Swing Pricing - Survey - Alfi

table of contentsPART I – SWING PRICING INDUSTRY SURVEY 5-10Introduction and executive summary 5Targeted audience of the swing pricing survey 5Anti-dilution practices 6Implementation, objectives and evaluation 6Factor & threshold policy 7Disclosure 8Governance and monitoring 9Client questions and NAV error policy 9Regulatory guidance 9Respondents who did not utilise swing pricing 9Conclusion 10PART II – SWING PRICING GUIDELINES 12-28Section 1 – introduction, terms of reference and key principles 12Section 2 – definition of key terms 13Section 3 – swing pricing – an overview 13Section 4 – calculating the swing factor 15Section 5 – conceptual considerations 16Section 6 – operational considerations 17Section 7 – investment fund structures 20Section 8 – performance considerations 24Section 9 – audit and legal considerations 25APPENDICES: 29-32suggested disclosure alternatives 30-323

part I - swing pricing industry survey

part I - swing pricing industry surveyIntroduction andexecutive summaryIn spring 2010 the Association of theLuxembourg Fund Industry (ALFI) reconveneda swing pricing working group.This group was formed from variousALFI members over a broad spectrum ofdisciplines including fund auditors, fundpromoters, asset managers, legal representativesand third party administrators.The primary goal set by the chairman wasto review, and if necessary update, guidancepreviously issued by ALFI in late 2006. Inorder to facilitate these objectives a surveywas commissioned to research what hashappened in the industry since the publicationof the original brochure.The survey was designed to extract headlineinformation and trends, providing the workinggroup with sufficient data to identifywhere further guidance was necessary. Theresult was that the survey responses werelargely qualitative in nature and broken downinto several thematic categories as follows:Awareness of the existing ALFI2006 publication on swing pricingAnti-dilution methods on the productrangeImplementation, objectives andevaluationFactor and threshold policyDisclosureGovernance and monitoringClient reaction and NAV errorpolicyRegulatory guidanceRespondents who did not utiliseswing pricingSeveral key findings were extracted from theresponses received. Specific examples of suchwould be:Of the nineteen responses, thirteen fundpromoters are utilising swing pricing as ananti-dilution technique. This has increasedsignificantly since 2006 which perhaps mayhave been expected given the impact thecredit crisis had on spreads (widened significantly)and fund liquidity (volatility on flows).There are still some grey areas inadoption of the practice, such as reporting,disclosures and impact to shareholdertax calculations.Fund promoters who use swing pricingseem to trend towards certain geographiclocations (in the sense of where the parentcompany is headquartered).The overwhelming majority of marketparticipants who have adopted swingpricing have found it beneficial.The results of the survey can befound on the following five pages.Targeted audience ofthe swing pricingsurveyALFI distributed the survey to the top 30Luxembourg domiciled promoters by AUM(€m 1,292 representing 77.73% of theLuxembourg AUM as of 31.12.2009[€m 1,663]). In addition the survey wasadvertised in an ALFI mail-shot to theindustry where we received an additionalnumber of responses from promoters andfund administrators. In total 19 responses 1were received. The respondents representeda wide geographic diversity in terms of theircultural centre and the location of theircorporate headquarters, and account for€m 944 representing 56.80% of theLuxembourg assets under management(31.12.2009).From the geographic spread of responseswe can see that a number of organisationspresent in the Luxembourg market who havetheir country of origin and cultural heritagein Switzerland, the UK or the USA, appearto have introduced this measure across theirfunds, whereas, from the evidence presented,promoters in Germany and Italy have beenless willing to implement this. One reasonpotentially explaining this could be fundpromoters seeking consistency with locallydomiciled funds (i.e. a German promoterbeing reluctant to introduce swinging on a1 One of the 19 responses was received from a firm with fundsentirely domiciled outside of Luxembourg; the AUM values andthe bar chart only reflect the firms domiciled in Luxembourg.5

part I - swing pricing industry surveyLuxembourg range when it is unable to doso on a German-domiciled fund).In addition one Norwegian fund promoter(with funds domiciled in Norway) responded tothe survey and confirmed it had also adoptedthe practice. Interestingly no responses werereceived from organisations headquartered inother European locations. Whether this fact isindicative that there is a cultural divide inattitudes to swing pricing cannot be confirmed,however there is a suggestion. Note howeverthat other factors may influence the lack ofresponses from these firms (e.g. such as the factthe survey was distributed in English only).The sample is broken down as follows:Nine firms that use swing pricing as a solutionseem to have adopted it post the publicationof the ALFI paper in November 2006mainly around the time of the financial crisis.Four promoters had adopted it prior to 2006.We conclude therefore there seems to be atrend towards adoption of the practice.Implementation, objectives andevaluationIt would appear that there is no overwhelmingrationale in discriminating which productsswing and which do not: where differenti ationoccurs, the practice is influenced according tothe underlying investments held, the investortype and the distribution channels rather thanthe legal structure of the fund.RespondentsBreakdown of responses654321No swingswingThe majority of respondents employed a partialswing approach with a select few choosing thefull swing method. The logic for choosing oneover the other was varied: some respondentschose partial to limit the frequency with whichtheir funds swung and therefore reduce NAVvolatility. Others stated that the product hadsufficient liquidity to effectively manage smallflows and that they were only concerned withmaterial events triggering dilution.0BE DE IT CH UK USCountry of corporate headquartersAnti-dilution practicesInvestor protection against dilution isrecognised as the overwhelming aim ofimplementing swing pricing for manyrespondents. In addition to swing pricingmany promoters also use redemption gatesand or dilution levies as remedies on theirfund ranges. These can either be presentinstead of swing pricing or co-exist withswing pricing on the same fund range.The choice of full swing seemed to beattributed to index funds by one promoter.Another promoter wanted to ensure performanceacross their multi-jurisdictional rangeswas similar, and because full swinging is theonly method recognised by the Swiss regulator,the individual promoter applied the samemethod to their Luxembourg range.The choice of partialor full swing23%PartialFullMix of bothIn response to questioning about what therationale of applying a dilution levy wouldbe as opposed to swing pricing, severalpromoters differentiated that they applieddilution levy without swing pricing andgenerally on institutional product ranges.15%62%6

part I - swing pricing industry surveyIn cases where the promoter decided toemploy partial swing, its application wasgenerally found to be mechanical in that theadministrator will follow set parameters laidout by the promoter in the swing pricingpolicy document. One slight exception to thisis that a small number of promoters statedthat they reserved the right to decide whetherto invoke the swing on a discretionary basis.When asked whether with the benefit ofhindsight the effort was worth it, themajority of promoters are extremely positiveabout the effect it has had. The main reasonscited for this were existing investorprotection, resultant performance and also apositive client perception of the promoter asprotecting the long-term interests of theclient. One organisation however reservedthe right to withhold judgement as it hadonly recently implemented a swing pricingpolicy and had found the process complexand drawn out.There were some areas promoters highlightedas potentially unclear and where furtherinformation was requested in an update ofthe ALFI brochure, especially around:the complexities around investor taxation;clarification on what constituted a NAVerror in the swing process;specifics around threshold and disclosureof threshold policy;more detailed information on financialstatements disclosures; andspecific operational considerations(e.g. shareholder activity cut off).Factor & threshold policyThreshold levels for funds applying partialswinging are usually determined by frontoffice areas.Threshold policyof promotersemployingpartial swing38%8%High (x>5%)Medium (1%>x

part I - swing pricing industry surveySwing factors are generally determined byusing data across a full range of asset classes.It was however noted that certain types ofsecurities (i.e. certain types of derivatives)posed problems such as determining reliablespreads. In certain cases, fund promotersexcluded certain security types whendetermining factors, or indeed, have beenless willing to apply swing pricing wherea fund predomin antly holds specific typesof securities.DisclosureIn terms of thresholds, the majority ofpromoters were reluctant to disclose the levelof threshold they apply, either in the prospectusor the annual accounts. Some respondentscommented that the act of disclosing thesedetails was contradictory to the principle ofinvestor protection and therefore avoideddisclosing the threshold. On balance itappears that the majority of promoters prefernot to disclose thresholds to ensure clients donot actively manage trades below the triggerlevel of the partial swing.In terms of factor, three promoters said theywere disclosing or would be willing to disclosethe precise factors applied to investors;the remaining ten respondents who appliedswing pricing were not willing to provide thislevel of detail. In understanding the reasoningwhy, some providers claimed it wouldn’t bepracticable to disclose the factor in theprospectus due to the frequency on whichspreads change and factors are updated.All promoters applying swing pricingconfirmed that they only issued the swungNAV when an event was triggered.With regards to financial statements, allresponses noted accounts are currentlyprepared in accordance with LuxembourgGAAP. One provider did however note theywere considering converting fromLuxembourg GAAP to IFRS. As nopromoter was currently using IFRS, thisrestricted the ability of the survey toexplore any potential complexities IFRSmay bring in respect of specific swingpricing treatment and disclosures.Separate lineDebit cost ofthe InvestmentDo you record portfolio transactions costs as aseparate expense line item in the financial statementsor are they debited against the cost of the investment?4 9YesNoIf an event occurs at the end of the reporting period,does the organisation use the swung NAV forperformance reporting purposes?9 4CapitalIncomeDo you treat the swing component onsubscriptions and redemptions based onswung NAV as income or capital?10 38

