NZ fund ambiguous buy-sell spread rules could be in need of a do-over to bring them into line with offshore practices, according to a leading financial services lawyer.
Lloyd Kavanagh, Minter Ellison Rudd Watts partner, said the current NZ buy-spread regulations, as defined in the Financial Market Conduct Act (FMC), “do not explicitly provide for what to do”.
Under the current NZ regulatory regime, the use of buy-sell spreads “is not a black and white issue, and judgment needs to be exercised”, Kavanagh said.
The FMC does not require NZ regulated funds (including KiwiSaver schemes) to apply buy-sell spreads but the issue cropped up during market volatility this March as trading costs – particularly in fixed income funds – blew out. In mid-May the Financial Markets Authority (FMA) issued new guidance on the matter, noting the buy-sell spreads “can be an appropriate tool for use in many [managed investment schemes] MIS, including some KiwiSaver schemes”.
Kavanagh said the FMA guidance helped clarify the status quo “but it would be better if there was more detailed and clearer rules, for example as in the European UCITS and AIF [alternative investment fund] regimes”.
The FMA guidance note says “material costs driven by investors transacting in fund units should generally be borne by those transacting investors as a group over a particular period”.
“Buy/sell spreads on entry and exit to the fund can be an appropriate tool to help to achieve this,” the regulator says.
However, the FMA stops short of endorsing spreads as best practice, putting the onus on managers to develop their own strategies to fairly apportion explicit fund entry and exit costs.
“When considering if and when buy/sell spreads are suitable for their funds, KiwiSaver scheme managers should take into account likely fund inflows and outflows under different scenarios,” the FMA says. “KiwiSaver scheme managers should also be particularly diligent in avoiding making the scheme unnecessarily complex.”
The regulator says MIS managers have the option of making buy-sell spreads permanent features or intermittent (according to market conditions) as long as the process is specified in scheme governing documents.
Kavanagh said in normal times when investor flows are evenly-balanced there was “no issue” in issuing buy or sell orders at net asset value (NAV).
“But, particularly at times of high levels of volatility, major inflows or outflows can raise questions as to whether all investors (ie the existing investors who are not subscribing or redeeming) should bear the additional costs of the underlying transactions required to take account of the inflow or outflow,” he said. “This is especially pronounced if the underlying investments are illiquid or subject to high transaction costs to acquire or sell.”
George Carter, head of Nikko Asset Management NZ, said while it’s not clear why the FMA issued the guidance, the move “could allay fears that buy-sell spreads are bad”.
“In fact, buy-sell spreads are healthy and good for investors when they’re done right,” Carter said.
Nikko, for instance, added buy-sell spreads to its KiwiSaver scheme after initially allowing entry and exit at NAV. The manager, along with a raft of others, also increased buy-sell spreads on its fixed income funds in the wake of the March COVID-19 bond liquidity squeeze.
Earlier this month, though, Nikko removed spreads on its NZ fixed income funds, arguing that the “volatility has since subsided and trading costs have moderated significantly”. But the manager maintains spreads on a range of other equity and diversified funds.
The FMA says managers could also consider alternatives such as ‘swing pricing’ or ‘anti-dilution levies’ – essentially more complex versions of spreads – to fairly attribute trading costs to investors entering or leaving products.
Either way, the regulator says while spreads (or whatever cost-recovery mechanism funds use) are not fees per se, “it is appropriate to treat buy/sell spreads as individual action fees for disclosure purposes”.
Funds should disclose indicative spreads and how they would work in practice.
Unlike in some other jurisdictions, though, FMC-regulated managers have “no requirement to disclose trading expenses”, the FMA says.
New rules due to take force in Australia next year, for example, will see all fund managers and superannuation schemes – disclose all trading costs, including buy-sell spreads, incurred by members in their annual statements.
Spreads are standard practice in the Australian managed fund and superannuation sectors.
The FMA says it “will monitor the implementation and level of buy/sell spreads in conjunction with MIS Supervisors”.