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UK regulator to launch review of private market valuations

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The UK’s top financial regulator is preparing to launch a sweeping review of valuations in private markets, according to people familiar with its plans, amid growing fears over the impact of higher borrowing costs on the sector.

The Financial Conduct Authority’s exercise, which follows a major review of asset managers’ liquidity in the aftermath of last year’s UK bond market turmoil, will look at the “disciplines and governance” over valuations, one of the people said.

That includes looking at who within a firm is accountable for valuations, how information about those valuations is passed upwards to the relevant management committee and board, and what other governance procedures are in place, the person said.

The exercise, to be kicked off by the FCA by the end of the year, comes as global regulators grow increasingly uneasy about the potential for blow-ups in private assets and other markets following the abrupt reversal of more than a decade of low interest rates.

The International Organization of Securities Commissions (Iosco), a global securities watchdog, recently warned the $13tn global private capital sector was too complacent about the possible risks, highlighting valuations as one of a number of areas where vulnerabilities could emerge.

Private assets such as real estate and unlisted shares and bonds are often valued using models that are typically slower to respond to deteriorating market conditions than listed assets.

Assets are usually valued on a quarterly basis, meaning a sharp market correction may not feed through to the valuations for weeks, if not months.

Fund managers who invest in private markets typically have greater discretion over the valuation of their own assets because their holdings are not subject to the daily swings of public market sentiment.

If the FCA does not feel that the governance processes are robust, it can call out failures. If a firm does not respond to that then it can be ordered to make improvements, because valuations are “part of the risk environment” for regulated firms, the person added.

The second person said the review had not yet been fully scoped out and would not begin until later this year. The number and type of asset management firms involved has not yet been finalised, the person said.

The FCA declined to comment.

About 2,600 firms are in the UK’s £11tn asset management industry, with the FCA acting as their primary regulator. They include hedge funds, venture capital and private equity, as well as large institutional asset managers.

Richard Olson, a valuations expert at investment bank Lincoln International, said the FCA’s probe could be a “wake-up call”, that could push some funds towards outsourcing valuations.

An executive at a large institutional asset manager welcomed the review. “Private markets can’t just mark to their own models, there needs to be an independent verification process,” he said.

In July, the FCA sharply criticised asset managers’ liquidity management, warning that some firms’ plans to deal with large-scale redemptions “lacked coherence”, and ordered them to make improvements.

US regulators have responded to fears about private markets by ordering private funds to make more extensive disclosures about their performance and expenses, an initiative that has prompted a lawsuit from a coalition of private equity, venture capital and hedge funds.

Additional reporting by Costas Mourselas, Will Louch and Josephine Cumbo

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