part I - swing pricing industry surveyIf a swing was applied at the year end,promoters were split on how this wasapplied in practice - several responses didnot disclose at all whereas others added it asa note to the financials, as a footnote in theschedule of investments or disclosed it as aseparate line within the primary statements.In terms of treatment, the majority ofrespondents treated the swing adjustment asa capital adjustment to the assets while asmall number preferred to treat the adjustmentas an income or expense item.Governance and monitoringMany promoters have set up swing pricingcommittees to oversee how the policy isapplied and review swing events; others reviewswing events through monthly MIS reportingby the administrator to senior management.In the overwhelming majority of cases thepolicy was approved by the fund board ofdirectors and reviewed at least annually.Client questions and NAVerror policySome respondents had witnessed increases inclient questions post implementation of swingpricing. This varied from one extreme werethe majority of promoters received infrequentquestioning to the other where one promoterstated they received regular ongoing questionson the policy. A significant number ofpro viders did not witness any noticeablechange in the level of queries.Where questions have been received,several promoters commented that clientsare provided with a copy of the swingpricing policy and also reminded of theunderlying rationale behind the practice– i.e. investor protection.Feedback received on what may constitute amaterial NAV error when a swing pricingpolicy was misapplied was varied. In general,it was clear that where the swing pricing policyhad been incorrectly applied (i.e. a fund wasswung to bid when it should have been swungto offer) this would be considered an error.Opinion was however split around instanceswhen the swing pricing policy was appliedcorrectly with the information known at thattime, but where that information subsequentlychanged (i.e. where a shareholder dealwhich triggered the swing was subsequentlyreversed).Regulatory guidanceOn the question of whether there wassufficient regulatory guidance on swingpricing, the responses were split. Of theentire sample of respondents eight promotersindicated that more specific regulatoryguidance should be offered, while theremaining seven were satisfied with theoverall level of information provided.Where more information was requested,it seemed to be focussed on providinginformation around best practice andmaintaining flexibility of approach.More explicit information was requested onthe criteria that should be included in thedecision-making process on when to applyswing pricing.In terms of UCITS IV some promoters wereinterested to have more guidance on thepotential implications of cross-bordermergers or where one fund within a masterfeederrelationship swung; other providershad no concerns as they assimilated thescenarios to the guidance provided for inspecie transfers.Respondents who did not utiliseswing pricingFor the remaining promoters who were notusing swing pricing, there was still a clearappreciation by all of the subject matter.All were aware of the ALFI guidance issuedin 2006 and were considering whether theyshould implement it within their fundranges. The main reasons or obstaclespreventing adoption of swing pricing rangedfrom the effort and operational complexity itwould take to implement to concerns aboutclient understanding in certain markets andthe acceptance of the practice.9

part I - swing pricing industry surveyConclusionALFI received responses to this survey froma broad population of promoters andadministrators of Luxembourg funds. Thisprovides a high level of comfort that theinformation received is representative of theindustry and allows credible conclusions tobe drawn.It is evident that swing pricing has becomemore of an accepted standard in the marketplace.Whether this can be completelyinterpreted as “market practice” is still adebatable point. However the argument forlabelling it as such is certainly much strongerthan was the case when ALFI published itsoriginal guidance in 2006.Of the sample tested there appears to bealmost complete adoption by organisationsof Anglo-Saxon, U.S. and Swiss origination.The reasons why promoters from otherEuropean countries have not introducedswing pricing on their fund ranges areunclear though potential reasons have beencited. There is some evidence of uptakeamong Belgian and German promoters;however there is no information available asto why French or Italian firms do not applyswing pricing.In terms of the application of swing pricing,there seems to be a clear preference forpartial swing.All providers agree that more guidance couldbe given in areas such as presentation infinancial statements and the practicalapplication of swing pricing. In responseto these requests, ALFI has updatedits guidelines.10

part II - swing pricing guidelines

part II - swing pricing guidelinesSection 1 -introduction, termsof reference andkey principlesIn 2004 the CSSF published Circular 04/146on market timing and late trading. To assistmembers, ALFI issued a guidance paper thatprovided practical advice on the subject.The ALFI market timing working groupwas asked to look at practical ways inwhich some of the recommendationsincluded in the paper could be implemented.Swing pricing has been identified as apossible means of protecting a fund’sperformance and thus the interest of existinginvestors from the dilution effect of frequenttrading which is also a characteristic ofmarket timing activity.This is the second edition of the paper thathas been compiled by a reformed ALFIworking group. The group collated therevisions from a series of meetings withpractitioners operating swing pricing andthrough a comprehensive survey ofLuxembourg fund promoters. This hasresulted in a series of revisions andmodifications to reflect changes in workingpractice and clarification on a number oftechnical points in areas such as taxationand financial reporting. This document isavailable in a PDF format on ALFI website:www.alfi.lu.Scope and terms of referenceThe primary purpose of this paper is tounderstand the issues and limitations relatingto swing pricing and to provide consideredresponses to such issues. It is not, however,within the terms of reference of the group toconsider the pros and cons of swing pricingrelative to other methods of dealing withdilution or market timing. Moreover, thegroup has not been asked to recommendswing pricing, or any other method, as anindustry standard. Equally there is nointention to mandate the compulsory useof swing pricing. Should a promoter decideto implement swing pricing, the paperwill provide practical guidance relating tothe key issues to be considered and torecommend standards of best practice asendorsed by ALFI.Key principlesTwo main principles evolved as the studyprogressed and the paper was compiled.Firstly, there should only be one NAVreported for all external performance andcomparison purposes. Therefore if swingpricing is employed it is the swung price thatis reported. This is based on the premise thatthe evolution of a fund’s NAV and ultimatereturn to investors is impacted by variousfactors above and beyond the performanceof the investment manager. Examples of suchfactors include the policy for pricing securities,the application of fair value pricing andthe accounting policies and conventionsadopted by the fund.The second key principle is that swingpricing is applied for the ultimate benefit ofthe fund investors by countering the dilutioneffect of investor activity and is not intendedas an additional service charge such as aback or front end load. The benefit ofswinging the NAV is realised by the fund andin the case of a multi-share class fund, isattributed to all of the fund’s share classes onthe same basis as with any fund level revenueor capital item.BenefitsStudies have shown that investors ordinarilybenefit from swing pricing in the long termas these measures are designed to protect afund from suffering the costs of tradingsecurities as a result of investor movements.Funds that apply swing pricing showsuperior performance over time compared tofunds (with identical investment strategiesand trading patterns) that do not employanti-dilution measures. Swing pricing helpspreserve investment returns as the value tolong-term investors normally exceeds thevalue of the swing factor applied on entry toor exit from the fund. In addition swingpricing should act as a deterrent to theshort-term speculative investor(s) as theirinvestment will need to have increased bymore than twice the value of the swingfactor for any gain to be realised. Investorsthat trade at a swung price are effectivelypaying the dealing costs associated with their12

