CIS 7 Annex 1 G Valuation and Pricing of authorised funds

1.

Introduction

Application

(1)

(a)

This Section 1. applies to authorised fund managers and depositaries;

(b)

Section 2. applies to authorised fund managers;

(c)

Section 3. applies to depositaries; and

(d)

Sections 4. and 5. apply to authorised fund managers and depositaries, as indicated.

Explanation

(2)

(a)

This annex provides details of the types of checks and standards of control which an authorised fund manager and the depositary of authorised funds should have in place for the valuation of the scheme property and pricing of units.

(b)

This annex then sets out conditions under which the FSA would not consider it necessary for a pricing error of below a certain amount to result in compensation being payable to an investor.

(c)

This annex relates to CIS 7.3.2 G, CIS 7.4.2 G, CIS 7.8.2 G and CIS 7.9.2 G.

2.

Pricing controls by authorised fund managers

Introduction

(1)

This section details the type of control regime the FSA considers that an authorised fund manager should employ to satisfy its obligations under CIS 7.3.1 R (3)(c) and CIS 7.8.1 R (4).

(2)

Evidence of persistent or repetitive errors, or errors consistently in an authorised fund manager's favour, is likely to make it more difficult for an authorised fund manager to demonstrate it meets the standards in this section.

Method for valuing scheme property

(3)

An authorised fund manager should determine its method for valuing the scheme property and apply it on a consistent basis.

Source of share prices and currency rates

(4)

(a)

Share prices and currency rates used should be up to date and from a reputable source.

(b)

The mere use of a source for prices and rates does not amount to delegation under CIS 7.10.4 R (Delegation) and obtaining assistance under CIS 7.6.1 R (Committees and appointments).

(c)

Although it should not be necessary to carry out significant substantive checking, the reliability of the source of prices and rates should be kept under regular review and doubtful prices or rates should be followed up.

Valuation agents

(5)

(a)

The use of a third party to carry out the valuation function amounts to delegation, in accordance with CIS 7.10.4 R (Delegation) and obtaining assistance under CIS 7.6.1 R (Committees and appointments).

(b)

Where the pricing function is delegated under CIS 7.10.4 R or when assistance is obtained under CIS 7.6.1 R, the authorised fund manager should satisfy itself that the valuation agent's system is robust and will produce accurate results.

(c)

An authorised fund manager should keep the valuation agent's controls and procedures under review. That review should ensure that changes to controls and procedures, including a series of minor changes, do not have a significant adverse effect on the accuracy of the system.

(d)

An authorised fund manager should review the outputs from the system regularly, and on any significant system change.

(e)

In addition, if the valuation agent is also responsible for calculating dealing prices of units, an authorised fund manager should regularly review this system.

Reconciliation

(6)

(a)

Unless the valuation and record keeping systems are integrated, the valuation output should be agreed with an authorised fund manager's records of the authorised fund at each valuation point.

(b)

In addition, an authorised fund manager's records, including debtors and creditors, should be agreed with the depositary's records of stocks and both capital and income cash on a frequency agreed between the authorised fund manager and depositary. Reconciling items need to be followed up promptly, and debtors reviewed for recoverability.

Inclusion of investment transactions in valuations

(7)

(a)

Systems should be in place by which all investment transactions are confirmed as quickly as possible in writing or by electronic means to an authorised fund manager or to a valuation agent.

(b)

It is desirable that all deals to which the authorised fund is committed, which have been notified not less than one hour before a valuation, are included in that valuation, at estimated prices if necessary.

(c)

Unless, however, there is likely to be significant movement in the price of a unit, it is more important that an accurate cut-off procedure is in place to ensure that omissions or duplications do not take place, than it is to ensure that estimates are included in a valuation.

Prices obtained otherwise than from the main pricing source

(8)

(a)

Where prices are obtained otherwise than from the main pricing source (for example unquoted, suspended, or illiquid stocks), an authorised fund manager should maintain a record of the source and basis for the value placed on the investment.

