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Citicorp Trustee Company Limited; April 2002

NEWS & VIEWS

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Welcome to the second edition of News & Views for 2002

This issue of News & Views covers the following industry matters:

Bond Pricing
Methods of Single Pricing
Handbook Amendments

BOND PRICING

As promised in our February edition of News & Views we wish to make a few comments about the pricing of illiquid bonds as some of our clients have recently expressed concerns. Connected with this is a concern over the reliability of prices from some existing price sources and in particular the fact that some pricing sources rely on the last traded price irrespective of when that trade may have taken place. All these concerns have to be reconciled with the requirement for pricing against the best available information.

The difficulties involved in valuing infrequently traded bonds revolve around the problem of when to query a bond price from a pricing source if it has not moved for a period of time. How long should you observe a 'static' price before a query should be initiated in order to obtain a 'fresh' quote? A further question arises regarding the wisdom of accepting a replacement price from only one broker.

Our first observation is that a completely satisfactory solution to this problem is unobtainable and that we are all forced to rely upon existing technology and price feeds with any attendant shortcomings regarding 'static prices'. We also feel it is impracticable to adopt an approach that involves checking every price against the 'market' with all the administrative burdens that this would entail. In any event how many brokers should be contacted in order to obtain a reliable price? Some management groups routinely obtain lists of broker prices for all the holdings, but many still have concerns regarding the degree of reliability that should be placed on these lists.

For a realistic approach we would endorse a pricing method already used by some managers in that any existing price feed is supplemented with a manual procedure involving oversight of bond prices, in particular, static prices. The monitoring of static prices is a process that may in many cases already be automated. To determine whether a price is static we would suggest that 24 hours is a long enough period in a situation where the manager has real concerns as to whether prices received from the feed are realistic. If there is no evidence of any real trades having taken place in the stock which is displaying a static price since the previous day's valuation point then an updated price should be obtained from two or more brokers and the average of the broker prices used in the valuation.

METHODS OF SINGLE PRICING

The long awaited Consultation Paper (CP131) on single pricing has now been issued. The CP proposes amendments to the CIS Sourcebook rules on the existing dilution levy method of single pricing, to reflect the contents of Discussion Paper DP08 and responses thereto. Readers will recall that DP08 suggested an alternative single pricing method based on the mid-market net asset value with a swing adjustment to reflect an allowance for dealing costs in the underlying assets, the direction of the swing depending upon whether the fund is expanding or contracting on that day. Having reviewed both the existing dilution levy method and the proposed swinging single pricing method, the FSA have concluded that both are reasonable methods of recovering the costs of dealing in investments from transacting investors. As either method does not provide full transparency about dilution and potential costs, there is no real advantage in preferring one method over the other. Therefore the FSA are proposing to allow a choice between the two methods while at the same time proposing to change disclosure requirements in order to improve transparency.

The FSA's timetable now involves a deadline of 31/5/02 for responses to the CP with an aim of finalising the new rules and guidance by the autumn of 2002.

Mandatory Single Pricing for Unit Trusts

Within CP131 the FSA have acknowledged that the introduction of compulsory single pricing for unit trusts would not happen until the end of 2003 at the earliest. This timeframe would allow a reasonable period for the new single pricing rules and guidelines to have 'bedded down'.

Some commentators have expressed disappointment that the FSA have not decided upon one method of single pricing, and believe that one of the original aims of introducing single pricing namely to help aid investor understanding of the product, has been lost. That fact that there will soon be three methods of pricing available (one traditional method for unit trusts and two methods for ICVCs) can only increase confusion over pricing in the minds of investors.

HANDBOOK AMENDMENTS

Having worked with the new handbook for a few months now, some inconsistencies, unintended consequences or small 'drafting errors' have become apparent. This applies not only to our own industry but also to other sectors of the financial services market. In recognition of this the FSA have stated that they intend to publish a consolidated CP (consultation paper) every two months containing proposed amendments to cover the scenarios mentioned above. In this context the FSA will consider reasoned requests for small amendments, particularly those that would be unlikely to have significant impact on consumer protection. Through the use of regular amending CPs in this way, the FSA hopes that it will be able to respond promptly to the need for minor changes. The first such amending CP will be CP 130 which will consult on amendments to the parts of the handbook that include senior management arrangements systems and controls (SYSC) and certain aspects of the Conduct of Business Sourcebook (COBS) and the Interim Prudential Sourcebooks for insurers and friendly societies.

FSA Guidance

The FSA in a recent policy statement explained the circumstances when it will issue general guidance. General guidance is defined as written guidance, which can be intended to be temporary or continuous in nature, that is given generally to all, or a class of regulated persons. General guidance will normally be given in the handbook itself, unless it is urgent and/or temporary in nature in which case a guidance note may be issued. On rare occasions of urgency general guidance may also be given in other publications/newsletters or on the FSA website to be followed up with a handbook amendment or guidance note at the earliest opportunity.

The FSA have said that they would not normally issue general guidance through trade associations or industry representatives unless it felt that that body could assist in the dissemination of the information in a case of urgency. It would also need to be confident that the guidance would be communicated under the FSA label.

The material in this communication is for information purposes only. At the time of publication, this information was believed to be accurate, but neither Citibank nor Citicorp Trustee Company Limited makes any representation or warranty to any person as to the accuracy or completeness of the material contained herein. The material contained herein does not constitute in any way investment or legal advice or a recommendation reference or endorsement by Citibank or Citicorp Trustee Company Limited or any person or entity named herein.

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Citicorp Trustee Company Limited; April 2002 NEWS & VIEWS

Citicorp Trustee Company Limited; April 2002

NEWS & VIEWS