part II - swing pricing guidelinesinvestment. As mentioned above, the methodof applying swing pricing to the traded NAVprice of funds is not applied for the benefitof fund agents and or service providers butsolely to protect investors’ interests.Section 2 - definition ofkey termsSummarised below are the definitions of keyterms used in this paper.Capital activityNet value of subscription, redemption andswitch orders received by the transfer agentfor a single fund on any one trading day.DilutionThe reduction in value of a fund, and henceNAV per share, that occurs as a result of capitalactivity dealt at a NAV that does not reflect thedealing costs associated with security tradesundertaken by the investment manager.Full swingThe NAV is adjusted each time there is capitalactivity. The direction of the swing is determinedby the net capital activity of the day.Multi-share class fundA fund having more than one share class.The NAV of the fund is the sum of the netassets of the different share classes. Eachshare class has its own NAV per sharedependent on its weighting in the fund.The share classes may have different featuressuch as expense rates, distribution policies,currencies, type of investor.Partial swingThe NAV is swung as for full swing but onlywhen a predetermined net capital activitythreshold (i.e. the swing threshold) is exceeded.Partial swing can also be referred to assemi-swing pricing. For consistency, “partialswing” will be used throughout this document.Single pricing fundA fund which calculates one single NAV pershare which is used for all capital activityregardless of whether inflow or outflow.Swing thresholdThe net capital activity, expressed as apercentage of the NAV and or an absolutemonetary value, required to trigger the NAVswing process where partial swing pricing isemployed. Factors influencing the determinationof the swing threshold are described insection 3.Swing factorA swing factor is the amount (normallyexpressed as a percentage) by which theNAV is adjusted in order to protect existinginvestors in a fund from the cost of tradingsecurities as a result of capital activity. Theswing factor is triggered as a result of capitalactivity exceeding a pre-defined threshold(for partial swing) or any capital activity (forfull swing).Underlying investment fundsAn investment fund in which otherinvestment funds invest.Section 3 - swingpricing - an overviewThe issue - dilutionA characteristic of frequent trading is thattransaction costs are incurred and thisdilutes the value of existing shareholders’interests in a single-priced fund. This fall invalue happens because the single price atwhich investors buy and sell the fund’sshares only reflects the value of its net assets.It does not take into account the dealingcosts that arise when the portfolio managertrades as a result of capital activity incurringa spread on the underlying securities.In other words, the charges incurred fall noton the client who has just traded, but on allinvestors in the fund.13

part II - swing pricing guidelinesThe costs associated with an active shareholderwill impact the value of the fund and thereforeall shareholders suffer to some extent. Asinvestment horizons have reduced in recentyears, the dilution impact of trading costs oninvestment funds is emerging as a keychallenge within the industry.It is worth noting that whilst swing pricing isparticularly relevant to single-priced funds,dilution can also occur in a dual priced fund tothe extent that the spread between the fund’sbid and offer NAV does not reflect all theunderlying security dealing costs.Swing pricing – a method ofcounteracting dilutionThe CSSF published Circular 04/146 and ALFIhas issued a guidance paper on market timingand late trading. Whilst both documentsdescribe various methods of combating dilution,this paper is limited to explaining swing pricing.Swinging a fund’s NAV price is an attempt topass on the cost of underlying capital activityto the active shareholders and thus to protectinvestors from costs associated with capitalactivity. However, it must be understood thatswing pricing affords protection againstdilution at the fund level and is not designedto address specific shareholder transactions.The operational processThe primary operational considerationsassociated with swing pricing comprise:1. Should full or partial swing be adopted?2. If partial swing is adopted, what is theappropriate swing threshold for a particularfund?3. Once the decision is made to swing theNAV, what is the appropriate swing factorfor a particular fund?4. Determination of the frequency of review.5. The procedure in case of special events.6. The error correction policy when applyingswing pricing.1, 2 and 3 are dealt with in this section,whereas considerations 4, 5 and 6 arecovered in sections 4 and 9 respectively.I. Full or partial swingGenerally, swing pricing operates suchthat once the net capital activity is calculatedthe NAV is swung using one of the followingmethods:(a) Full swing: The price is swung onevery dealing date on a net deal basisregardless of the size of the net capitalactivity. No threshold is therefore applied inthe full swing model.(b) Partial swing: The process istriggered, and the NAV swung, only whenthe net capital activity exceeds a predefinedthreshold known as the swing threshold.The pros and cons of full and partial swingare considered in section 5. At a high level,the key questions to consider are equaltreatment of investors; the relationshipbetween capital activity and underlyinginvestment activity; operational complexityand the ease of understanding for investors.II. Determination of the swingthresholdIn principle, the swing threshold shouldreflect the point at which a net capitalactivity triggers the investment manager totrade a fund’s securities. As an example, thepolicy would state that a net capital activitygreater than X% of the fund’s NAV wouldtrigger swing pricing. Factors influencing thedetermination of the swing thresholdordinarily include:a) The fund size.b) The type and liquidity of securities inwhich the fund invests.c) The costs, and hence the dilution impact,associated with the markets in which thefund invests.d) The investment manager’s investmentpolicy and the extent to which a fund canretain cash (or near cash) as opposed toalways being fully invested.Ideally the application of swing pricingshould be mechanistic and triggered on aconsistent basis.14

part II - swing pricing guidelinesIII. Determination of the appropriateswing factorGenerally, swing pricing operates such thatonce the net capital activity is known for agiven dealing date and the swing pricingprocess is triggered, the NAV of all of thefund’s share classes (in the case of a multi-shareclass fund) is swung on the following basis:Net inflows- the price used to process alltransactions is adjusted upwards by theswing factor to a notional offer price.Net outflows- the price used to process alltransactions is adjusted downwards by theswing factor to a notional bid price.There are two main approaches to determinethe amount by which the NAV is swungonce the swing process is triggered asoutlined below.The most commonly adopted approach isto calculate the NAV using the standardmethod defined in the prospectus and thenapply the swing factor (see “Section 4 -calculating the swing factor) to arrive at theswung NAV. Under this approach theissues that need to be considered are:Determining an appropriate swing factor;Periodic validation of the spread;Monitoring the portfolio for changes incomposition.An alternative approach is to swing the NAVby an amount equal to the actual bid or offerspread plus the actual transaction costsincurred directly as a result of the capitalactivity. In the case of a net capital inflow, thisis achieved by firstly valuing the underlyinginvestments at offer price and then increasingthe NAV, thus generated, by the actualtransaction costs incurred in the relevantunderlying security transactions. In the case ofa net capital outflow, the underlyinginvestments are valued at bid price and then theactual transaction costs incurred in the relevantunderlying security transactions are subtracted.This might be difficult to apply in practice,bearing in mind the following considerations:Bid and offer prices may not be quotedon certain exchanges depending on thetype of security;Thinly traded securities may not have acurrent market price;There may be accounting systems limitationsthat prevent the calculation of a bid,offer and mid NAV;The extent to which it is possible tocapture actual transaction costs (e.g.broker fees and commissions) and applythem to the swing factor in a timelymanner for a daily valued fund;The costs associated with systemsenhancements required to achieve theaforementioned points;If the fund’s NAV is calculated on a T+1basis, it might be possible to include theactual costs associated with investmentactivity. For funds valued intraday, thiswould not be possible and a basis pointestimate would have to be calculated tocover broker, transaction and fiscal charges.Finally, a variation on the methods describedabove is to develop a model that uses acombination of actual elements to be includedin the swing factor (e.g. actual transactionand dealing costs) and an estimatedcomponent (e.g. an estimate for the bid oroffer spread on the underlying securities).Section 4 - calculatingthe swing factorThe bid offer spread is a key factorto be included in the swing factor. If it isnot possible to calculate a NAV based onthe bid and offer prices of underlyingsecurities, then an estimate of thebid offer spread applicable to the marketin which the securities are traded wouldbe reasonable.Additionally, the following items should beconsidered when deriving the swing factor:1. Net broker commissions paid by the fund;2. Custody transaction charges;3. Fiscal charges (e.g. stamp duty andsales tax);4. Any initial charges or exit fees applied totrades in underlying investment funds;15

