In a move to strengthen valuation practices across the investment fund industry, Luxembourg’s financial supervisor CSSF on Wednesday unveiled a glimpse of next year’s plans to revise its valuation guidelines for investment fund managers.
The upcoming changes, due to be formalised in 2025, aim to incorporate lessons learned from recent supervisory actions and address persistent valuation-related issues identified by the regulator during recent years.
The CSSF provided a glimpse of the areas it wants to tackle during a speech by Jean-Francois Carpantier, head of the UCI Risk Macro division at the supervisor, at an event hosted by the Luxembourg Valuations Professionals Association, LVPA.
“Robust valuation processes are essential for maintaining the integrity and resilience of Luxembourg’s investment fund ecosystem,” said Carpantier to an audience of valuation experts. “This revision will provide clearer guidance to help fund managers enhance their valuation frameworks in the face of evolving market conditions and economic uncertainties.”
“We can see that the valuation practices have materially positively evolved over the last years. It remains, in our view, a key ingredient for a sound ecosystem and also a key contributor to the current and future resilience of our industry.”
Luxembourg is the legal domicile of more than 14,000 unlisted alternative investment funds, which makes it the world’s biggest private market hub outside the United States. These asset classes, which include funds specialised in real estate, infrastructure, private debt and private equity, are not as easy to value as listed asset classes like stocks and bonds.
Digitalisation and AI
The surge in interest in private markets, and the expected retailisation of this market thanks to new private vehicles like Eltifs in Europe and Eltafs in the U.K., have led to closer scrutiny among regulators. Markets experts also noted the increased demand for more regular valuations, also because of digitalisation of services and the introduction of artificial intelligence. Many funds still are valued only once per quarter. According to fund valuation experts, other international private market hubs, notably the U.S., London and Singapore, are also upgrading their valuation practices.
Carpantier listed eighth enhancements that the CSSF is considering:
- Alignment with AIFMD principles: The new circular will incorporate the general principles referred to in the AIFMD delegated regulation, providing a harmonised framework for valuation practices.
- Pre-investment transparency: Fund managers will be required to make detailed information on their valuation procedures and pricing methodologies available to investors before they commit capital.
- Stress scenario planning: Valuation policies must define the specific methods to be used when market conditions are likely to have a negative impact on the fund’s assets.
- Valuation model governance: Comprehensive documentation will be needed on the development, validation, and review processes for any valuation models employed.
- Depository oversight: Fund managers will be obligated to ensure depositories have all information necessary to fulfill their valuation-related oversight responsibilities.
- Independence of functions: The new circular will reinforce the need for a clear separation between the valuation function and risk management function.
- Competence requirements: There will be a renewed emphasis on the competence and independence of staff directly responsible for performing asset valuations.
- Third-party due diligence: Fund managers utilizing external valuation providers will be expected to conduct thorough due diligence and ongoing monitoring of these service providers.
Carpantier indicated that his overview of these forthcoming changes was not conclusive. He said that the new guidelines will be designed to enhance the reliability, transparency, and resilience of valuation practices across Luxembourg’s investment fund industry. He also encouraged industry participants to begin reviewing their current frameworks in anticipation of the revised circular.
“The journey is not over yet,” Carpantier concluded. “We can see that the valuation practices have materially positively evolved over the last years. It remains, in our view, a key ingredient for a sound ecosystem and also a key contributor to the current and future resilience of our industry.”
Since 2019, European and global financial supervisors have repeatedly underlined the need for robust valuation processes, especially considering the impact that geopolitical events like the Covid-19 pandemic and the war in Ukraine have had on investments. CSSF in 2022 was part of a European review and has since then drawn on a variety of reports underpinning the need to improve valuation practices.
Lack of documentation
In his speech to the LVPA, Carpantier spoke about “preliminary findings” that the regulator is using as a basis for its tighter guidelines. CSSF found several problematic aspects of investment fund managers’ valuation practices. One of the key issues identified is a lack of sufficient documentation supporting the fair valuation of investments.
Another area of concern is the weaknesses observed in fund managers’ valuation policies and procedures. Carpantier said the CSSF found that these policies often lack a clear description of the parties involved in the valuation process and the timeline of that process.
Additionally, many policies fail to adequately assess the appropriate valuation frequency for different asset types, and they may not clearly list the standard information sources used to determine asset valuations, he pointed out. Valuation policies also often fail to address what happens under stressed market conditions, he said.
Further reading on Investment Officer Luxembourg:
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- New valuation association is a big deal for private equity