Asset Valuation: Key Lessons from the CBI

Following the Central Bank of Ireland’s (CBI) examination of Irish fund managers’ adherence to valuation methodology and principles guidelines, valuation frameworks have attracted much interest. There is a rising expectation that other European regulators will soon adopt comparable regulatory monitoring, as corporations are now compelled to update their valuation systems and undergo internal evaluations by 2024.

This post will review the main findings of the CBI study and offer crucial actions to guarantee adherence and fortify your asset value system.

Application of policies and procedures for group asset appraisal

According to the CBI, several companies were found to rely significantly on group-wide valuation rules and procedures. These frequently needed more precise information on how the Irish entity carried out its appraisals, which could have resulted in inaccurate information about the firm’s particular operations, local regulatory compliance, and the roles and duties of those participating in the Irish valuation process.

We advise implementing a stand-alone entity-level valuation policy and extensive valuation procedures to address these worries. These records ought to describe the following:

• Principles of valuation
• Roles and responsibilities assigned
• Methods of valuation
• Measures to guarantee the valuation process’s independence

Absence of official error methods for asset valuation

The CBI and other national competent authorities (NCAs) prioritize procedures for early identification, escalation, and investor transparency. According to the CBI’s examination, many companies either needed more procedures or more specific valuation error procedures.

Investors may have been mistreated because some operations need more controls and escalation mechanisms for valuation errors or inaccurate NAV computations.

A stand-alone set of comprehensive error procedures for your entity is essential to resolving these problems; more than group processes are required. A well-defined escalation strategy with roles and responsibilities should be in place to deal with mistakes. These procedures should describe how businesses revalue, recalculate, and resettle impacted transactions or investor compensation. It is necessary to establish materiality thresholds and a method for dealing with errors that surpass them, which may involve informing the regulator.

Although CBI Consultation Paper 130’s final guidance on “Treatment, Correction, and Redress of Errors in Investment Funds” has not yet been released, it offers insightful information about what the regulator expects. It can be a helpful guide when creating your error procedures.

Policies and practices of poor quality

A few businesses in the CBI sample had subpar asset valuation policies and procedures that needed more specifics to fully address the valuation process. In certain instances, businesses merely substituted passages from operations manuals or fund documents for specific asset valuation rules and procedures.

We advise that your company establish an extensive, stand-alone set of asset valuation-specific policies and processes. These documents should detail the operational duties and responsibilities of each party concerned. More than simply relying on excerpts from previously published materials, such as operations manuals or programs of action, is required.

Insufficient proof of regular reviews

Most sampled firms needed help demonstrating that they regularly reviewed their valuation rules and methods.

As a result, we advise that reviews be thoroughly recorded, version-controlled, and governed by a transparent procedure for implementation and monitoring.

The observations of the central bank

During its review, the CBI noted several things in addition to the main conclusions:

Stress testing for liquidity

The CBI investigated the degree to which companies conducted scenario analysis and liquidity stress tests (LSTs) as part of the asset valuation review. Both standard and stressed market conditions should be used for periodic LSTs, emphasizing less liquid assets.

Even though all companies carried out scenario analysis and stress testing, it is essential to integrate the findings into liquidity management frameworks and apply them to guide risk mitigation, risk management, and decision-making. Decisions made as a result ought to be formally recorded and authorized.

ESMA also highlights the necessity of methodically incorporating LST results, particularly for less liquid assets, during market stress.

We advise implementing monitoring systems with predetermined circumstances to initiate the use of alternative valuation models. To resolve the shortcomings found in the asset valuation model, regular follow-up meetings should be conducted with knowledgeable staff members who evaluate these shortcomings.

The asset valuation function’s independence

Conflicts of interest may have arisen because certain companies’ asset valuation rules and procedures were unclear in defining the operational duties and responsibilities within the asset valuation function.

As a result, businesses should ensure that the valuation function is independent and that duties are separated.

• Policies and procedures: Firms’ detailed, entity-specific valuation policies and procedures should clearly outline all stakeholders’ operational roles and responsibilities in the asset valuation process.
• Frequent periodic reviews: To guarantee their continued applicability, top management should evaluate the policies above and procedures “at least annually, or where required throughout the year.” All money under management should be subject to these regulations and guidelines.
• Error procedures: Formal and thorough error procedures should be in place to direct the proper response to valuation errors or inaccurate NAV estimates. These processes should be evaluated once a year.

How Can GERAI LTD Help with Frameworks for Valuation?

The ultimate obligation is to evaluate AIF assets, determine net asset value (NAV), and publish that NAV rests with an AIFM. Suitable and uniform policies and processes must be set up for every AIF under its supervision to satisfy regulatory requirements.

A third-party AIFM like GERAI LTD will help to ensure that robust policies and procedures are in place to facilitate proper and impartial valuations, even though the regulation allows the valuation process to be assigned to an independent external valuer. This entails ensuring that AIFMD rules are followed, that valuation procedures and principles are followed, and that financial positions are accurately reflected in typical and stressful market situations.

As mandated by the regulation, GERAI LTD can offer thorough initial and continuing due diligence on external valuers. From the standpoint of continuous monitoring, we will regularly evaluate the effectiveness of asset valuation control frameworks, rules, and processes, strengthening arrangements where they are found to be inadequate.

Please contact us immediately at GERAI LTD with any questions.