part II - swing pricing guidelines5. Any swing factors or dilution amounts orspreads applied to underlying investmentfunds or derivative instruments.Other points to be considered include:The tiering of the swing factor to reflectthe size of the net capital activity thustaking account of the sliding scale ofbroker costs associated with trade size.For example, larger trades might result inbetter broker arrangements.The sale of an illiquid security couldimpact the market price if the resultingsecurity trade is of sufficient size. Althoughdifficult to quantify, arguably this elementcould be included in the swing factor.Sufficient time should be allowed betweenthe order cut off time and the funds’valuation point to calculate the days’capital activity and the adjusted swungNAV prices. These additional stepsrequired in the operation of swing pricingmay prolong the overall time to completethe pricing and valuation process andcould lead to delays in the release ofinvestors’ order confirmations andpublication of NAV prices.If it is not possible to determine the cost ofcertain transactions (e.g. commissioncharged by a clearing broker in relation toexchange traded derivatives) and theirimpact on the swing factor, it should not becompulsory to take these elements intoaccount. Similarly, if certain costs andexpenses cannot be directly attributed to atransaction, these too should not be takeninto account in calculating the swing factor.Periodic verification of the swing factorIt is recommended that the swing factorshould be monitored to ensure reasonabilitywhen compared to the charges incurred andshould be revised as and when necessary.The objective is to ensure that the swingfactor is consistent with the fund’s securityand investment profile, the markets in whichit invests and the various cost componentsidentified above. This should be undertakenby a swing pricing committee under thesupervision of the fund’s Board of Directorsor equivalent responsible body. Oncedetermined, it is recommended that periodicreviews are performed using historic data tothe current threshold and swing factors.Section 5 - conceptualconsiderationsThe pros and cons of swing pricingIn deciding whether or not to introduce swingpricing, there are various factors that need tobe taken into account. The significant advantagesand disadvantages of this valuationmethod are summarised below:AdvantagesIs arguably the most straightforward andcomplementary anti-dilution technique toapply on single-priced funds.Reduces the drag on performance fromcapital activity and therefore protectsexisting investors.Protects against dilution at the fund level.Acts as a deterrent against frequent tradingactivity.Acts as a deterrent against market timingactivity.DisadvantagesAs swing pricing is applied on capital activityat the level of the fund it is limited in that itdoes not address each investor transaction.Fairness to investors – without a client– specific swing mechanism, certaininvestors will unduly benefit or sufferowing to the actions of other investors asof the relevant dealing day.Swing pricing may not be transparent toinvestors.Ordinarily increases performance volatilityin the short term.Large transactions relative to the size of thefund are always likely to trigger a price swing.Full versus partial swing pricingIf it is decided that swing pricing is theappropriate tool for a given fund, the nextquestion is whether full or partial swingshould be adopted. The relative merits of fullversus partial swing are considered below.16

part II - swing pricing guidelinesFull swing pricingAdvantagesTransparent and easy to understand.Therefore relatively easy to explain to salesand marketing teams and clients.Consistent treatment of shareholdertransaction on all dealing dates.Always benefits the fund.DisadvantagesGreater NAV volatility as the price is swungon each dealing date. However if a fund isconstantly growing, the NAV will alwaystrend to pricing on an offer basis (and viceversa for a shrinking fund). Hence, if a fundis consistently experiencing net capitalactivity in one direction, full swing couldactually reduce NAV volatility.Small net capital flows may not require theinvestment manager to trade. This leads tothe investment manager retaining a smallcash balance in the fund.In such circumstances swinging the NAV isnot justified as the fund does not incur anytrading costs.Increased risk of swinging the price thewrong way due to the late capture ofcapital activity or an error in processingshareholder transactions.Partial swing pricingAdvantagesAs the capital activity must exceed theswing threshold before the NAV price isswung, there is a lower exposure to NAVmiscalculations as a result of operationalerrors compared to using full swing.As the price is not swung on each valuationdate there is normally a lower impacton NAV volatility and fund performance.DisadvantagesDetermining and monitoring the appropriateswing threshold is onerous.More difficult to explain and less easilyunderstood by marketing teams and clients.Section 6 - operationalconsiderationsObjectiveWhen debating whether to implement swingpricing, consideration should be given to theimplications on the production and publicationof NAV prices to ensure that there are noadverse consequences for recipients furtherdown the process chain (e.g. late publicationor incorrect content). NAV delivery willtypically be dependent upon the times set fordeal cut-off and the valuation point. Swingpricing will introduce the additional processbeing the task whereby the transfer agentcalculates the day’s capital activity.Dealing InformationA swing pricing model requires the capitalactivity for a fund to be known beforedetermining whether to swing the NAV priceon any particular dealing day. This can beeither a total monetary amount or a percentageof total net assets. Unit orders are moreproblematic to value than consideration-basedorders and normally require that their value isestimated using the last available NAV price.The consolidation of all capital activity on anygiven day may be time consuming dependingon the number of orders received by thetransfer agent. As this information is requiredbefore it can be determined whether or not toswing the NAV of the fund this may delay thecompletion of the pricing process.Effective communication channelsaround factor and threshold changesAs both factors and thresholds are reviewedperiodically, an effective communicationchannel should be put in place between theareas generating any changes and thedepartments (or outsourced administrators)applying the changes in practice.Other operational issues to beconsideredEven if some of the markets in which thefund invests are closed which preventsthe investment manager from trading onthat day, swing pricing should be appliedas it is the investor activity that triggersswing pricing.17

part II - swing pricing guidelinesFair value pricing and interaction withswing pricing - it is recommended that theswing factor should be applied to the fairvalued NAV.Fund of funds and funds investing inother single-priced securities –the NAV for a fund of funds investing insingle-priced securities or funds shouldhave a swing factor equivalent to theentry and exit charges or costs ofacquisition or disposal.Basis of fee calculations – whetherto calculate performance, managementand other NAV based fees uponthe unswung NAV or swung NAV?Recording the swing factorThe last point raises the broader question asto the accounting treatment when adjustingfor the swing factor. One method is for theswing adjustment to be captured directlyand, thus recorded, in the NAV calculationprocess such that only one NAV, the swungNAV, is calculated. When calculating theNAV, the production process might notallow a further adjustment, to introduce theswing factor, once the NAV has been determined.Therefore it may be necessary tomake the swing adjustment outside of themain fund accounting systems on thevaluation date. The swing adjustment wouldthen be posted in the next NAV valuationwithin the capital account of the fund usingthe capital activity information provided bythe transfer agent.Both methods of accounting for the swingfactor are valid; there will be no materialdifference on the fund’s NAV. The advantagesand disadvantages are set out hereunder.One-line adjustmentOutside of fundAdvantages• Fund accounting NAV is thesame as dealing NAV• Easy to implement• NAV fluctuations may make theimpact to variable expensesimmaterial• No impact to variable expenses• Parallel processing possible soless impact to NAV delivery• The net benefit for the fund caneasily be tracked by reference tothe fund-level swing adjustmentDisadvantages• Potential impact to NAV deliverydue to sequential processingrequirements• If the fund is growing there maybe a significant impact onvariable expenses• Fund accounting NAV is not thesame as dealing NAV• Requirement to make fund leveladjustment when processingcapital activity• Technology builds requiredAs noted above, both methodologies are equally valid and the method selected will largely bedependent on workflows and system limitations and, if applicable, any restrictions that mayexist in the fund’s governing documents regarding the basis of charging NAV based fees.Fund mergersThere are a number of different methodsthat could be employed when calculating thevalue of funds where the absorbing fundoperates swing pricing and it is applied onthe day of the merger:(i) The value of the assets of the absorbedfund is adjusted by a similar swing factorto that applied by the absorbing fund.This has the effect of valuing the assetsof both funds in a consistent manner.Furthermore, this neutralizes the impactof swing pricing on the shareholders ofthe absorbed fund by recognizing thatthe investment manager of the absorbingfund may not have to trade securities as18

