Key Insights for asset managers on valuation frameworks: Lessons from the CBI

Valuation frameworks have gained significant attention following the Central Bank of Ireland's (CBI) review of Irish fund managers' compliance with valuation methodologies and principles guidelines. With firms now required to conduct internal reviews and update their valuation frameworks in 2024, there's a growing expectation that similar regulatory scrutiny will be adopted by other European regulators in the near future.

In this article, Stephen Hickey and Kevin Curtis from Ocorian's AIFM team in Ireland discuss key lessons learned from the CBI review and provide essential steps to ensure compliance and strengthen your asset valuation framework.

Use of group asset valuation policies and procedures

The CBI observed that several firms relied heavily on group-wide valuation policies and procedures. These often-lacked specific details on how the Irish entity conducted its own valuations, potentially leading to inaccuracies in the context of the firm's unique operations, compliance with local regulations, and the roles and responsibilities of those involved in the Irish valuation process.

To address these concerns, we recommend implementing a standalone entity-level valuation policy and a comprehensive set of valuation procedures. These documents should outline:

• Valuation principles
• Assigned roles and responsibilities
• Valuation methodologies
• Controls to ensure independence within the valuation process

Lack of formal asset valuation error procedures

The CBI and other national competent authorities (NCAs) prioritise early detection, escalation, and investor transparency procedures. The CBI's review revealed that many firms lacked a dedicated valuation errors procedure or had inadequate procedures.

Some procedures were insufficiently detailed, lacking controls and escalation measures for valuation errors or incorrect NAV calculations, which could potentially lead to unfair treatment of investors.

To address these issues, it's crucial to have a standalone set of detailed error procedures for your entity, rather than relying solely on group processes. A clear escalation plan with defined roles and responsibilities should be in place to handle errors. These procedures should outline how firms will revalue, recalculate, and resettle affected transactions or investor compensation. Materiality thresholds should be defined, and a process should be established for handling errors that exceed these thresholds, including potential notification to the regulator.

While the final guidance for CBI Consultation Paper 130 on "Treatment, Correction, and Redress of Errors in Investment Funds" has not yet been issued, it provides valuable insights into the regulator's expectations and can be a useful reference when developing your error procedures.

Poor quality policies and procedures

A small number of companies in the CBI's sample had poor quality asset valuation policies and procedures that lacked the necessary detail to adequately cover the valuation process. In some cases, firms simply used excerpts from existing fund documentation or operations manuals as a substitute for dedicated asset valuation policies and procedures.

We recommend that your firm have a comprehensive, standalone set of policies and procedures specifically for asset valuation. These documents should clearly outline the operational tasks and responsibilities of all involved parties. Relying on extracts from pre-existing documentation, such as program of activity or operations manuals, is insufficient.

Limited evidence of periodic reviews

The majority of firms sampled could not provide clear evidence of periodic reviews of their valuation policies and procedures.

Therefore, we recommend that reviews be well-documented, version-controlled, and subject to a clear governance process for execution and follow-up.

The central bank’s observations

In addition to the key findings, the CBI also made several observations during their review:

Liquidity stress testing

While conducting the asset valuation review, the CBI examined the extent to which firms performed liquidity stress tests (LSTs) and scenario analysis. Periodic LSTs should be conducted under both normal and stressed market conditions, with a particular focus on less liquid assets. 

Although all firms were performing stress testing and scenario analysis, it's crucial to incorporate the results into liquidity management frameworks and use them to inform decision-making, risk management, and risk mitigation. Resulting decisions should be formally documented and approved.

ESMA also emphasises the need for a systematic incorporation of LST outcomes, especially for less liquid assets, under stressed market conditions.

We recommend implementing monitoring systems with predefined conditions to trigger the use of alternative valuation models. Regular follow-up meetings should be held to address weaknesses identified in the asset valuation model, with experienced personnel assessing these weaknesses.

Independence of the asset valuation function

Some firms' asset valuation policies and procedures lacked clarity in delineating operational tasks and responsibilities within the asset valuation function, potentially creating conflicts of interest. 

As such, firms should ensure clear segregation of roles and independence within the valuation function.

• Policies and procedures: Firms should have comprehensive, entity-specific valuation policies and procedures clearly outlining the operational roles and responsibilities of all parties involved in the asset valuation process.
• Regular periodic reviews: The aforementioned policies and procedures should be reviewed by senior management ‘at least annually, or where required throughout the year’, to ensure their ongoing suitability. These policies and procedures should be applied to all funds under management.
• Errors procedures: Formal and comprehensive error procedures should be in place to guide the appropriate response to valuation errors or incorrect NAV calculations. These procedures should also be reviewed annually, at a minimum.

How can a third-party AIFM assist with valuation frameworks?

An AIFM bears ultimate responsibility for the valuation of AIF assets, the calculation of net asset value (NAV), and the subsequent publication of that NAV. For each AIF under its management, appropriate and consistent policies and procedures must be established to meet regulatory expectations.

While the regulation permits the valuation process to be delegated to an independent external valuer, a third-party AIFM such as Ocorian will assist in ensuring that robust policies and procedures are in place to facilitate proper and independent valuations. This includes ensuring compliance with AIFMD regulations, adherence to valuation principles and methodologies, and the accurate reflection of financial positions under both normal and stressed market conditions.

Ocorian can also provide comprehensive initial and ongoing due diligence on external valuers, as required by the regulator. From an ongoing monitoring perspective, we will continuously assess the adequacy of asset valuation control frameworks, policies, and procedures, taking necessary steps to strengthen arrangements where weaknesses are identified.

About Ocorian AIFM services

Ocorian is a specialist provider of AIFM services for private capital alternative investment managers.

We have extensive expertise in managing private equity, real estate, infrastructure, and private debt funds.

Our AIFM teams are based in Dublin and Luxembourg. By having sector specialists amongst its team, the AIFM can ensure a smooth alignment of investment processes with the fund manager and offer expertise on complex risk and compliance matters.

Ocorian is also authorised to provide fund administration services and real asset depositary services.

As a result, we can provide a seamless one-stop-shop solution to help fund managers realise their investment strategies and deliver value to their investors.