The Financial Markets Authority (FMA) has earmarked small fund managers and mortgage funds, in particular, for greater scrutiny following its first risk assessment of the licensed investment scheme sector.
Primarily based on input from supervisors, the inaugural FMA sector review found a correlation between manager size and potential risks – especially concerning governance.
Under the FMA definition, smaller firms manage under $250 million, medium-sized enterprises hold between $250 million and $10 billion while larger players control $10 billion or more.
“The governance risk of small managers is typically higher than that of larger fund managers, driven by factors such as relatively weaker financial strength, less consistent reporting to the manager’s board, limited capability and capacity of the board and/or senior management, and fewer independent directors,” the review says.
Most NZ licensed managers fit into the medium-sized box, which the FMA says contains some high risks mostly due to “systems, processes, and capability not keeping pace with the growth of the businesses”.
Despite noting the tiny systemic risk of a sub $250 million fund manager falling over, the regulator indicated it would step up oversight of smaller managers.
“… based on the risk ratings, the likelihood of a risk materialising is much higher in small fund managers, indicating a need for greater supervision or FMA scrutiny,” the review says.
But the regulatory warning falls doubly on licensed mortgage fund managers that suffer both from size issues and idiosyncratic asset class risks.
The FMA report says the risk for mortgage fund managers is “higher than that of other sub-sectors”, mostly due to investment-related issues including liquidity, sensitivity to macro factors (interest rates) and concentration of assets.
“Mortgage funds also have limited staff, senior management and board resources due to their smaller size relative to other fund managers,” the review says. “Mortgage funds often have significant transactions with their related business partners. Although no mortgage fund manager has been found to have breached the conflict-of-interest rules, this still contributes to governance risk.”
However, policing the licensed mortgage fund sector should not be too onerous for the FMA with only three entities in the category: First Mortgage Trust; Norfolk Mortgage Management; and Midlands Funds Management.
The review covered 53 licensed managers but excluded superannuation, workplace savings, forestry and property funds.
Paul Gregory, FMA investment management director, said the review showed the value of licensed supervisors in monitoring the managed fund sector and ensuring “that existing mitigants and controls remain adequate and effective”.
According to a FMA spokesperson, the risk report provides all NZ fund managers with a good indication of the industry practices set to fall under the regulatory microscope this year.
Among other factors, the regulator named investment operations and outsourcing, board oversight, manager financial strength and offers of “new (and typically volatile and/or illiquid) financial instruments” as key risks.
Last week the FMA also closed off one of four vacancies in its top executive ranks with the appointment of Stuart Johnson to the newly created chief economist role.
Johnson was previously head of behavioural economics and conduct for the UK life insurance giant, Aviva.
The FMA has yet to fill the director positions covering transformation and operational delivery, strategy and design, and Te Ao Māori flagged in a restructure last year by new chief executive, Samantha Barrass.
At the same time, head of supervision, James Greig, is now “exploring future opportunities” after leaving the FMA during the break, the statement says.
Greig joined the regulator in 2016, rising to the director supervision rank in January 2021.