part II - swing pricing guidelinesa direct result of the merger. Yet, theinvestment manager may need toconsider assets of the absorbed fund (i)he intends to keep, (ii) he intends to selland (iii) the relative level of cash in bothfunds as these considerations maydetermine that the absorbed fund shouldswing to offer basis.(ii) Alternatively it is feasible to allocate sharesin the absorbing fund on the basis ofunswung prices and to subsequently adjustthe conversion ratio by the equivalentswing factor in order to take into accountincoming assets that will have to be sold,i.e. that will cause the fund manager todeal in securities and, therefore, incur coststhat would lead to dilution.Other points to consider that may modifythe method employed include:Special care should be taken to correctlydetermine the swing direction of the absorbingfund based on both the daily “normal”flows as well as the assets from the merger.It maybe appropriate to reduce the swingfactor of the absorbed fund or alternativelydeactivate the swing pricing mechanismahead of the merger.If the investment manager is required to sellmost or all securities and or the portfoliomainly consists of cash then it maybe moreappropriate to swing the absorbing fund tothe offer basis.The precise circumstances of each mergershould be considered on a case-by-casebasis in consultation with the investmentmanager as part of the merger project.It is recommended that the swing factor ofthe absorbing fund be reviewed followinga merger.Launch of a new fundThe issue price of a new fund shouldordinarily not be swung, as the investorsdealing at the initial issue price are all thesame investors that will incur the costs ofthe initial investments made by theinvestment manager. Accordingly swingpricing should only be applied to a fundfrom the second valuation date onwards.Launch of a new share classA new share class can be subject to swingpricing on the first day, if the sub-fundswings on that day. This is because anycapital activity in the new share class has animpact on the trading costs incurred by thewhole fund, not just the new share class.Consideration should be given to fixed pricelaunches (e.g. EUR 100) that are announcedin advance of the share class launch date toensure that the published NAV of the newclass is the fixed price, irrespective ofwhether the fund is swung or unswung onthat valuation date.Contributions and Redemptions in kindWhere investors subscribe in kind, careshould be taken to ensure that the basis ofvaluation is consistently applied to the fundand the assets being contributed into thefund. In practice this means ensuring thatassets are valued according to the sameprinciples and if the receiving fundis swung due to shareholder capital activity,then the same swing factor should beapplied to the valuation of the assets beingcontributed. The number of shares or unitsissued in exchange for the assets contributedin kind can then be determined bydividing the value of the assets subscribedby the receiving fund’s NAV price.It is important to understand whether theinvestment manager wishes to sell securitiesonce they have been contributed in kind ornot as this should be factored into theswing pricing adjustment accordingly.The assets contributed should always bevalued on a fair and consistent basis andwithout any prejudice to the existinginvestors. As any additional cost (audit) istypically borne by the specific investor(s)there is no reason to apply swing pricing toin specie transfers where there is no othercapital activity on the specific valuation date.For redemptions in kind, the first step is tovalue the fund’s assets and then, thepercentage to be transferred out as part ofthe redemption in kind, is calculated.The percentage is determined by dividingthe number of shares the investor isredeeming by the total shares in issue.19

part II - swing pricing guidelinesWhere an investor is exiting with securitiesand available cash this does not necessarilycause the investment manager to trade. Insuch cases, and if there is no other capitalactivity on the specific valuation date, theBoard of Directors of the fund may decideto forgo the impact of swing pricing incalculating the value of assets transferredout in kind.Liquidating fundsAs all assets will have been liquidatedresulting in the receipt of cash, prior tothe payment of liquidation proceeds tothe remaining investors, the NAV priceswill not need to be swung on the date ofthe liquidation.This does not apply where individual shareclasses are liquidated as they will continueto follow the swing process triggered by thenet capital activity happening at fund level.Section 7 - investmentfund structuresThis section considers the application ofswing pricing on investment funds withstructures ranging from an individual shareclass to the more complex pooling arrangementsand integrated master feeder structures.In doing so it is important to appreciate thatsome structures are under the control of asingle fund promoter whilst others aredistinctly independent. Perhaps most commonlyhowever in European distribution isthe mixture of both combined to form acomplex and sophisticated distributionnetwork. Bearing this in mind, when applyingswing pricing to the larger structures it isimportant to consider where and to whatextent transaction charges are incurred andthe impact of different capital activity.It is these components that will influence themost appropriate level at which to apply aswing pricing mechanism.As noted in the introduction, dilution is thereduction in the value of shares in a singlepricedfund that occurs whenever an investorbuys or sells shares in the fund. In the case ofa fund with a single share class the costsassociated with an active shareholder willimpact the future value of the fund andtherefore all shareholders suffer to somedegree from the impact of an active shareholder.Swinging fund NAV prices is anattempt to pass on the cost of underlyingactivity to the active shareholders and protectexisting investors from costs associated withcapital activity. So let’s consider this in thecontext of different fund structures.Funds with a single share classNAV prices could swing according to netcapital activity within the fund. A net subscriptionwill lead to the NAV price per shareswinging upwards to an offer price, and a netredemption will lead to the NAV per shareprice swinging downwards to bid. This swingisolates existing investors from the impact ofany trades within the fund associated withthe net capital activity.The benefits and costs of swinging prices arenot necessarily spread evenly across all activeshareholders, with the activities of oneinvestor having potential financial impact onother active investors. For example, considerthe impact of a large subscriber on thereturns of a smaller redeemer on the sameday. The net capital activity at fund level is asubscription, and so the NAV per share priceis increased to compensate the fund for thefuture transaction and investment costsassociated with investing the proceeds of thisnet capital activity. The subscriber pays ahigher price for the shares he has purchased.The price he pays is not impacted by theactivities of the redeeming shareholder andtherefore he receives no benefit or lowercosts as a result of the redemption activity.The redeeming shareholder, however, willbenefit from the fact that the NAV has beenincreased, and will receive a higher thananticipated level of proceeds from hisredemption. This additional benefit isreceived, indirectly, from the subscribingshareholder. As the NAV is always swungaccording to the net capital activity, the20

part II - swing pricing guidelinesoverall objective of eliminating dilution ofthe fund is always achieved.In summary, and in comparison to a fundwithout any provision to apply swing pricing:The fund and the long term investors arebetter off, as there is no material impact asa result of transaction and investment costsincurred from investing or disinvestingsubscription or redemption proceeds;Active shareholders transacting in thedirection of the net capital activity of theday will incur dilution of their investment,though the level of dilution is not necessarilymade better or worse by the impact ofactivity of other shareholders;Shareholders transacting in the oppositedirection to the net capital activity at fundlevel will benefit from a swinging price.Funds with multiple share classesIf one accepts the premise of existing shareholdersimpacting each other, then one canapply the same premise to a fund with amultiple share class structure. Economicactivity takes place at fund level, so thedecision to swing prices should take placeonly after considering all capital activity atfund level.The single share class fund example is extended.There are situations where one share classwithin a fund has net subscriptions, whilstanother has net redemptions. Assuming the netactivity of the two share classes combinedtriggers a swing price adjustment, the swingprice adjustment applied to the net capitalactivity at the fund level (subscriptions –redemptions) will compensate the fund for anyunderlying transaction costs. In this instance thecapital activity in one share class is being offsetby the capital activity in any of the others withno overall impact on existing shareholderswithin the fund. In this case these other shareholderscould be within the same share class,or in any other share class within the fund.With the increasing development of newtypes of hedged share classes (e.g. currencyhedged), the transaction costs may increasinglybe incurred at the share class level.Where the share class level costs becomesignificant, it may be worth considering anadditional swing factor at the share classlevel. It is quite conceivable, in these cases,that the fund will swing in one direction andthe share class in the opposite direction, suchthat share class swing factor may be addedto or deducted from the fund level swingfactor to arrive at a share class specific factor.The technology changes required to achievethis are more complex than with fund levelonly swing factors.Master feeder fund structuresMaster feeder structures are typically set-upas an efficient way in which to pool assetsunder common management. The maindifference between a master feeder structureand a more classic pooling structure is thatpooling is normally used to manage commonassets in a range of investment vehicleswhereas master feeder structures are normallya series of feeder funds set-up tofacilitate the effective access for investors toinvest into a fund. Perhaps this is more easilydescribed by considering pooling as anefficient method by which an investmentmanager can manage common assets andmaster feeder funds are typically used todistribute investment funds. Alternativelyas both structures share similar features,a master feeder structure could be consideredas a simplified pooling structure.When it comes to applying the logic describedabove in relation to master feeder fundstructures it is important to identify whichfund is actually trading in securities (i.e. instock markets as a result of capital activity).This normally takes place at the level of themaster fund and so swing pricing, if used,should be applied at this level.It may also be appropriate to apply swingpricing at the feeder fund level as well.This can be determined by considering theinvestment objectives and holdings of thefeeder fund. If, for example, the feeder fundinvests solely in the master fund then it isunlikely that there is a reason to apply swingpricing to the feeder fund.21