(b)

The methodology, procedure and controls for the valuation of those stocks should be regularly reviewed to ensure that the valuations are fair and reasonable in the circumstances.

Investment and borrowing powers/compliance

(9)

Procedures should be in place to monitor the applicable rules in CIS 5 or CIS 5A and, if breaches occur, to ensure they are rectified in accordance with CIS 7.5.3 R or CIS 7.10.3 R.1

Unapproved securities

(10)

To assist with the identification of the level of investment in securities that are not approved securities, the authorised fund manager should notify the depositary of any trade in unapproved securities as soon as reasonably practicable.

Dividends, interest and expenses

(11)

(a)

A system should be in place to ensure that dividends are accounted for as soon as stocks are quoted ex-dividend, unless, as with some foreign stocks, it is prudent to account for them only on receipt.

(b)

Fixed interest dividends and interest should be accrued at each valuation point unless the level of materiality makes a longer interval appropriate.

(c)

Similar considerations apply to the expenses of an authorised fund.

Tax positions relevant to the authorised fund

(12)

(a)

The full tax position should be reviewed regularly, including the basis for the current tax charge, the assumptions being used, and the tax rate applicable.

(b)

Adjustments should be made for substantive changes (for example alterations to the tax profile or likely tax charge) when they occur.

Dual-priced AUTs

(13)

In the case of dual-priced AUTs, the justification for figures included for dealing expenses and commissions included in the price of a unit should be reviewed regularly, separately for different markets of different sectors. Adjustment should be made for substantive changes (for example changes in the rate or basis of stamp duty) as and when they occur.

Valuation limits

(14)

(a)

An authorised fund manager should fix a percentage or absolute limit for certain key elements of the valuation, so that any movement outside these limits is investigated. The investigation and its outcome should be evidenced and retained by the authorised fund manager.

(b)

These key elements could, where relevant, include:

(i)

the movement of the prices and values of individual stocks;

(ii)

changes in currency rates; and

(iii)

accrual figures for income, expenses, and tax.

Prices which appear not to have changed after a fixed period of time should be investigated, since this may be the result of a price movement having been missed.

Cash

(15)

Cash should be reconciled to the bank account regularly, with outstanding items promptly followed up, and a full reconciliation should be sent to the depositary at a frequency agreed with the depositary.

Recording of units in issue

(16)

Controls should be in place to ensure that the correct number of units in issue is recorded at each valuation point. This should be reconciled with the register of Unitholders or shareholders at a frequency agreed with the depositary.

Verification by the fund manager of the assets of the authorised fund

(17)

A copy of the valuation used to produce the price of the units should be sent to the fund manager at least weekly, which he should check. When the authorised fund'svaluation point is less frequent than weekly, a copy of the valuation used should be sent to the fund manager as soon as practicable after the valuation point.

3.

Pricing checks by depositaries

Introduction

(1)

This section provides details of the types of checks a depositary should carry out to be satisfied that the authorised fund manager adopts controls and systems which are appropriate to ensure that prices of units are calculated in accordance with CIS 4 or CIS 15, and to ensure that the likelihood of incorrect prices will be minimised. These checks also apply where a manager has delegated all or some of its pricing functions to a third party or where an ACD has obtained the assistance of a third party to carry out all or some of its pricing functions.

Review by the depositary of authorised fund manager's controls and systems

(2)

A depositary should thoroughly review an authorised fund manager's controls and systems to confirm that they are satisfactory.

(3)

This review should be carried out:

(a)

at the start of a depositary's appointment, taking into account (where relevant) any relevant report made by the retiring depositary in accordance with CIS 7.4.3 R (3) (Duty to inform the FSA : for ICVCs) and CIS 7.9.3 R (3) (Duty to inform the FSA : for AUTs); and

(b)

thereafter, on a frequency dependent on the risk profile of the authorised fund;

(c)

when major changes are made by an authorised fund manager to its systems; and

(d)

when necessary, to ensure that a series of minor changes do not have a significant adverse effect on the integrity of the systems.

