Clifford Chance

The FCA has explored the risk of harm to investors and market integrity flowing from inappropriate valuations of private assets through a multi-firm review. The results, published on 5 March 2025, identified weaknesses in governance, identifying, documenting, and addressing conflicts of interest, and having defined processes for carrying out ad hoc valuations. Some of these issues are likely to crop up again in the FCA's multi-firm review of conflicts of interest in private markets later this year.

Context

The FCA's review sits against a backdrop of heightened interest in private market valuation processes both domestically (with a June 2024 Financial Stability Report from the Bank of England highlighting the potential for vulnerabilities in the private equity sector stemming from opaque valuation practices) and internationally (with IOSCO currently reviewing its 2013 principles for the valuation of collective investment schemes to determine whether updates are necessary).

The FCA's findings are punctuated by examples of good practice and concrete actions that firms should take to improve. Importantly, the findings affect a broad cross-section of firms. The FCA's review deliberately included a variety of asset classes, including private equity, venture capital, private debt and infrastructure assets. Whilst the review did not include UCITS, the FCA's report states that the findings are relevant to certain UCITS funds and must be considered in conjunction with existing valuation requirements for UCITS set out in the FCA Handbook.

All asset managers, alternative investment fund managers, investment and portfolio managers and investment advisors should now actively review their own practices against the findings, implement the action points and change their practices where needed.

The FCA's findings

A theme throughout the FCA's findings is sensible governance of the valuation process: ensuring that meetings are minuted, records are kept, policies and procedures are followed and decisions are effectively challenged.

The findings are not limited to governance, with granular comments from the FCA over the valuation methodologies that are used, the data that feeds those methodologies, the importance of back-testing and secondary methodologies and appropriate valuation frequences. As a result, firms will need to consider not just the governance over the valuation processes but those processes themselves.

The findings are similarly not limited to matters of a purely internal nature. They cover use of auditors, use of valuation agents and disclosure to investors, meaning firms will also need to consider (and potentially update) their practices vis-à-vis third parties. The FCA's finding that firms should consider whether they can improve reporting to investors on valuation, including providing detail on asset-level performance, will require firms to consider the sometimes difficult division between NDA and confidentiality restrictions that can exist at a portfolio company level with the need for the manager to ensure a level of transparency to investors.

The types of conflicts of interest the review identified in the context of valuation practices

The FCA's findings on conflicts of interest are particularly detailed and will serve as a useful prompt when firms consider conflicts of interest in their own valuation processes. Potential conflicts of interest highlighted by the FCA include:

• Performance and management fees: Conflicts arising from performance and management fees linked to valuation, which may vary across product type.
• Asset transfers: Conflicts between the interests of investors when assets are transferred, such as in relation to continuation funds where there may be unequal access to information between investors to form their own view on price and valuation.
• Redemptions and subscriptions: Where the frequency of valuation of assets in open-ended funds does not align with dealing frequency, the consequent risk of investors dealing at prices that do not reflect the true investments value.
• Investor marketing: Conflicts around marketing unrealised performance (i.e. the incentive to show positive and stable movements in value over time where the unrealised performance of existing funds is used to support fundraising for new vehicles).
• Secured borrowing: The potential for valuations to be inflated to attract a greater amount of initial borrowing or avoid breaching an LTV covenant.
• Uplifts and volatility: The potential for conservative adjustments to be used to provide a less volatile valuation profile over time to suit investor preferences.
• Employee remuneration: Direct and indirect links between employee remuneration and valuations.
• Valuation committee independence: Valuation committees that lack sufficient expertise, or consist predominantly of senior investment professionals.

Areas of weakness identified

Areas of weakness highlighted by the FCA include:

• Not considering conflicts issues deeply enough and/or missing the identification of certain conflicts. While conflicts around fees and remuneration were identified by all firms, "other potential conflicts were only partly identified and documented".
• Record keeping failures, in particular not sufficiently documenting conflicts and the way they are managed. For example, in relation to investment trusts, most firms had identified but not documented the greater risks around valuation. In some cases, valuation committee minutes failed to document deliberations and decision making adequately.
• The inherent conflict arising from valuation committees that are comprised of investment professionals, and independence lacking where valuation committees lack sufficient valuation experience to provide independent judgment on valuations.

How do the findings of this review relate to the further multi-firm review of conflicts of interest referenced in the FCA's portfolio letter of 26 February?

The FCA's February 2025 Dear CEO letter to its asset management alternatives portfolio indicated that this year the FCA will be undertaking an additional review into conflicts of interest in firms managing private assets. The conflicts of interest identified in the FCA's valuations review arise in connection with valuation practices, and the governance and oversight of valuations specifically. The focus of the FCA's further multi-firm review appears to be on the management of wider structural conflicts, for example, arising out of asset managers operating multiple intersecting business lines, continuation funds, co-investment opportunities or partnering with other financial institutions. However, as the management of valuation related conflicts is likely to remain relevant in these contexts, there may well be overlap in the issues being examined later this year.

Action for firms to take

The FCA will conduct follow up work with specific firms it has identified as outliers through this review. One specific area of follow up it plans is in relation to the independence and expertise of valuation committees. The FCA notes it will be following up with firms where senior investment professionals were voting members in valuation committees, to understand how their position as voting members is consistent with the independence of the decisions made and whether this compromises independent oversight and challenge.

As illustrated by this publication, a multi-firm review typically involves a survey requesting information and documents from a sample of around 30 firms, followed by firm visits and interviews with key individuals, and targeted follow up supervisory action in relation to any identified issues. The FCA will then typically publish anonymised findings from its review. Although they can begin seemingly innocuously, the FCA uses these reviews as an exploratory tool to benchmark firms against one another. Any firm that is identified through such exercises as an "outlier" compared to peers could be at risk of further supervisory interventions, or an enforcement investigation being opened.

All affected firms would be wise to consider the findings of the review and identify gaps in their approach quickly, in view of potential for these issues to be further examined in the FCA's multi-firm review of conflicts of interest later this year.