Valuation Oversight for AIFMs - EY · 4 Valuation Oversight for AIFMs Under the current legislation, the valuation function may be conducted either by the AIFM itself or by an appointed

Valuation Oversight for AIFMs October 2017

ContentsIntroduction 3

1. Valuation: Marketing tool or compliance constraint? 6

2. AIFM Valuation process and procedure 8

3. Valuation resources 10

Conclusion 12

3Valuation Oversight for AIFMs |

On 22 July 2013, the Alternative Investment Fund Managers Directive (AIFMD) went into force. It requires among others, a direct involvement of the alternative investment fund managers (AIFMs) in the valuation of the alternative investment funds (AIFs) that they manage.

After almost four years since the introduction of the AIFMD, we considered the timing appropriate to listen to the viewpoints of professionals directly interested by the valuation governance of AIF assets. In this perspective, we organized a roundtable on the valuation oversight for AIFMs focusing on three key pillars:

• Valuation: Marketing tool or compliance constraint

• AIFM Valuation process and procedures

• Valuation resources

The roundtable was structured around 35 multiple choice questions, a subject of debate among the participants, further evidencing that the covered topics are still evolving after the enforcement of the AIFMD. The questionnaire was subsequently grouped into two types of questions: specific, regarding the three key pillars and generic, on valuation in general.

The majority of the participants in this roundtable were composed of risk managers who are directly involved in the valuation of the assets as well as other professionals like portfolio managers and depositary bankers. The majority of the participants work on multiple asset classes whereas a minority of them are specialized on either real estate (RE) or private equity (PE). During the roundtable all type of funds were represented: regulated funds, non-regulated funds with a regulated manager (e.g., Reserved Alternative Investment Funds, RAIFs) and non-regulated funds. Furthermore, the assets under management (“AUM”) or under administration by the groups represented indicates that all of the participants had asset under management above €500m with nearly half of them managed or administered more than €5b of AUM. A key result of the roundtable is that the participants’ wide variety of backgrounds confirms once again the growing relevance of valuation within the professionals of the alternative investment fund industry, as already evidenced in the EY 2016 Global Private Equity and Investor survey.

Introduction


4 | Valuation Oversight for AIFMs

Under the current legislation, the valuation function may be conducted either by the AIFM itself or by an appointed external valuer. In order to be appointed, the external valuer must be professionally recognized, offer professional guarantees and grant its independence from the AIF, the AIFM and any other person with close links to the AIF or AIFM.

Most of the roundtable’s participants have internalized the valuation function engaging external advisers only by exception (e.g., complex valuations, non-ordinary alternative investments). The minority (22% of the total) has externalized the function.

AIF Valuation Oversight - Roundtable composition

Valuation Officer11% Depositary banks

11%

Asset/Portfolio Managers33%

Risk Managers44%

EY 2016 Global Private Equity and Investor Survey

Regulators & Auditors are increasingly attentive to proper application of valuation policies and valuation skills (e.g., Patriarch partners case)

PE managers use transparent and independent valuation as a compétitive advantage

PE managers are increasingly opening up their files to Investors/LPs in a move for more transparency

Investors/LPs are performing more due diligence, want to understand valuation process and are increasingly comfortable with valuation function outsourcing

Independent directors are increasingly looking into valuation matters

Perspectives of the participants

Sources: EY 2016 Global Private Equity & Investor Survey


One of the major topics covered in the introduction was whether or not the AIFM still remains fully responsible towards the AIF in case an external valuer is nominated. In this regard, the Directive mentions that the AIFM remains ultimately responsible for the proper valuation of the assets, the calculation of the net asset value (NAV) and the AIFM’s liability towards the AIF. On the other side, the external valuer is liable to the AIFM for any losses incurred by the AIFM as a result of the external valuer’s negligence or intentional failure to perform its tasks.

Since the ultimate purpose of valuation is measuring and mitigating risks, the participants agreed in considering the initial phases, the set-up and the investment, the most critical ones in terms of time and resources dedicated. This conclusion is mainly due to the focus on the internal policies and procedures required to comply with the AIFMD valuation requirements (i.e., set-up of written internal policies and procedures for each AIF).

Parties eligible to perform the valuation function

AIFM or EXTERNAL VALUER

Internal valuer

• Functionally independent

• Definig control checks and safeguards• Dealing with inappropriate influence• Mitigating conflicts of interest

• Experienced in valuation matters

• Eventually supported by external valuation experts

External valuer

• Independent from AIF/AIFM

• Experienced in valuation matters

• Selected by initial and periodic due diligences

• Complied with the overall requirements on delegation

• Instructed by AIFM


Valuation: Marketing tool or compliance constraint?

1


The increasingly stringent regulation and the trend towards fair value reporting have led to an increased demand for independent valuation services in recent years. The main point of debate within the roundtable was the use of external valuations as a marketing tool or their function representing a mere compliance constraint.

In this regard, the different types of AIFs seem to impact significantly. In detail, the participants agreed on distinguishing the cases of regulated and unregulated entities. In case of regulated entities, valuation is considered an ordinary service to be performed in order to meet the regulatory constraints. By contrast, the unregulated, in particular the new form of RAIF, offers more opportunities to externalize valuation functions due to the wide range of assets they can invest in. The RAIFs as well as other types of non UCITS regulated entities (e.g., SICARs and SIFs) can adopt a relatively more flexible fund strategy and invest in different asset classes having fewer restrictions in terms of portfolio diversification. In conclusion, excluding the specific exceptions just mentioned, valuation represents a must–have rather than a marketing tool to increase the marketability of the funds.

