Regulators across the globe are in the process of reviewing how valuations are conducted. This review has arisen as almost a decade of low interest rates draws to a close. Regulators fear that increasing borrowing costs stemming from the current rising interest rate environment will detonate private markets. As a result, some global regulators are conducting supervisory assessments of the current valuations landscape, while other regulators have created their own policy surrounding private valuations.
What are global regulators doing?
In the UK, the Financial Conduct Authority (FCA) is preparing to assess private valuations from the start of 2024. The FCA’s review will determine the responsible party within a company for valuations, how a firm transmits valuation information to pertinent management and will identify any additional governance protocols currently in place.
Throughout 2023, The Central Bank of Ireland enhanced its focus on adopting a thematic approach to supervising the funds sector. The Central Bank’s strategy assesses sector risks and promotes higher industry standards. The focus adopted by the Central Bank of Ireland includes initiatives created by the European Central Bank. One of the current Common Supervisory Actions (CSA’s) made by the European Central Bank relates to Asset Valuation. James O’Sullivan, Head of Function – Fund & Firm Authorisations at the Central Bank commented that the Central Bank of Ireland’s Asset Valuation supervisory action was largely completed as of September 2023, with several firms being issued with risk mitigation programmes following their inspection.
In the US, regulatory reviews of private valuations led to the creation of the ‘Private Fund Advisor Rules’. On August 23rd, 2023, the US Securities and Exchange Commission (SEC) voted in favour of imposing these regulations on the private funds industry. Up to now, the US private funds market has been subject to light regulations that enable fund managers to administer their clients’ funds at their own discretion.
The Private Fund Advisor Rules aim to enhance investor protection, by disallowing private fund advisers from offering their investors preferential treatment related to redemptions and information, if such treatment could negatively impact other investors in a significant way.
The Advisor Led Secondary Rule is the provision of the regulation that deals with valuations of private assets. The provision requires all fund managers to receive a fairness or valuation opinion from an SEC-approved opinion provider who is independent from the transaction. The role of the independent opinion provider is to compute the value of any assets being sold by the fund advisor. The regulation states that the fund manager is also responsible for providing its investors with a written summary of the extent of the business relationship between themselves and the independent opinion provider over the previous two-year period. The fund manager must distribute both the valuation opinion and the relationship summary to investors under the Private Fund Advisor Rules.
What are the implications of valuation regulations?
It is important to look closely at and understand the implications of the US Private Fund Advisor Rules, as it is highly likely they will set a precedent for other Central Banks as they establish their own valuation regulations. The enforcement of US regulations regarding private valuations will prompt regulators and investors to scrutinise the following:
1. The valuation methodology
At present, there is no set valuation methodology that fund managers must follow to value private assets because these assets are not subject to the day-to-day volatility of the public market. Therefore, the way in which private fund advisors perform their valuations will be heavily scrutinised.
2. The objectivity of the valuation methodology
As scrutiny of private valuations intensifies, there will also be heighted attention surrounding how impartial and transparent a private fund advisors’ fair value assessment is. Fund managers will need to ensure they are not overvaluing or undervaluing their assets as if they are, their valuation is likely to arrive at a much different estimate than that of the independent valuer.
3. Its ability to withstand stringent operational due diligence
Because operational risks significantly affect the return on a private investment, the Private Fund Advisor Rules place a strong focus on operational due diligence. Private fund advisors will need to perform continuous due diligence measures to ensure they are providing an accurate assessment of an asset’s fair value.
4. Differing valuation opinions
Private fund advisors are likely to be heavily scrutinized if their assessment of an assets value is significantly different to the valuation opinion arrived at by the independent advisor. This is because any material difference in the valuations will lead to investors questioning the capability of the fund advisor. If investors think their fund manager is overvaluing or undervaluing an asset, they may lose confidence in their fund advisors’ abilities and may take their business elsewhere.
How can KPMG help you?
It is highly likely that Irish firms will soon face scrutiny of their valuation methods like those mentioned above. It is imperative businesses take the time to refine their current procedures and ensure they conform to regulatory standards to future proof their business.
KPMG’s Financial Instruments (KFI) team consists of thirty people who provide expert and business-orientated independent valuation services, tailored to the unique requirements of our clients. The KFI team can help your business review fair value calculation and its valuation policy. The KFI team is readily available and eager to engage with you to identify the right solution for your business. We look forward to hearing from you.
Contact us for more
For further information on the issues mentioned above, or any related issues, please contact our Asset Management team.
