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FMA releases findings of MIS custody review

13 December 2019

FMA releases findings of managed investment scheme (MIS) custody review

The Financial Markets Authority has published a summary report on a review of custody arrangements in managed investment schemes (MIS) in response to questions raised by the International Monetary Fund (IMF).

The thematic review, conducted by PwC, focused on retail funds and found 99.95% of MIS assets are being held in custody appropriately. Assets typically not held in custody were mainly bespoke assets, such as derivatives and term deposits¹.
The review identified issues around the consistency and independence of custody arrangements.

MIS managers are responsible for the investment strategy, while supervisors are responsible for custody: holding and safeguarding the scheme’s assets and keeping accurate records. By default, supervisors are custodians but they may appoint another appropriate independent person as custodian.

One of the issues raised by the review was that supervisors are 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 weakens 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.”

Two other key findings from the review were:
• Because a very large proportion of managed fund assets are invested in wholesale funds, where custody is not regulated (apart from fair dealing in the Financial Markets Conduct Act), supervisors need to ensure they do due diligence on the custodial arrangements of wholesale funds.

• The ‘annual audit (assurance) engagements’ obtained by custodians were generally positive but there were a variety of approaches implemented by schemes, which resulted in inconsistencies. Annual audit assurance engagements require custodians to procure a report from an auditor that provides assurances on custodial processes, procedures and controls.

Supervisors are licensed by the FMA but custodians are not. In 2017, the IMF recommended that custodians be licensed by the FMA. The regulator has concluded there is more that supervisors can do to implement sufficient controls and oversight of custody arrangements within the current legislation of the Financial Markets Conduct Act but will assess options after industry engagement.


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