint review the regulators found that the same unit pricing word or phrase can have different meanings even within one organisation.

   Proposed guidance: Up to date policies are required to ensure that all relevant matters are addressed in unit pricing and that all business operational areas work together effectively. Policies should be discussed, understood and applied consistently.

8. Reasonable allowance should be made for the value of all assets and liabilities attributable to unit holders, including non-marketable assets and future tax assets and liabilities

   In many cases the value of an asset can be readily and reliably determined from the quoted prices of similar assets that are regularly traded in a deep and liquid market. However, the value of some assets, including private equities, properties and international investments, may need to be estimated for a period until a firmer valuation becomes available or the asset is sold.

   The same applies to tax assets or liabilities, the value of which depends on a range of assumptions about the amount and timing of future cash flows.

   Proposed guidance: If updated values of assets and liabilities are not available at the time that a unit price is to be determined, then the value needs to be estimated on a reasonable basis that ensures that all unit holders, and potential unit holders, are treated equitably.

9. The value of an asset or liability for unit pricing purposes may not necessarily be the same as its value in the published accounts.

   The purpose of the provider’s accounts is to provide a true and fair indication of the financial position and performance of the provider. The value of assets and liabilities reported for that purpose may not necessarily be the same as that needed for unit pricing, where the priority is to ensure that unit holders are treated equitably.

   Proposed guidance: Any differences between published unit prices and the corresponding assets and liabilities in the provider’s accounts need to be able to be reconciled and explained to investors.

10. Errors need to be compensated

    Errors may still occur. However, by diligent focus on risk management and control of systems and processes, the size and frequency of errors can be minimised.

    Proposed guidance: If a material error is identified then all affected unit holders need to be compensated in a manner that is fair to all unit holders, whether affected or not. The threshold test for compensation needs to be applied consistently in each instance and in good faith.