Good valuation practices are key to maintaining fairness and confidence as the market grows
Private markets firms need to better manage the process they use to value assets, according to a review of the sector by the Financial Conduct Authority (FCA).
The regulator's multi-firm review of valuation processes for private market assets – the findings of which were published today (5 March) – looked at practices and governance at a number of firms for valuing private equity, venture capital, private debt, and infrastructure assets.
Overall, the regulator found private markets firms demonstrated good practice in areas such as investor reporting, process documentation and use of third-party valuation advisers. It said they were also consistently applying valuation methodologies.
But the FCA also called for improvements in several areas – noting that better identification and documentation of potential conflicts of interest in the valuation process was needed as was increased independence within firms' own valuation processes.
It also said that some firms needed to enhance processes for ad hoc valuations in times of market disruption.
There is an increasing onus on private market firms to get their own valuations correct, as private markets lack the frequent trading and regular price discovery present in more liquid public markets.
This means firms must estimate private asset values using judgement-based approaches to meet applicable accounting standards.
The FCA said: "This introduces a risk that firms could inappropriately value private assets, for reasons including insufficient expertise, focus, or poorly managed conflicts of interest, increasing the risk of harm to both investors and market integrity."
Private markets have grown significantly in recent years – prompting the FCA to carry out its review – as investors, including defined contribution pension schemes, seek to diversify investment and seek new sources of return.
FCA director of wholesale buy-side Camille Blackburn said: "Good valuation practices are key to maintaining fairness and confidence as the market grows. We were pleased that firms could usually evidence independence, expertise, transparency and consistency in their valuation process."
Despite this, Blackburn added "there is still more to do" noting the FCA expects firms to "carefully consider" its findings.
A growing market
An increasing numbers of asset managers are investing in private markets capabilities, building organically or via acquisition and joint venture, to meet rising investor demand from individuals and institutions from across the globe.
Aberdeen private market solutions Nalaka De Silva said private markets "could bring enormous benefits" for investor returns, particularly as pension funds look to allocate more to this area.
But he added: "One of the biggest barriers blocking greater retail access to private markets has been question marks around how we can assess valuations."
He called for a continued focus on improving practices in private market valuations – and the creation of "gold standard" guidance covering how a private asset should be valued, how frequently and who will value it.
"This may come from the FCA or it may come via industry collaboration – either way it needs to come," he said.
Valuing a private asset "is no easy thing" De Silva said. "Assets can range from technically complex infrastructure projects to portfolios of private companies at different stages of growth.
"What's more, there is no single standard for how to value a private market asset – creating inconsistencies – and we would not be surprised to see the same asset valued differently in two different portfolios."
For investors, particularly pension fund trustees and retail investors, to get on board with private markets, "we need to boost trust", said De Silva.
This includes improving the quality and availability of market information, he said, so individuals understand both the potential risks and the potential rewards of investing in private markets.
Boosting investor confidence
Commenting on the FCA's review, Investment Association director of investments and capital markets Galina Dimitrova said: "Ensuring firms are carrying out robust and accurate valuations is mission critical for the long-term success of private markets.
"Getting this right will boost confidence amongst investors whilst encouraging firms to invest in developing their private market capabilities."
She continued: "We support the FCA's recognition that a robust valuation is based on independence, expertise, transparency and consistency, and look forward to working with our members and the regulator as the industry looks to implement the FCA's best practice recommendations."
Next steps
The FCA's findings will be used in its review of Alternative Investment Fund Managers Directive (AIFMD) as it updates its rules in its handbook.
They will also form part of the FCA's contribution to the International Organization of Securities Commissions (IOSCO) review of global valuation standards to support the use of proportionate and consistent valuation standards globally in private markets.
This article was originally published by PP sister title, Investment Week
