YEARBOOK & DIRECTORY
Finance Dublin Yearbook 2024
Navigating valuations: reflections on 2023 and how 2024 is developing
Valuations were centre stage for regulators in 2023 writes Forvis Mazars’ Cian Higgins who analyses three major reports released during the year from ESMA, IOSCO and the Central Bank of Ireland and looks at a forthcoming report from the UK’s Financial Conduct Authority that shows the regulatory focus in the area looks set to continue throughout 2024.
In 2023 we witnessed an increased focus from regulators on valuations, with three important reports, outlined below, shedding light on valuation practices and challenges. Additionally, we’ll explore the anticipated review of private market valuations by the Financial Conduct Authority (FCA) in 2024, underscoring a growing concern over the impact of higher borrowing costs on the sector.
In January 2022, The European Securities and Markets Authority (ESMA) initiated a Common Supervisory Action (CSA) to assess the compliance of supervised entities with asset valuation rules under the UCITS and AIFM Directives. The final report, released in May 2023, highlighted several key findings:
1. Valuation policies and procedures: While most entities demonstrated satisfactory compliance, deficiencies were noted in documented and established valuation policies and procedures. Some lacked clarity in the allocation of operational tasks and responsibilities.
2. Valuation under stressed conditions: Issues arose regarding the distinction between normal and stressed market conditions in valuation policies, particularly for less-liquid assets.
3. Independence and third-party valuation: While overall assessments were positive, concerns were raised about the lack of independence in valuation functions, especially in smaller managers relying heavily on third-party data without adequate checks.
4. Early detection mechanisms: While broad compliance was observed, formal procedures for early detection of valuation errors and investor compensation were not consistently established.
5. Focus on private equity and real estate: Alignment issues between Net Asset Value (NAV) calculation, asset valuation frequency, and data availability were noted, particularly for funds invested in less-liquid assets like Private Equity (PE) and Real Estate (RE).
ESMA emphasized the importance of addressing deficiencies in the current economic environment, with challenges exacerbated by macroeconomic factors, tightening financial conditions, and increased interest rates.
The second report released by the International Organisation of Securities Commissions (IOSCO) highlighted the rapid growth of global private finance, reaching $12.8 trillion USD in June 2022, with a focus on private credit and equity funds. Despite acknowledging the benefits of private finance in stimulating economic growth, the report underscored potential risks, including:
1. Interest rate normalisation: The return of inflation and interest rate normalisation posed challenges to funding models within private finance, potentially impacting the availability of affordable funding.
2. Conflicts of interest: Conflicts were identified in valuation practices, transaction negotiations, and general partner-led secondary markets, emphasizing the need for effective management.
3. Risk transmission: The interconnectedness between private and public markets could lead to risk transmission, especially with the significant growth of private markets.
4. Lack of data: The lack of comprehensive data on private finance activities made risk mapping challenging, highlighting the need for improved transparency.
In December 2023, The Central Bank of Ireland released a ‘Dear Chair’ letter on the back of their review, conducted as part of ESMA’s CSA on asset valuations. It emphasized the importance of compliance with UCITS and AIFM Directives. While overall compliance was good, key findings included:
1. Group asset valuation policies: Some firms relied on group policies that did not adequately consider local regulatory nuances, potentially leading to inaccuracies in Irish entity valuations.
2. Asset valuation error procedures: Supervisors identified firms lacking stand-alone error procedures, risking unfair treatment of investors in case of valuation errors.
3. Quality of asset valuation policies: A minority of firms had poor-quality policies, lacking the necessary detail to cover the valuation process adequately.
4. Limited evidence of periodic reviews: The majority of firms failed to demonstrate periodic reviews of asset valuation policies and procedures, raising concerns about the accuracy of asset valuations.
Looking ahead to 2024, the Financial Conduct Authority (FCA) in the UK is set to launch a comprehensive review of valuations in private markets. Concerns over the impact of higher borrowing costs on the sector have prompted this examination into disciplines and governance over valuations. Key areas of focus include accountability for valuations within firms, information flow to management committees and boards, and overall governance procedures.
There has been heightened scrutiny of valuations in 2023, as evidenced by the aforementioned reports. As we move into 2024, the FCA’s upcoming review of private market valuations signals a continued focus on ensuring robust governance practices. Navigating these challenges requires a proactive approach from financial entities, emphasising the importance of transparent policies, independence in valuation functions, and periodic reviews to adapt to dynamic market conditions. As we anticipate the unfolding trends of 2024, it is crucial for market participants to remain vigilant and responsive to the evolving financial landscape.