AIFM obligation to establish appropriately and consistent

valuation procedures

Written policies and procedures: sound, transparent, comprehensive and appropriate documented valuation process

Proper and independent

valuation of AIF asset

For each AIF that AIFMs manage:

Valuation process

Valuation methodologies

Information and models

Value of individual assets

Calculation of NAV per share

Frequency of valuation of asset and NAV calculation

Regulatory requirements laid down in local law as a consequence of the AIFMD

Valuation policies

According to the participants’ experiences, valuation is often included in a portfolio of services offered to the institutional clients and in limited cases it is presented on a stand-alone basis. AIFMs rarely mentioned separately the valuation fee quotes in a service proposal as such.

In the context of valuation offering, the participants discussed whether valuations were market oriented or whether some conservatism was applied when coming to a valuation result. The large majority of the participants agreed on the application of a market-oriented approach also due to the explicit guidelines provided by the International Financing Reporting Standards (IFRS), the International Private Equity and Venture Capital Valuation Guidelines (IPEV) and the European Association for Investors in Non-Listed Real Estate Vehicles Guidelines (INREV). However from the debate it emerged that in a few cases a conservative approach may be more appropriate e.g., when the client is a fund reserved to a single shareholder, it might be preferable to apply a conservative approach given the high illiquidity of the investment. By contrast, if the fund holds a large investor base, the market oriented approach is generally considered more appropriate.


AIFM Valuation process and procedure

2


The current legal framework of valuation includes the AIFMD as well as the IPEV, INREV and IFRS valuation principles. According to the participants, the current regulatory framework is not detailed enough and barely covers all the asset classes within the alternative investments context. Nevertheless, some concerns that have characterized the past are being resolved.

The participants believe the processes and procedures are different depending on the underlying asset. What emerged from the discussion is that the assessment process for RE assets is less restrictive and in most cases is performed by third parties while, in PE it is generally internalized. Furthermore the participants clearly identified the roles and duties of the professionals involved in the valuation process as well as indicated that roles and responsibilities were generally speaking clearly defined. There is, however, a perception that market practices still need to emerge.

Valuation under constraint

AIFMD

IFRS and other GAAP-Fair Value

Measurement

Industryguidelines

Investors


Valuation resources3


According to the AIFMD, the AIFMs can delegate the valuation functions to an external valuer. The main parameters considered in the appointment of a third party are the specific expertise of the external appraiser in the valuation of the asset class and its contribution, in terms of value added, to the final outcome.

According to the participants, most of the fund managers (67% of the total) hold a dedicated valuation team within the group, often sited outside Luxembourg. With regards to the offer of available valuation trainings, there is a perceived lack of offering on the market for all of the asset classes.

Appointment of External

Valuer

Valuation function kept

internally

AIFM is ultimately responsible for the proper valuation

of AIF assets, NAV calculation and

publication

4.1 Review individual values4.2 Identify unexpected

differences and coordinate with external valuer to close gaps

4.3 Approve asset valuation

1.1 Inform external valuer of the methodologies to value assets

1.2 Define valuation process, monitoring and re-assessment frequency

2.1 Determine necessary information

2.2 Identify information owners

2.3 Set up instructions and templates

2.4 Etablish communication protocols with external valuer

5.1 Analyze reports prepared by external valuer

5.2 Prepare reports to BoD and central admin

3.1 Check quality of input data3.2 Transmit to external valuer

5. Report on asset valuation

1. Re-/Define valuation methodology

2. Set up process for exchange of information

3. Transmit checked data to external valuer

4. Review and approve asset valuation

5

4

3 2

1

Valuation process

Valuation process• Inputs• Methodologies• Monitoring and

reporting


Conclusion


To summarize:

• Near to all participants considered that making the right investments in the set-up phase for the proper design of valuation procedures is key. Doing so, will subsequently relieve significantly the valuation requirements for the benefit of a smooth NAV calculation process.

• Participants agreed on distinguishing between regulated and unregulated entities. In case of regulated entities, valuation is in fact considered an ordinary service to be performed in order to meet the regulatory requirements. By contrast the unregulated, in particular the new form of RAIF, is more prone to externalize valuation functions. This can be explained by the wide range of assets they can invest in, and also to comfort investors. Adopting a robust valuation process does therefore not appear as being used as a distinctive feature to convince the investor base, despite requests1 of the investor community to get comfortable with the valuations.

• The large majority of participants agreed on the application of a market-oriented approach while in a few cases a conservative approach might be more appropriate to apply (e.g., in presence of a single shareholder in a reserved fund).

• Processes and procedures differ depending on the underlying asset class. In case of RE assets, the assessment process is less restrictive and in most cases performed by third parties while in PE it is generally internalized.

• AIFMs may externalize the valuation function: most of the participating companies had a dedicated in-house valuation team that is often located abroad, which may eventually be complemented by specific external valuation expertise.

This first EY AIFM roundtable on the valuation oversight topic was particularly interesting, as it has shown that the market practices are still emerging, given the diversity of professionals involved and of asset classes covered. EY warmly thanks the roundtable participants for their active participation and gladly noted the interest cfor continuation of such initiatives.

1. EY 2016 Global Private Equity Fund and Investor Survey (in collaboration with Private Equity International)

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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Contacts

Christophe VandendorpeExecutive Director, TS-Transaction DiligenceEY Luxembourg+352 42 124 [email protected]

Edoardo Battista AncoraSenior Manager, TS-Transaction DiligenceEY Luxembourg+352 42 124 [email protected]

Documents

Valuation Oversight for AIFMs - EY · 4 Valuation Oversight for AIFMs Under the current legislation, the valuation function may be conducted either by the AIFM itself or by an appointed