The FCA's review comes at a time of increasing scrutiny in asset valuations, emphasised by recent news articles which highlight the potential fall-outs arising from valuation errors and inadequate processes/governance.

The FCA is committed to "targeted follow-up work with any outlier firms identified from our review", and it would not surprise us if an increasing number of asset managers were challenged on their valuations and whether they had taken sufficient independent valuation advice.

It was noted that most firms taking part in the FCA’s review engage with third-party valuation advisers, with good practice including the use of these services after having identified material conflicts of interest.

Full independent valuations were the most common service provided by third-party advisers, aligning with IPEV's best practice recommendation to use "external advisers to review methodologies, significant inputs, and Fair Value estimates for reasonableness," consistent with the FCA.

Figure 1: Number of participants using types of third-party valuation advisory services

When appointing an independent valuer, it is worth considering the following points, which should be tailored to a firm’s requirements and circumstances.

• Independent valuers should be instructed by the parties requiring reliance, with reports addressed accordingly. This is because valuers typically state in their reports that only the instructing party can rely on the valuation and there’s a restriction on any third-party reliance;
• The valuer should be aware of the relationships between the parties instructing and/or providing the valuation information and the party receiving the valuation and appropriately consider the scope of information review accordingly;
• Documenting the rationale for choosing the valuer, including reference to expertise and experience;
• The potential benefits of multiple valuers, and whether it would be appropriate to document these;
• Who will take ownership and provide representation as to the material facts and management information such as the forecasts;
• Developing a process to review and understand the critical components and assumptions for the valuation; and
• An appropriate period/interval to undertake valuations (see also our article on ad-hoc valuations).

The purpose of these independent valuations can be wide-reaching, including fund transfers, financial reporting, and disputes, among others.

Whilst the scope of the valuer will be defined by a specific contract and agreed scope, it would be expected that the valuer will provide a range of fair values based on the historical performance and forecasts provided for the assets by the instructing party. The valuer would typically challenge and understand those projections in coming up with a range that is supported by market data and analysis.

Generally, the independent valuer’s report would provide a succinct summary including the value range, key metrics and assumptions, rationale for the concluded discount rate and/or multiples, and reference to market data. A full independent report may also include further detail on key value drivers, risks, a valuation bridge where applicable (see below), and analysis of the market.

For periodic valuations of where there has been a recent transaction in the asset, the valuer should explain and/or bridge between time periods, clearly explaining the rationale for such change. This is referenced in the IPEV guidelines, which describes the method of “Calibration” that is typically used when the price of an investment is deemed fair value, as is generally the case in an orderly arm’s length transaction.

Furthermore, whilst leveraging experience and expertise of working with similar investors across relevant industries, third-party advisers may offer valuable, tailored insights into the valuation and performance of private assets, as well as broader sector trends. As part of the Deloitte Private Investments Fair Value Survey – 8th edition, a positive correlation was noted between the size of a firm and the number of External Fair Value Specialists (EFVS) engaged, with 90% of respondents expecting their EFVS to “assess, evaluate and possibly challenge investment specific details provided by the investment team or portfolio company, at least to some degree”.

In recent times, having observed trade tensions, high levels of inflation, and geopolitical instability, this level of independence and challenge can provide much needed rigour to a valuation process, and lead to increased long-term investor confidence.

Figure 2: Use of External Fair Value Specialist
 

The services provided by third-party valuers do vary and the FCA referenced lighter touch services such as inputs into a valuation through to a full valuation. The FCA’s Phase 1 questionnaire showed that most participants engaged a third-party valuation adviser to undertake a full independent valuation. The FCA stated that firms should inform their investors of the specific nature of service provided, its strengths and its limitations.

In conclusion, the use of a third-party adviser introduces additional independence, transparency, and challenge, ultimately delivering a more robust and defensible valuation. The adviser’s insights may also help to support better decision making and ensure consistency with other industry peers, especially in times of high uncertainty. This approach can help to reinforce a firm’s commitment to strengthening investor confidence and ensuring the long-term health of investments.