In January 2022, The European Securities and Markets Authority (ESMA) initiated a Common Supervisory Action (CSA) to assess the compliance of supervised entities with asset valuation rules under the UCITS and AIFM Directives. The final report, released in May 2023, highlighted several key findings:
Cian Higgins: Concerns over the impact of higher borrowing costs has prompted the UK's Financial Conduct Authority to launch a comprehensive review of valuations in private markets on private markets have prompted an examination into disciplines and governance over valuations.
Concerns were raised about the lack of independence in valuation functions, especially in smaller managers relying heavily on third-party data without adequate checks.
1. Valuation policies and procedures: While most entities demonstrated satisfactory compliance, deficiencies were noted in documented and established valuation policies and procedures. Some lacked clarity in the allocation of operational tasks and responsibilities.
2. Valuation under stressed conditions: Issues arose regarding the distinction between normal and stressed market conditions in valuation policies, particularly for less-liquid assets.
3. Independence and third-party valuation: While overall assessments were positive, concerns were raised about the lack of independence in valuation functions, especially in smaller managers relying heavily on third-party data without adequate checks.
4. Early detection mechanisms: While broad compliance was observed, formal procedures for early detection of valuation errors and investor compensation were not consistently established.
5. Focus on private equity and real estate: Alignment issues between Net Asset Value (NAV) calculation, asset valuation frequency, and data availability were noted, particularly for funds invested in less-liquid assets like Private Equity (PE) and Real Estate (RE).
ESMA emphasized the importance of addressing deficiencies in the current economic environment, with challenges exacerbated by macroeconomic factors, tightening financial conditions, and increased interest rates.
The second report released by the International Organisation of Securities Commissions (IOSCO) highlighted the rapid growth of global private finance, reaching $12.8 trillion USD in June 2022, with a focus on private credit and equity funds. Despite acknowledging the benefits of private finance in stimulating economic growth, the report underscored potential risks, including:
1. Interest rate normalisation: The return of inflation and interest rate normalisation posed challenges to funding models within private finance, potentially impacting the availability of affordable funding.
2. Conflicts of interest: Conflicts were identified in valuation practices, transaction negotiations, and general partner-led secondary markets, emphasizing the need for effective management.
3. Risk transmission: The interconnectedness between private and public markets could lead to risk transmission, especially with the significant growth of private markets.
4. Lack of data: The lack of comprehensive data on private finance activities made risk mapping challenging, highlighting the need for improved transparency.
Some firms relied on group policies that did not adequately consider local regulatory nuances, potentially leading to inaccuracies in Irish entity valuations.
In December 2023, The Central Bank of Ireland released a ‘Dear Chair’ letter on the back of their review, conducted as part of ESMA’s CSA on asset valuations. It emphasized the importance of compliance with UCITS and AIFM Directives. While overall compliance was good, key findings included:
1. Group asset valuation policies: Some firms relied on group policies that did not adequately consider local regulatory nuances, potentially leading to inaccuracies in Irish entity valuations.
2. Asset valuation error procedures: Supervisors identified firms lacking stand-alone error procedures, risking unfair treatment of investors in case of valuation errors.
3. Quality of asset valuation policies: A minority of firms had poor-quality policies, lacking the necessary detail to cover the valuation process adequately.
4. Limited evidence of periodic reviews: The majority of firms failed to demonstrate periodic reviews of asset valuation policies and procedures, raising concerns about the accuracy of asset valuations.
Looking ahead to 2024, the Financial Conduct Authority (FCA) in the UK is set to launch a comprehensive review of valuations in private markets. Concerns over the impact of higher borrowing costs on the sector have prompted this examination into disciplines and governance over valuations. Key areas of focus include accountability for valuations within firms, information flow to management committees and boards, and overall governance procedures.
There has been heightened scrutiny of valuations in 2023, as evidenced by the aforementioned reports. As we move into 2024, the FCA’s upcoming review of private market valuations signals a continued focus on ensuring robust governance practices. Navigating these challenges requires a proactive approach from financial entities, emphasising the importance of transparent policies, independence in valuation functions, and periodic reviews to adapt to dynamic market conditions. As we anticipate the unfolding trends of 2024, it is crucial for market participants to remain vigilant and responsive to the evolving financial landscape.
Cian Higgins is Head of Quantitative Risk at Forvis Mazars.