The UK financial regulator’s review into private markets valuations has identified several areas where fund managers need to improve to avoid investor harm.
The Financial Conduct Authority (FCA) launched the review last year due to concerns around the opacity of asset valuations compared to public markets, where assets are frequently traded and priced.
It assessed managers operating across private equity, venture capital, private debt and infrastructure assets, covering around £3tn of global assets under management.
The report raised concerns that some firms’ investor marketing efforts used unrealised performance of existing funds to support fundraising for new vehicles, as “they may have an incentive to show positive and stable movements in value over time”.
Read more: UK regulator warns on valuations and conflicts of interest at private asset firms
The regulator also identified potential conflicts when fees paid by investors were linked to valuations, and where vehicles priced redemptions and subscriptions using the fund’s net asset value (NAV).
“With periodic and judgement-based valuations there is greater potential for harm and conflicts between new, exiting and remaining investors, who could be transacting at prices that do not always reflect the value of the fund’s investments,” the FCA said.
The FCA also said firms may exaggerate the stability of valuations, which could harm investors by obscuring the true level of investment risk.
Other areas identified by the regulator were around asset transfers and NAV financing, as a borrower could inflate the value of their unrealised investments to borrow more, or to avoid breaching a loan-to-value covenant.
It also noted that where staff pay is directly linked to valuations, this could create a conflict, although it said this was not usually the case.
“The UK is the largest centre for private asset management in Europe,” said Camille Blackburn, director of wholesale buy-side at the FCA.
“Investor demand from individuals and institutions has driven significant growth.
“Good valuation practices are key to maintaining fairness and confidence as the market grows. We were pleased that firms could usually evidence independence, expertise, transparency and consistency in their valuations process.
“There is still more to do, and we expect firms to carefully consider our findings.”
The FCA’s findings will be used in its review of the Alternative Investment Fund Managers Directive (AIFMD) as it updates its rules in the handbook and will inform the FCA’s contribution to IOSCO’s review of global valuation standards to support the use of proportionate and consistent valuation standards globally in private markets.
Private markets have seen stratospheric growth globally in recent years, as investors look for diversification away from public markets and for higher returns. Private credit alone has been predicted to grow to $3tn (£2.4tn) by 2028, according to ratings agency Moody’s.
