Luxembourg’s financial markets authority CSSF has given fund management companies until the end of this year to review the way they determine the value of their investment funds. Investment Officer recently spoke to Marco Zwick, the CSSF director in charge of supervising investment funds. “We noted some room for improvement,” he said.
In particular smaller firms managing alternative investment funds may be challenged by the review of fund valuation methods that CSSF announced in the summer. Luxembourg is home to some 300 management companies that collectively employ about 7,000 people that work with global funds worth 4,944 billion euro. An average ’ManCo‘ employs 23 people, according to PwC data. Most of these try to manage valuations in-house.
Even though CSSF observed an ”overall satisfactory level” of compliance with valuation requirements, it has concluded that Luxembourg can do better.
“Most issues concern the content of the valuation policies and procedures,” said Zwick. “More precisely, these were, in a number of cases, not sufficiently comprehensive and detailed concerning the description of the valuation process including the allocation of the tasks and responsibilities of each party involved and how the independence of the valuation function is ensured.”
Less-liquid assets in focus
CSSF now is asking the industry to make sure that its systems of controls performed on the prices of the assets are accurately documented, notably for the less-liquid assets, held mostly in alternative investment funds, and processes to apply under stressed market conditions. Zwick said the programme recommends “further improvements” of the valuation models, and calls for “appropriate disclosures to investors” of the valuation methods and governance arrangements.
Following last year’s European supervisory assessment by the European Securities and Markets Authority, or Esma, CSSF in July decided to order a broad assessment of fund valuation frameworks and to assess a number of challenges, “especially for the small investment fund managers,” said Zwick, in emailed answers to written questions.
He outlined three challenges in particular. External professional support, for example, is something that investment fund managers might rely on in order to complement their existing competences. Undue influence and conflict of interest need to be prevented, while fund managers also need to be ready to accept additional costs.
Adequate safeguards needed
In terms of organisation, Zwick pointed out that the valuation function “must be performed independently from the portfolio management function“ and that “adequate safeguards” must be put in place “to prevent undue influence and conflicts of interest.”
“This separation also extends to risk management activities in the context of complex strategies or illiquid financial instruments, except in cases where the proportionality principle may be applied,” Zwick said. “Due to their size or staffing, implementing these separations effectively might prove challenging for smaller entities.”
What’s more, fund managers need to recognise that additional costs can be incurred to raise the quality of the valuation framework.
Most AIFMs keep valuation in-house
Luxembourg AIFMs - management company responsible for managing alternative investment funds - on average have four FTEs dedicated to the valuation function, on an average staff of 23 people, according to the PwC ManCo Observatory. Some 86 percent of the 259 Luxembourg AIFMs try to keep their valuation function in-house. That suggests that about 35 AIFMs have fully outsourced their fund valuation processes.
Roughly one third of Luxembourg’s total fund assets under management are held in alternative investment funds, a fund class most targeted at professional investors and ultra-high net worth individuals that has witnessed strong growth in recent years.
Zwick said that the CSSF remains open to directly exchange on a bilateral basis with the supervised entities if they have specific questions or want to discuss their actual valuation setup. He also pointed out that the CSSF has an open dialogue with the Luxembourg Valuation Professionals Association in order to understand and discuss potential issues impacting the market.
Like CSSF, Ireland has also decided to step up its supervisory actions on fund valuations. A spokesperson for the Central Bank of Ireland in August told Investment Officer that the Dublin-based supervisor was preparing a “broader industry communication” on the valuation of funds. This paper is yet to be published.