(4)

A review should be carried out more frequently where a depositary knows or suspects that an authorised fund manager's controls and systems are weak or are otherwise unsatisfactory. In particular, the prices of unapproved securities and (where unquoted) the basis for their calculation should be subjected to frequent verification, and an examination of the sources of the prices of those security should be carried out.

(5)

Additionally, a depositary should from time to time review other aspects of the valuation of the scheme property of each authorised fund for which it is responsible, verifying, on a sample basis, if necessary, the assets, liabilities, accruals, units in issue, security prices and any other relevant matters, for example an accumulation factor or a currency conversion factor.

(6)

The depositary's review should include an analysis of the controls in place to determine the extent to which reliance can be placed in them.

(7)

A depositary should ensure that any issues, which are identified in any such review, are properly followed up and resolved.

(8)

Where an authorised fund manager's systems are manual, or have been installed or amended recently and are therefore unproven, the level of checking will need to be increased accordingly. This will also be necessary where a number of instances of incorrect pricing have previously been identified.

4.

Recording and reporting of instances of incorrect pricing

Recording and reporting by the authorised fund manager

(1)

An authorised fund manager should record each instance where the fourth significant figure of a price of a unit is incorrect, and, as soon as the error is discovered, report the fact to the depositary together with details of the action taken, or to be taken, to avoid repetition.

Reporting by the depositary

(2)

In accordance with CIS 7.4.3 R and CIS 7.9.3 R (Duty to inform the FSA), the depositary should report any breach or potential breach of the rules in CIS 4 or CIS 15 immediately to the FSA. This would extend to instances of incorrect pricing of units or late payment. However, notification should relate to instances which the depositary considers material only. Materiality should be determined by taking into account a number of factors, including:

(a)

whether an authorised fund manager has followed the pricing controls set out in Section 2;

(b)

the significance of any breakdown in management controls or other checking procedures;

(c)

the significance of any failure of systems, including situations where inadequate back-up arrangements exist;

(d)

the duration of an error (the longer an error persists, the more likely that it will have a material effect on a price);

(e)

the level of compensation to be paid to holders in an authorised fund; and

(f)

an authorised fund manager's ability (or otherwise) to meet the need for compensation in full.

Factor (a) would tend to decrease materiality whereas the other factors mentioned will tend to increase it.

(3)

A depositary should also report to the FSA immediately any instance of incorrect pricing where the error is greater than 0.5% of the price of a unit, where a depositary believes that reimbursement or payment is inappropriate and should not be paid by an authorised fund manager.

(4)

In accordance with SUP 16.6.13R, a depositary should also make a return to the FSA on a quarterly basis which summarises, by authorised fund manager, the number of instances of incorrect pricing during a particular period. This should include:

(5)

(a)

the number of errors which were greater than 0.5% of the price of a unit; and

(b)

the number of errors which were less than 0.5% of the price of a unit where a depositary did not consider an authorised fund manager's controls and systems to be adequate.

5.

Incorrect pricing of units and reimbursement or payment

Introduction

(1)

(a)

CIS 7.3.1 R (3)(d) and CIS 7.8.1 R (5) place a duty on the authorised fund manager to take action to reimburse affected holders, former holders, and the scheme itself, for certain instances of incorrect pricing or late payment. Paragraph (8) and CIS 7 Annex 1, 2 sets out how money could be paid or reimbursed. This annex does not overrule any legal right to claim compensation.

(b)

However, reimbursement or payment may not be required, if it appears to the depositary that the incorrect pricing is of minimal significance. Paragraphs (4) to (6) outline the conditions which the depositary should take into account in considering whether an instance of incorrect pricing is of minimal significance.

(2)

The word "normally" is used throughout this Section 5 to denote "unless the depositary directs otherwise".