part II - swing pricing guidelinesWhereas, for example, if the feeder were toinvest 50% into the master fund and 50%into exchange traded securities, then it maybe appropriate to apply swing pricing to thefeeder fund with a swing factor reflecting thetransaction costs incurred in the purchase orsale of the exchange traded securities.In practice it is common for master feederfund structures to have several feeders linkedto a master and this is often extended with arange of master funds linked to multiplefeeder funds. The feeder funds may havevarying investment objectives ranging fromfully investing into one master fund versus apercentage allocation in several master fundscombined with investments in other securities.Regardless of such arrangements, therules for applying swing pricing as describedabove work across all of these structures.Fund of fund structuresThere are many similarities between thesestructures and master feeder fund structures.Not surprisingly though the distinguishingfeatures are that these structures are set-up toaccommodate the investment by one investmentfund into another. These can either beinternal arrangements whereby an investmentmanager is selecting from a range of fundsoffered by a single promoter or alternatively abroader investment objective that includesinvestment funds of other promoters.The main consideration when applyingswing pricing for such structures is theability to look through to the underlyingswingpricing and or any other dilutionpolicies. It is this level of detail plus anyentrance or exit charges levied by theunderlying funds in which the fund of fundsinvests that will allow an appropriate swingfactor to be determined. This is typicallymuch easier where the funds all belong toone promoter and significantly more difficultwhere external funds make up the portfolioof the fund of funds.Working on the premise that sufficientinformation is available to determine a swingfactor that could be applied to the fund offunds, then the rules outlined above concerningthe application of swing pricing can alsobe applied to fund of fund structures. It isworth noting particularly for a fund of fundswith a broad investment remit enabling it toinvest in other promoters’ funds, that it ispossible that the fund of funds may swing itsprice in one direction whilst the underlyingfund into which it invests may swing in theopposite direction. An example of this beingwhere there is net capital inflows into thefund of funds and net capital outflow at thelevel of the underlying investment fund dueto redemptions from other investors exceedingthe investment from the fund of funds.This is quite common in practice and reflectshow the investment industry has developedwith investment managers investing in otherinvestment managers’ funds or - a hybridmodel where distributors (purchasers ofinvestment funds) establish investment fundsfor distribution purposes that in turn investin underlying investment funds.Finally, it should be taken into account thatfunds domiciled in certain jurisdictions maynot be authorised to apply swing pricing.So lets consider a Luxembourg fund of fundsinvesting in a underlying fund domiciled inanother jurisdiction. Whilst the fund of fundsmight swing its price based on the level ofcapital activity from investors, the underlyingfund will not be able to swing its price whenthe Luxembourg fund of funds makes aninvestment into this fund. This has the effectthat prices will only be swung at the level ofthe Luxembourg fund. It may well be that thenon-Luxembourg domiciled fund has analternative method to protect the fund’sinvestors such as a dilution charge. Whilstthere is little that can be done, it is worthconsidering the various circumstances and theoverall impact on the fund of funds.Funds operating a pooled investmentstructurePooling is perhaps the most complex of allthe investment structures to administer.Essentially pooling is operated using systemstechnology to combine the interest of severalfunds (investment vehicles) into one large22

part II - swing pricing guidelinesinvestment pool that is managed as a singleportfolio by the investment manager. Eachinvestment vehicle receives units or shares inthe underlying pool, equivalent to its shareof the total investment value of the pool.Again the premise considered above isextended. If one agrees that the activities ofinvestors in one share class can impact theactivities of investors in other share classes,then one can apply the same logic to fundsinvesting in common pools. The investmentmanager trades securities at the level of thepool so the decision to swing prices shouldtake place only after considering all capitalactivity at pool level. Without swing pricingthe capital activity of one fund will impactthe performance of another fund sharing acommon pool (transaction and investmentcosts are incurred at pool level, and so theimpact of such costs is shared between allpool owners). Consistent with the rules, byapplying swing pricing at the level of thepool this will transfer the pool’s trading costto those funds with capital activity.The same principle applies whereby economiccost and benefit will be transferred betweenactive shareholders within different fundssharing common pools, but that no shareholderis worse off than it would have beenhad it transacted in isolation, and that certainactive shareholders and all passive shareholdersare better off than they would have beenwithout any provisions for dilution.It is true to say that swinging prices at poollevel will impact the value of top level fundsholdings in these pools, in effect automaticallyswinging top level fund prices sufficientlyto compensate for any dilutive impact.As noted previously economic activity takesplace at pool level, so the decision to swingprices should take place only after consideringall activity at pool level.Such considerations include:the number of funds participating in a pooland the level of each fund’s activity maydetermine whether the mix of fund types inthe pool merit the use of swing pricing;the portion of a participating fund’s assetsthat are invested in the pool (or invested inother assets);if some funds are invested into more thanone pool and the different pools havediffering bid or offer spreads.As pooling structures typically have so manyentities and intricate relationships anddependencies it is recommended that extensivesystems testing is performed beforeusing swing pricing on pooling structures.SummaryThe costs and benefits associated with the capitalactivity of an individual shareholder within ashare class will impact other shareholders;within the same share class, orwithin other share classes within the samefund (in the case of multiple share classfunds), orwithin a master fund with several feeders, orwithin other funds sharing a common pool(in the case of funds using a pooledinvestment structure).Applying swing pricing on fund structuresand pools will not eliminate this transfer ofcost or benefit between shareholders.However swinging prices will spread costsand benefits more equitably betweencategories of investors, and will protectexisting investors (and underlying fundperformance) from a portfolio’s trading costsassociated with capital activity.Similar to master feeder funds and fund offunds the specific set-up and relationship ofthe pooling complex should be consideredon its own merits in order to optimise theuse of swing pricing with pooling structures.23

part II - swing pricing guidelinesSection 8 -performanceconsiderationsSwing pricing and the impact onperformanceSwing pricing is primarily used to addressdilution, protecting existing investors fromexperiencing lower fund performance as aresult of dealing costs arising from thecapital activities of other investors. However,there are certain points to consider. Swingpricing could increase the tracking error (i.e.the difference in return based on the swungNAV compared to benchmark) and potentiallyresult in an increase in NAV volatilityas discussed in section 5. This creates anumber of issues that are outlined below.Risk assessmentThe introduction of swing pricing is likely toincrease the level of tracking error between afund and the index against which it isbenchmarked. This may in turn result ininvestors incorrectly estimating the inherentlevel of portfolio risk of a given fund. This isexplained by considering that performance ismeasured using the swung NAV which islikely to contain an increased level ofvolatility compared to the returns of theunswung NAV price. It is therefore importantto clearly disclose the use of swingpricing so that it is transparent to the usersof performance data.Competitor and peer performanceanalysisThe swing effect may, to some extent, maskthe investment manager’s performance in theshort-term if performance is measured usingthe swung NAV.The use of the swung price is considered mostappropriate for investment performancereporting because investors are impacted bythe return of the fund as a whole and not justthe performance of the manager. Since thepurpose of swing pricing is ultimately toprotect the existing investor, the impact ofswing pricing on performance is seen as a validcomponent of long-term return to investors.This point is based on the common view thatthe users of NAV data are only interested in oneNAV, the traded NAV, be it swung or unswung.External fund performance reportingAgain, the same logic applies for performancereporting in monthly fact sheets and marketingmaterial. Based on the arguments above, theswung price should be used and disclosure ofthe unswung price is optional.Internal fund performance reportingPerformance reporting for internal purposescould be based on either the unswung NAV orthe swung NAV. However, contributors haveargued that investment managers are generallymore concerned with the performance divergencebetween the NAV based upon valuationpoint prices and closing market prices than theimpact of swing pricing.Disclosure of information onexternal reportsTransparency and clarity of information iscritical for the investor. However, a keyconcern is that by providing too muchinformation, it might lead to confusion.Similarly if partial swing is used, a frequenttrader may be able to determine the probabilitythat the price will swing if too muchinformation is made available.A question therefore arises regarding theamount of information that should beprovided in the fund’s prospectus, financialstatements and supplementary informationincluded in investor performance reporting.It is recommended that the principles ofswing pricing are disclosed to investors butthe details may remain confidential to ensurethat this information cannot be used to thedetriment of the fund.Performance fee calculationsPerformance fees are specifically designedto remunerate the investment managerfor out-performance of a benchmark.As performance fees are ordinarilycrystallized on a specific date, the use ofthe swung price could significantly distortthe performance fee calculation.When calculating performance fees it isappropriate to use the unswung NAVand it is recommended that the basisof calculation is disclosed in the fund’sprospectus.24

