FCA's Review: A Closer Look at Private Market Valuations

The Financial Conduct Authority (FCA) in the UK is set to embark on a comprehensive review of private market valuations. This move comes against the backdrop of rising interest rates and an economic downturn, placing increasing pressure on private equity firms and their portfolio companies.

Evaluating "Disciplines and Governance"

The FCA's review plan focuses on scrutinizing the "disciplines and governance" surrounding private market valuations. Key areas of examination include:

Responsibility Within Firms

·      Determining who is accountable for setting valuations.

·      Assessing how valuation information is communicated upwards within the organization.

Governance Procedures

·      Reviewing the governance processes in place for valuations.

·      Ensuring that valuations are aligned with the impact of higher interest rates on lending.

Potential FCA Actions

The FCA has the authority to take actions if it deems that governance processes are inadequate. These actions may include:

·      Highlighting failures in governance.

·      Requiring firms to make necessary improvements.

Scope and Launch Date

The full scope of the FCA's review has not yet been finalized, but it is expected to be launched by the end of the year. This move by the FCA has been described as a "wake-up call" by industry experts.

Implications for Different Fund Sizes

·      Smaller Funds: The review may push smaller funds toward full outsourcing of valuation processes.

·      Larger Funds: Larger funds are likely to face heightened scrutiny and increased risk associated with valuation practices.

Impact on the UK Asset Management Industry

The UK's asset management industry, with approximately £11 trillion in assets, consists of around 2,600 firms. The FCA's review signals an increasing level of scrutiny within the private equity sector.

Global Regulatory Concerns

This move by the FCA is part of a broader global trend of increased regulatory scrutiny in the private equity industry. Regulators worldwide are concerned about potential risks in private assets, particularly after a decade of low-interest rates.

·      Quarterly Valuations: Private assets are typically valued on a quarterly basis, unlike public markets that are valued daily.

·      FCA's Ongoing Focus: The FCA began monitoring liquidity issues last year after certain liability-driven investment funds struggled to raise additional collateral when UK government bond yields surged.

International Oversight

The International Organization of Securities Commissions (Iosco) has also expressed concerns about the private sector, which is valued at $13 trillion globally. Valuations have been identified as a particular area of vulnerability. In response to these concerns, the US Securities and Exchange Commission (SEC) has ordered private funds to provide more extensive disclosures regarding performance and expenses. This regulatory move has prompted legal action from a coalition of private equity, venture capital, and hedge funds.

As the FCA's review unfolds, it will shed light on the evolving landscape of private market valuations and their implications for the financial industry at large.

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