NAV Error Due To CFD Reset

The press release below describes a NAV error that was caused by the over-statement of an interest accrual on open contract for difference (CFD) positions. Basically, an interest receivable amount remained on the balance sheet after the interest was actually received. So the amount was double-counted in the NAV. How could such an error arise? Let’s take a look at fund accounting for CFDs to find out.

First of all, some equity CFD basics.

Now, how did the fund above double-count the interest income amount? Let’s work an example.

Let's suppose the investment manager had a negative view on ABC Limited. ABC is trading at $80 per share. On July 26th, the IM executes a SELL TO OPEN on behalf of the fund and thus creates a SHORT position of 50,000 CFDs. If the IM had bought CFDs, he’d have to pay a financing charge. But because this is a short position, the fund earns interest.

Assume the broker pays interest of 1%. So the fund earns $80 x 50,000 x 1% / 365 = $110 per day while the position remains open. In reality, this daily amount will change as the price of ABC changes. For this example, we’ll keep it constant at $110 per day. The fund accountant must ensure that the CFD interest receivable amount per the broker statement agrees to the interest receivable amount included in the NAV.

Ten days later it is August 5th and the ABC position has lead to an interest receivable amount of $1,100. This is included in the NAV. This broker resets CFD positions monthly on the 5th. Regarding the interest income, upon reset, the fund accountant must ensure that cash increases by the CFD Interest Receivable amount ($1,100) and the CFD Interest Receivable line decreases by the same amount.

Fund accounting systems easily manage to accrue and receive bond interest without manual intervention. But CFDs can present a problem for some administrators because many accounting systems do not have an instrument type for CFDs. Therefore, some offline work might be required. It appears, in the error outlined in the press release, that a manual error resulted in interest received being included in cash but also being mistakenly shown as interest receivable.

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