part II - swing pricing guidelinesGiven the sensitivity of performance fees,care should be taken to ensure that thecalculation methodology is documented andmechanistically applied by the fundadministrator. The management company ordirectors of the fund are ultimatelyresponsible for the on-going monitoringand consistent application of theperformance fee calculation processand policy. The verification of the accurateand consistent application of the calculationmethodology should be checked as partof the work performed in the fund’sannual audit.Section 9 - audit andlegal considerationsAs a general comment, it should be noted thatit might be necessary to review a fund’s Articlesof Incorporation to ensure that they do notrestrict the introduction of swing pricing.Financial reportingWhere a swing pricing policy exists, be it afull or partial model, due considerationshould be given in terms of capturing accuratedata and making relevant disclosures onsemi-annual and annual accounts. Financialstatements represent a description of underlyingassets and liabilities of the fund at aspecific point in time. These are usuallyvalued in accordance with the relevantaccounting principles together with the rulesof the fund as defined in the prospectus.Where a swing pricing factor has been appliedto the last valuation of the period, thetreatment in the financial statements maydepend on how exactly it has been capturedwithin the NAV calculation process. There aretwo options:Option (i) Where the factor has been bookedas a single line adjusting entry, the entry itselfis likely not to be reflective of any actual assetor liability held by the fund as at that date.Thus, in accordance with relevant accountingprinciples it may be necessary to remove thisline item from the statement of net assets.This is the case under both LuxembourgGAAP and IFRS (reference to the tableon page 26).Option (ii) Where the swing factor has beenapplied on a line by line basis to individualsecurities within the portfolio, the swungNAV could be used as the basis of financialstatements prepared under LuxembourgGAAP. However, that may imply a change inthe basis of valuation of specific assets(i.e. from mid to bid). Thus, the valuationmechanism should ensure that it complieswith the valuation policy contained in theprospectus and is incorporated into thepricing policy of the fund.In terms of IFRS reporting, portfolio investmentsare generally recorded at fair valuethrough profit and loss and are required tobe valued at bid price. No adjustment forfuture transaction costs is permissible. Thus,the line by line swing adjustment describedabove could not be reflected via the fairvalue of investments line in the statementof financial position. Rather a reconciliationbetween the swung NAV used for capitalactivity and the IFRS NAV using bid pricesmay be required in order to assist the readerof the financial statements.25

part II - swing pricing guidelinesThe following table sets out guidance on how the above could be captured:Luxembourg GAAPIFRSStatement of netassets / FinancialpositionStatistical information(i.e. three yearsummary of net assetvalues)• Where a swing factor has been applied as aone line adjusting entry, the asset or liabilitycreated is not representative of a real asset orliability and should be excluded from thestatement of net assets; or 1• Where a swing factor has been captured byeach individual security, this may imply a changeof valuation basis and is included in thevaluation of those securities in the statement ofnet assets (refer to the notes to the accounts). 2• The NAV per share disclosed for each shareclass should be consistent with the NAV pershare applied to capital activity. This mayconflict with the statement of net assets(refer to the notes to accounts).• Where a swing factor has been applied as aone line adjusting entry, the asset or liabilitycreated is not representative of a real assetor liability and should be excluded from thestatement of financial position; or• IFRS requires valuation of investments touse bid prices with no adjustment for futuretransaction costs (refer to the notes to theaccounts).• IFRS only requires 2 year comparatives.The NAV per share disclosed for each shareclass should be consistent with the NAV pershare applied to capital activity.Statement ofoperations andchanges /comprehensive incomeNotes to the accounts:Depending on the accounting policies in placethere are a number of acceptable practices forthe recording of the swing factor adjustmentactually paid or received during the year.• The year-to-date swing amount posted couldbe treated as part of the realised result forthe fund, as a separate line item. 3• The year-to-date swing amount posted couldbe included within the line item reported forcapital activity. 4• If transaction costs are disclosed separatelyas expenses in the statement of operationsthe year-to-date swing amount posted couldbe reported as a separate line item underincome. (However, this treatment is currentlyvery rare for funds under Luxembourg GAAP). 5• Description of the swing pricing process inplace as described in the prospectus anddetails of any material changes made to thepolicy during the period.• As at the date of the financial statements, alist of the sub-funds to which swing pricingwas applied.• Description of any change of valuation basisas a result of applying swing pricing.• It would also be acceptable to disclose theswung NAV in a footnote to the financialstatements that also provides a reconciliationof the traded NAV to that disclosed within theprimary statements.• Where different statements use adjusted orunadjusted swing figures, clarity on that forthe investor.Depending on the fund’s accounting policiesand on how the relevant financial instrumentsare classified under IFRS there are a number ofacceptable practices for the recording of theswing factor adjustment actually paid orreceived during the year:• The year-to-date swing amount posted couldbe treated as a realised result for the fund,as a separate line item. 3• The year-to-date swing amount posted couldbe included within the line item reported forcapital activity. 4• If transaction costs are disclosed separatelythe year-to-date swing amount posted couldbe reported as a separate line item underincome. 5• Description of the swing pricing process inplace as described in the prospectus anddetails of any material changes made to thepolicy in the period.• As at the date of the financial statements,a list of the sub-funds to which swing pricingwas applied• The fund could include, in the notes to theaccounts, a reconciliation between the IFRS“bid NAV” and the fund’s swung NAV toassist the shareholders. Alternatively, thisadjustment may be included in the statementof financial position.1 See appendix page 30 (options A & B)2 See appendix page 30 (option C)3 Corresponds to option D in the appendix on page 314 Corresponds to option E in the appendix on page 315 Corresponds to option F in the appendix on page 3126

part II - swing pricing guidelinesSwing errorsWithin the context of CSSF circular 2002/77,materiality thresholds have been establishedwith regard to NAV errors. Careful considerationshould be given in respect of thechanges to processes introduced with theimplementation of swing pricing.The most common issue encountered is thatof the accurate calculation of capital activitybeing the determinant factor that will triggerthe direction in which a fund’s price is swungand additionally for partial swing, whetherthe swing threshold is breached. This isfurther complicated when considering thecircumstances and conditions which give riseto order processing errors and the impact onthe final value of the calculated capitalactivity. Generally speaking the cause oferrors can be categorised between:i) those created by the order originator and;ii) those under the control of the Fund’sprocessing agents.In the first instance timing is normally themost relevant factor to consider as mosterrors in orders sent by an order originatorare only identified on receipt of the confirmationissued after the order has been pricedusing the relevant NAV (either swung orunswung). Regardless of the price that wasultimately used, the identification of an errorof this nature can only be called by the orderoriginator who holds the original recordswith the details of the order requested. Theparticular significance being that an error isonly identified after the order has beenincorporated in the capital activity of thedealing day which is used to determinewhether to swing the fund’s NAV. Theresulting swung or unswung NAV thenbecomes the price that is applied to theerroneous order. Therefore one singleincorrect order could give rise to the incorrectapplication of swing pricing to a fund’sNAV.In the second instance there are additionalcircumstances that could give rise to an errorbeyond the incorrect processing of an orderreceived from an order originator.Examples include:application of an incorrect swing factor toa fund’s NAV;swinging the fund’s NAV in the wrongdirection;failure to swing a fund when the swingthreshold has been breached.There are many more scenarios that couldgive rise to similar administrative error.The main contrast for consideration is that afund’s agents have little or no control overerrors that fall within category i) andmaterially more influence and controlover the processing of orders and theapplication of swing pricing that enablesthem to mitigate against the risk ofcategory ii) errors.In conclusion when implementing swingpricing the fund promoter should reviewtheir error and omissions policy and updatein the appropriate manner to provide clarityas to the principles of what constitutes anerror in respect of swing pricing and theimplications that this brings in respect ofthe CSSF circular 2002/77 covering materialNAV errors.Prospectus disclosureThe prospectus should disclose that swingpricing may be applied to adjust the NAV onthe basis of actual capital activity, in order totake into account the costs and chargespayable on the effective acquisition ordisposal of assets in the fund. The prospectusshould indicate that swing pricing will beapplied on the basis of objective criteria. It isrecommended that the prospectus wordingcovers the following points:Possibility for the fund to swing the NAV.A short description of the swing pricingmechanism disclosing that in case there arenet inflows of assets, the NAV will beadjusted upwards and in case of net outflows,the NAV will be adjusted downwards.The prospectus should disclose themaximum swing factor as a percentageof a fund’s NAV.27

