Imminent FCA review of private markets participants’ valuation practices

The FCA is due to start contacting fund and asset managers operating in private markets to assess their valuation practices. When news of this review was first broken by the Financial Times at the end of September 2023, it was suggested the review would begin at the end of the year. If that is true (and the FCA has been cagey about commenting on this), the review is imminent if it has not already begun. You don’t want to be the firm that is contacted and found to be asleep at the wheel on this.

This review follows a 2018 review into hard-to-value assets. As a reminder, common poor practices observed by the FCA then were: tick-box valuation processes, insufficient second-line expertise to be able to challenge the first line, insufficient independence of valuation from portfolio managers, and ineffective valuation committees.

It is not so much that the FCA believes the industry is filled with bad actors deliberately inflating values where, for example, remuneration or client fees are tied directly to AUM (although no doubt they exist). Rather, there is a concern that general market practices are of a poor standard. As such, firms need to be comfortable in justifying exactly what they are doing; it is not enough that a firm’s internal perception of its own culture is that there are no nefarious practices.

It remains to be seen what the outcome of this review will be, partly because we do not know the motive. The FCA has declined to comment on the reports. Will this result in action against firms who the FCA find to have seriously deficient arrangements? Or is the FCA considering new rules or guidance for the industry, and using this to inform its work? It may be both. Either way, the safe bet for firms would be to make sure the house is in order.

The FCA will expect firms to have, as a minimum:

Policy and procedures: A policy and procedures setting out your methodology for valuing your portfolio. This should include specific processes for how each type of asset is valued, including what data is used. If you apply industry standard guidelines (such as IPEV or INREV), then outline that. It is important that you articulate everything you are doing in practice.

Effective governance arrangements: Your policy should also detail how you ensure good governance around valuation practices. For fund managers, valuation should be functionally independent from the portfolio management function, and there should be no improper influence on staff involved in valuation. Remuneration policies should appropriately mitigate the risk that staff involved in valuation are incentivised to artificially inflate values. Governance goes beyond what is in the policy and needs to be ‘live’. You should be able to evidence that sufficient management information is provided to the valuation committee, and that there is effective challenge and scrutiny at meetings.

If you think your arrangements to date may have been insufficient, in the event that the FCA do contact you, you should at least be able to demonstrate to them that you are on the case and are now remedying this. So an internal review of your practices as a first step is essential.

Please let us know if you need any help in this area. Our team has extensive experience in helping firms prepare and implement valuation policies and procedures.