(3)

If a depositary deems it appropriate, it may, in spite of the circumstances outlined in (4), agree to a payment from the authorised fund manager or from the authorised fund to the holders, former holders, the authorised fund or the authorised fund manager (where appropriate), following an instance of incorrect pricing.

Instances where incorrect pricing is normally of minimal significance

(4)

A depositary may consider that the instance of incorrect pricing or late payment is of minimal significance if:

(a)

the authorised fund manager and depositary meet the standards of control set out in Section 2 and Section 3 of this Annex; and

(b)

in the case of incorrect pricing, the error in pricing of a unit is less than 0.5% of the correct price.

Instances where incorrect pricing is not normally of minimal significance

(5)

Any instances of incorrect pricing not covered by (4) will not normally be of minimal significance.

(6)

Where either a single factor or more than one factor causes an incorrect price over a period of time, the incorrect price is normally not of minimal significance:

(a)

if the standards in Sections 2 and 3 are not met, for all days on which there is an incorrect price; or

(b)

otherwise, only on those days where as a result the price is incorrect by 0.5% or more of the price of a unit.

(7)

If a depositary considers that reimbursement or payment is inappropriate, it should report the matter to the FSA, together with its recommendation and justification. The depositary should take into account the need to avoid prejudice to the rights of holders, or the rights of holders in a class of units.

(8)

The summary table sets out the effect of this annex on some circumstances in which incorrect pricing can occur, and how holders, former holders, the authorised fund or the authorised fund manager can be reimbursed or paid.

(9)

It may not be practicable, or even, in some cases, legally permissible for the authorised fund manager to obtain reimbursement from holders, where the holders have benefited from the incorrect price.

(10)

In all cases where reimbursement or payment is normally required, amounts due to be reimbursed to holders for individual sums under £10 will not, normally, need to be paid, although an authorised fund manager may pay such a sum, or may wish to make up smaller amounts to a higher figure (such as the £10 minimum).

Authorised fund

A

Authorised fund manager

B

D

F

Incoming holder

C

Outgoing holder

E

DEALINGS BETWEEN AN AUTHORISED FUND AND AUTHORISED FUND MANAGER(WHETHER OR NOT UNITS ARE SOLD OR REDEEMED FROM HOLDERS)

A

The authorised fund gains in relation to the authorised fund manager

(issue at too high or cancellation at too low a price). If:

(1)

incorrect price by less than 0.5%: normally no action;

(2)

incorrect price by 0.5% or more: the depositary will normally compensate the authorised fund manager from the authorised fund.

B

The authorised fund loses vis-à-vis the authorised fund manager

(issue at too low or cancellation at too high a price). If:

(1)

incorrect price by less than 0.5%: normally no action;

(2)

incorrect price by 0.5% or more: the depositary will normally direct the authorised fund manager to compensate the authorised fund.

DEALINGS BETWEEN HOLDERS AND THE AUTHORISED FUND MANAGER (WHETHER OR NOT THERE IS AN ISSUE OR CANCELLATION OF UNITS

C

Incoming holders gain in relation to the authorised fund manager

(New holders buy units at too low a price). If:

(1)

incorrect price by less than 0.5%: no action;

(2)

incorrect price by 0.5% or more: see paragraph (9) of this Section 5.

D

Incoming holders lose vis-à-vis the authorised fund manager

(New holders buy units at too high a price). If:

(1)

incorrect price by less than 0.5%: normally no action;

(2)

incorrect price by 0.5% or more: the authorised fund manager will normally compensate incoming holders

E

Outgoing holders gain in relation to an authorised fund manager

(Outgoing holderssell at too high a price). If:

(1)

incorrect price by less than 0.5%: no action;

(2)

incorrect price by 0.5% or more: see paragraph (9) of this Section 5.

F

Outgoing holders lose in relation to the authorised fund manager

(Outgoing holders sell at too low a price). If:

(1)

Incorrect price by less than 0.5%: normally no action;

(2)

Incorrect price by 0.5% or more: the authorised fund manager will normally compensate outgoing holders.