part II - swing pricing guidelinesShould the swing pricing mechanism onlyapply if net inflows or outflows exceed acertain threshold, this should be mentionedin the prospectus. There is no obligation todisclose the actual threshold percentage ormonetary value in the prospectus.The prospectus should disclose that theperformance fee will be charged on thebasis of the unswung NAV.It is also recommended that the prospectuscontains appropriate wording explainingthat swing pricing is designed to prevent thedilution of existing investors.It might be advisable to include in theprospectus a reference to the fact that thevolatility of the fund’s NAV might not reflectthe true portfolio performance (andtherefore might deviate from the fund’sbenchmark) as a consequence of theapplication of swing pricing.Articles of incorporationIt is recommended that the articles ofincorporation refer to the possibility toswing the NAV or at least contain a generalprovision that the NAV may be adjusted toreflect certain dealing charges.Key investor information document(replacing the simplified prospectus)As the European Directive 2009/65/EC, theCommission Regulation (EU) 583/2010 and theCESR papers in relation to the content of thekey investor information documents do notrefer to swing pricing, it should not be disclosedin the key investor information document.In accordance with (article 3 of) theCommission Regulation (EU) 583/2010, noother information or statements than thosespecified in this Regulation may be includedin the key investor information document.German Tax ReportingSince Aktiengewinn (AG) is reported as apercentage of net assets, should the swingadjustment be taken into consideration whencalculating AG? One could take theargument a step further and ask whether theadjustment should be split, pro rata, as partof the overall German tax calculation.Since the swing adjustment is a mechanismto recoup trading costs associated with largeinvestments or divestitures and is not a truereflection of the underlying securities’ valueand the associated gains and losses of thefund, one could argue not to include theadjustment in the calculation of AG.If German tax were to be taken intoconsideration, there would probably be anadverse impact to the ultimate NAV delivery.Since the concept of swing pricing is not onethat is recognised within German taxregulation, there is currently no formalposition supported by any official guidanceregarding its application to required reporting.As such, exclusion of any swing factorin this regard could be considered appropriateor, at least, could currently not bechallenged from a technical perspective.It is felt that a further driver for exclusion ofthe swing factor from German tax reportingis operational efficiency - this is especially sosince the impact to the tax calculation ofinclusion or exclusion is expected to benegligible, if any. Consulting with yourfunds’ tax adviser for a final opinion on theissue of German Tax is the advisableapproach taking into account any furtherclarification surrounding this point issuedsubsequent to this paper.28

appendicesThe examples in the appendices are provided as an aid to practitioners applyingswing pricing.Each organization’s swing pricing procedures and processes may vary slightly givingdifferent results.Therefore the basis of certain calculations and/or the presentation of FinancialStatements may differ from the examples, however, it is unlikely that there will beany material impact.29

appendix: suggested presentation of swing pricing in financial statements prepared underLuxembourg GAAPSTATEMENT OF NET ASSETSAS AT Month Day, YearA B CASSETSInvestments in securities at acquisition cost 990 000.00 990 000.00 990 000.00Unrealized appreciation (depreciation) on investments 10 000.00 10 000.00 (*) 30 000.00Investments in securities at market value 1 000 000.00 1 000 000.00 1 020 000.00Cash at banks 50 000.00 50 000.00 50 000.00Amounts receivable on sale of investments 50 000.00 50 000.00 50 000.00Amounts receivable on subscriptions 50 000.00 50 000.00 50 000.00Interest and dividends receivable, net 50 000.00 50 000.00 50 000.00Prepaid expenses 10 000.00 10 000.00 10 000.00Formation expenses (net) 10 000.00 10 000.00 10 000.00Unrealized gain on forward exchange contracts 10 000.00 10 000.00 10 000.00Other assets (swing adjustment) 0.00 0.00 0.00LIABILITIES1 230 000.00 1 230 000.00 1 250 000.00Amounts payable on purchase of investments 50 000.00 50 000.00 50 000.00Amounts payable on redemptions 50 000.00 50 000.00 50 000.00Management fees payable 50 000.00 50 000.00 50 000.00Taxes and expenses payable 30 000.00 30 000.00 30 000.00Unrealized loss on forward exchange contracts 10 000.00 10 000.00 10 000.00Other liabilities 10 000.00 10 000.00 10 000.00200 000.00 200 000.00 200 000.00TOTAL NET ASSETS - unswung / swung NAV 1 030 000.00 1 030 000.00 1 050 000.00Number of shares outstanding 100 000.00 100 000.00 100 000.00Net asset value per share - swung 10.50 10.50 10.50Alternatives methods of presenting the statement of net assets:A Swing pricing factor applied to NAV per shareB Swing pricing factor applied to NAV per share & reconciliation shown to the statement of net assetsC Swing factor applied on a line by line basis to the individual securities in the portfolioFor methods A & B please refer to the description of ‘option (i)’ on page 25For method C ((*) nb the presentational difference) please refer to the description of ‘option (ii)’ on page 2530

appendix: suggested presentation of swing pricing in financial statements prepared underLuxembourg GAAPSTATEMENT OF OPERATIONS AND CHANGES IN NET ASSETSFOR THE YEAR ENDED Month Day, YearD E FNet assets at the beginning of the yearINCOMEDividends, net of taxes - - -Interest on bonds, net of taxes - - -Bank interest, net - - -Other income - - 100.00- - 100.00EXPENSESManagement fees - - -Custodian fees, interest and bank charges - - -Administration, audit and other expenses - - -Taxe d'abonnement - - -Transaction costs - - 95.00- - 95.00NET INVESTMENT INCOME (LOSS) - - 5.00Net realized gain (loss) on sales of investments - - -Net realized gain on swing pricing 100.00 - -Net realized gain (loss) on forward exchange contracts - - -Net realized gain (loss) on foreign exchange - - -NET REALIZED GAIN (LOSS) FOR THE YEAR 100.00 - 5.00Change in net unrealized appreciation (depreciation) on investments - - -Change in net unrealized appreciation (depreciation) on forward exchange contracts - - -INCREASE (DECREASE) IN NET ASSETS AS A RESULT OF OPERATIONS 100.00 - 5.00Proceeds from subscriptions of shares - 100.00 -Cost of shares redeemed - - -Dividends paid - - -Net assets at the end of the year - - -Alternatives (see the notes on page 26 in respect of ‘the statement of operations and changes / comprehensive income’):D Swing pricing component of capital activity shown as realised gains/lossesE Swing pricing component of capital activity included with other capital activity movementsF Swing pricing component of capital activity shown as investment incomeA fund that chooses either presentation A or B in its Statement of Net Assets could use any of the suggested presentationsabove for its Statement of Operations and Changes in Net Assets. Most commonly presentations D or E are used.A fund that chooses presentation C in its Statement of Net Assets is most likely going to use presentation D in its Statementof Operations and Changes in Net Assets but again it could use any of the 3 alternatives.31

appendix: suggested presentation of swing pricing in financial statements prepared underLuxembourg GAAPNOTES TO THE ANNUAL ACCOUNTS FOR THE YEAR ENDED Month Day, YearNotes extract2. Significant Accounting Policies2(...) Swing PricingThe investment manager needs to undertake transactions in order to maintain the desiredasset allocation as a result of subscriptions or redemptions, which may generate additionalcosts for the fund and its shareholders. As a consequence, in order to protect the existinginvestors’ interest, from these capital movements, when net capital movements exceed athreshold pre-defined by the Board of Directors, an adjustment of the NAV per share used isapplied. This adjustment reflects the estimated tax and dealing costs that may be incurred bythe fund as a result of these transactions, and the estimated bid-offer spread of the assets inwhich the fund invests. A periodical review is undertaken in order to verify the appropriatenessof the swing factor being applied.The NAV per share as disclosed in the statistical information is the published NAV per sharewhereas the total net assets disclosed in the statement of net assets is the total net asset valueexcluding any year end swing adjustment.As at year end, swing pricing was applied on the NAV per share of the following sub-funds:[name of the sub-fund].OR2. Significant Accounting Policies2(...) Swing PricingThe investment manager needs to undertake transactions in order to maintain the desiredasset allocation as a result of subscriptions or redemptions, which may generate additionalcosts for the fund and its shareholders. As a consequence, in order to protect the existinginvestors’ interest, from these capital movements, when net capital movements exceed athreshold pre-defined by the Board of Directors, the valuation of the underlying securities isadjusted on a line by line basis to reflect these costs. This adjustment reflects the estimatedtax and dealing costs that may be incurred by the fund as a result of these transactions, andthe estimated bid-offer spread of the assets in which the fund invests. A periodical review isundertaken in order to verify the appropriateness of the swing factor being applied.As at year end, swing pricing was applied on the NAV per share of the following sub-funds:[name of the sub-fund].32

Revised version February 2011 - replaces version November 2006.Any questions about this brochure or other information you need about swing pricing?Please address your request to the following email address:francois.drazdik@alfi.luswing pricingsurvey, reports & guidelines