Against a backdrop of a growing allocation into private markets and significant COVID-induced market volatility, ensuring adequate governance of unlisted assets has become a key priority for regulators and institutional investors alike.
Speaking at the 8th Fund Summit, a panel of industry experts discussed best practice governance and lessons learnt from recent experience, with strong, independent and critical valuation processes and systems flagged as key prerequisites.
Geoff Stewart, Head of Investment Risk at the Australian Prudential Regulation Authority (APRA), told the conference that the regulator is focusing on improving standards. “We’re looking at ways of really raising the bar in this critical area, improving practices across the board, given that trustees are presiding over significant financial institutions that support the well-being of millions of beneficiaries. Some guidance elements have been moved into standards to support improvement in individual practices.”
Policies, procedures and systems
Top on the list of priorities is the importance of having strong policies, procedures and systems in place before a significant revaluation event occurs. That includes having an action plan ready to deploy that includes revaluation triggers and processes for monitoring or adjusting valuations.
In a recent review of 30 responsible entities, APRA found that there is room for improvement across the sector, particularly at the smaller end of the spectrum. “We found that most entities were pretty oriented towards taking action, but that action wasn’t necessarily well coordinated or pre-thought out. In some cases, there was a scramble to take action and come up with a valuation approach. That might have been good enough for the moment, but it didn’t really meet the standards in terms of ongoing governance of asset valuations,” Stewart said.
This was echoed by Naresh Subramaniam, Director of Superannuation and Investments at PwC Australia. “Our observations were that there was a varying degree of maturity during COVID. There were funds which had triggers in place and already knew how to trigger a revaluation, and some were a bit like policy ‘on the run’, so there was a spectrum in terms of governance,” Subramaniam said.
Francis O’ Sullivan, Head of Risk, Private Markets at QIC, told the audience that streamlining policies, procedures and data flows is critical at times of market stress and volatility.
“During COVID, asset owners were dealing with the issue of whether to devalue their assets. Asset managers were getting a lot of queries. The valuers themselves were under time pressure, so it was quite a pressure-cooker at the time and any inefficiencies in your process were going to become evident. Having a really efficient and streamlined process is really important, and if there are ‘cracks’ there, it is essential that you get on top of them quickly,” O’ Sullivan said.
O’Sullivan said that having a solid data governance framework underpinning valuations was particularly important.
“Having efficient data flows with your valuers was incredibly important, particularly during periods of significant market volatility, so that needs to be really crisp. Particularly in certain sectors where they did go to monthly valuations during COVID, when you are dealing with independent valuers, that interaction and the oversight of that interaction needs to be really good.”
The importance of having strong policies and procedures was also stressed by Cleyde Hazell, Regional Head of Private Capital APAC at BNP Paribas Securities Services, who said that firms that were well across the data side were not only better equipped to manage withdrawals, but were also better able to respond to opportunities. “Much of the industry focused on how they could get cash back to meet withdrawals and deal with member switches. This is one side. The other side we saw, was some of our clients trying to get access to cash to invest in opportunities arising in private capital,” she said, noting that during the pandemic, BNP Paribas observed an increase in investments in longer-term type assets.
Hazell said that having solutions in place that provide cashflows on demand are essential to facilitate quick decision-making in volatile markets. “Being able to provide reports for the operations teams or to the C-suite to see the cash flows, with the internal rates of return for example or some reports that the client can go and take to their valuation committees [is important]. If you can do that as the client requests on a self-service or as-needed basis, that really helps clients to be able to make decisions quickly,” she said.
Independence of valuations
If having policies and procedures around revaluations is one key factor, ensuring those valuations are independent and accurate is equally critical, with APRA’s review identifying a number of areas of potential concern. In particular, not all funds were able to demonstrate sufficient independence and ability to challenge valuations; while board level knowledge with respect to valuation matters was, at times, also found wanting.
“Some boards showed quite an alarming lack of knowledge and conviction to challenge the information given to them and for them to actually approve, so that was certainly an issue,” Stewart said.
“Another issue is that, in some cases, there were significant delegations given to management such as CIOs sitting as chair of a valuation committee and not having any apparent challenge; or delegations to move valuations within very broad bands,” Stewart said.
He also said that, while relying on external third-party valuation providers is a way of ensuring independence, regulated entities cannot outsource the responsibility of ensuring those valuations are accurate. “[Among some entities] an over-reliance on external parties and passively accepting information and revaluations [was a concern]. Again, the concepts of knowledge and challenge really come to the fore,” Stewart said.
That was echoed by O’Sullivan. “We do like our valuers to have good, strong opinions and be able to stand behind their valuations. What we did was push them and made sure that the valuations they were providing were reflective of fair value,” he said. “Certainly, if you’re dealing with independent valuers, a strong valuation management process is incredibly important. At the end of the day, the role of your valuations committee is, or should be, to challenge and ultimately approve valuations and so having an efficient process where you get the papers to them on time, enabling to challenge what’s being put in front of them, is important,” he added.
Hazell said that while custodians act on client instructions, they do track, check and challenge valuations that come from fund managers.
“For any instructions for calls or fees, we are able to see if the request that comes from the fund manager regarding the commitment matches the information we have in our master diary, where we record and track all the information relating to the investment. We can also see if something is unusual, so we actually play a part that is quite important in terms of checking and challenging. There is of course a limit; if we receive a statement from a general partner, and we see a valuation done out of cycle and it doesn’t look right – we can go through our controls, check and go back to the client. So then the client has to give us a proper instruction to say ‘that’s ok’ before we’ll process it,” she said.
Stewart said that APRA won’t go so far as to stipulate exactly how funds should set up valuation functions, so long as they meet requirements around internal knowledge, challenge, appropriate vetting of valuation data and appropriate governance structures with conflicts of interest management.
“If there is external valuation information coming in, it should be properly challenged and vetted for appropriateness. If a fund has the time and resources to build their own internal valuation capability, then that’s fine as well, as long as there are appropriate checks and balances around that valuation process,” he said.