Private Market Valuations In The Spotlight

We often hear our clients and other stakeholders in the private markets space lament that regulation was not written with unlisted investment in mind or that the regulator is not as familiar with the ecosystem. Hot on the heels of its new secondary objective to position the UK for international growth, and attention from ISOCO and the Bank of England on private markets, the FCA has undertaken a deep dive in the sector.

The output of the FCA's Private Market Valuations Review shows both that private markets are important to the UK's international competitiveness, and that they will be receiving a commensurate level of attention from now on. 

36 managers and advisers in the private markets formed the multi-firm review, all being surveyed and some being visited. The FCA's write-up demonstrates a thorough look under the bonnet of the industry and that it has really gotten to grips with where the risks are. 

If your firm operates in venture capital, private equity, private debt, infrastructure equity, infrastructure debt - or if it otherwise needs to apply judgement-based valuations to assets (e.g. real estate) - the feedback from the review will be an invaluable read.

While long, the write-up contains action points and highlights good and bad practices that will help you to quickly identify how your firm might fare under review. Realistically, actioning this feedback will require a gap analysis across your valuation processes, practices and paperwork. It will require you to assess everything from what triggers a valuation to who is influencing the end result.

However, while it may be a big job, it's an important one, and we would recommend prioritising it. As the FCA has announced a further multi-firm review in the private markets space later this year, specifically on conflicts of interest, it would be worth taking any steps to identify and bolster areas of weakness sooner rather than later.

To help, we have summarised some of the key takeaways and, of course, we'll be on hand to assist you in identifying or rectifying any gaps over the coming months.

Valuation Process and Committee

The unlisted nature of private markets means that there is less open and frequent trading, meaning that valuations are not necessarily determined by the price point that buyers and sellers accept. The judgment that is involved in private market valuations means that the FCA is concerned about their quality.

Specifically, the regulator is concerned that private market valuations could be inadequate, incomplete or inappropriately influenced, meaning poorer outcomes for investors. Taking steps to identify your firm's strengths and weaknesses in this area is key.

Many examples of good practice emerged as part of the review, including:

• the consistent application of established valuation methodologies

• the use of third parties to advise on valuations, where this brings added independence and expertise

The FCA has used the review to draw to firms’ attention the need for:

• functional independence of those deciding on valuations from those doing portfolio management, which includes looking at the voting members of any valuation committee

• expertise in those who can challenge valuations

• those responsible for valuations to have authority and expertise

• a consistent process for valuations triggered by market or asset-specific events, ideally with thresholds and types of events that would trigger such an ad hoc valuation

• strong record keeping at valuation committee

  
  

>> Actions in practice

The procedures and practices relating to valuations needs to be reviewed to ensure that the FCA will be happy that sufficient controls are in place for the judgments made to be reliable. This will also require looking at the personnel involved with the valuation process and, depending on your setup may require and injection of authority and expertise, or a reduction of influence by those in the front office.

Conflicts of interest

Proper identification of conflicts is key, in the regulator’s view, to ensuring that judgment in private market valuations is properly exercised and that good outcomes for investors are protected.

While the FCA found that staff were able to discuss conflicts in theory, it noted that the identification of conflicts was often lacking in firms' paperwork including the paperwork relating to individual valuations. 

Firms will need to review their documentation and processes to show that all valuation conflicts are properly identified, considered and managed.

When updating your conflicts, you should consider the following potential areas as these were highlighted and commented on within the review:

• investor fees

• asset transfers

• redemptions and subscriptions

• investor marketing

• secured borrowing

• employee remuneration

>> Actions in practice

You want to ensure you have identified all valuation-specific conflicts and documented these in your processes and valuation paperwork.

When documenting these, meaningful descriptions should be added, and you should detail the level of materiality and any action you have taken to mitigate the risks.

Other Themes

Above, we have summarised the two meatiest themes of the Private Market Valuation Review, but other areas are also covered and worth reviewing. For example, there is content on investor reporting and transparency, the use of borrowing, backtesting, fee structures, staff remuneration, marketing that refers to unrealised performance and valuation models.

The themes throughout focus on building trust in the quality of valuations, and in the judgment of the firms determining them, to ensure good investor outcomes. When testing your firm's processes and procedures, these are the key principles to keep in mind.

Next steps

As mentioned above, the next step in private market supervision is another multi-firm review this year on conflicts of interest.

Not only are the results on conflicts described above useful preparation for such a review but, if your firm were to be one of the firms visited, being able to demonstrate what action you took in relation to the Private Markets Valuations Review generally and, if relevant, to the portfolio letter sent to asset managers earlier this year will be valuable.

In our view, it is more likely you will be caught by the next multi-firm review if your business involves intersecting business lines, continuation funds, co-investment opportunities or partnering with other financial institutions, as the FCA has flagged that it considers these aspects of private market can increase the potential for conflicts.

As a final note, the FCA is also due to revise the Alternative Investment Fund Managers Directive (AIFMD) for the UK and has promised to use what it has learnt from the Private Markets Valuation Review in how it approaches this task. This may mean we see rules that are more tailored to private markets coming through.

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Adempi's team of FCA compliance consultants support firms affected by the Private Markets Valuations Review. We advise, support and train firms in venture capital, private equity, private debt and infrastructure to navigate FCA rules and expectations.

If your firm would benefit from support or a sounding board on how to approach adapting your valuations and conflicts processes, you can reach the team at contact@adempi.co.uk