Independent and transparent security valuations have become essential to financial institutions that must meet growing regulatory requirements with a focus on valuations and liquidity. Panel members joining this week’s A-Team Group webinar, Managing Valuations Data for Optimal Risk Management, agreed that independence and transparency are key to valuations, and highlighted growing market understanding and interest in high-quality valuations data that can be used not only to comply with external regulations, but also to support internal checks and balances.
A-Team Group editor-in-chief Andrew Delaney noted that valuations is a hot topic across capital markets – you can read a supporting A-Team Group special report here – and set the scene for the webinar discussion, reporting on a Performance Benchmarking survey carried out by the company at the end of 2012. The research, among 36 European institutions focused on the buy side and representing both global and local responsibility, shows the drivers for data quality in valuations as client satisfaction, compliance with regulations including accounting requirements, and risk management considerations.
The research shows 55% of respondents saying valuations transparency from vendors is good, with 40% saying it is average. Data quality provided by vendors was judged on the basis of the number of sources and range of attributes used in pricing considerations, timeliness and breadth of coverage including illiquid and complex securities.
After reviewing the A-Team Group research, Delaney moderated discussion among panel members Anthony O’Connor, head of product management, OTC pricing and risk, global product at HSBC; Peter Jones, senior director, enterprise solutions at S&P Capital IQ; and Cynthia Sachs, head of BVAL services at Bloomberg Data Solutions.
His first question concerned the importance of valuations to risk management. O’Connor responded: “From a risk perspective, there are a number of aspects, such as the liquidity and transparency of a position you are trying to value. With a wide range of products to value, more risk is associated with less liquid assets. The use of valuations is also important to understand, as they can be used for collateral, net asset value production and profit & loss, all of which have different risk profiles. We reduce risk by using prices from multiple sources including both external vendors and internal pricing models.” While O’Connor described HSBC’s approach to reducing risk, he warned that risk can never be completely eliminated from valuations.
Sachs said hard to price securities garner most interest in terms of risk management and cited structured products, particularly collateralised loan obligations (CLOs), as among those most difficult to price. She sad: “Clients want clarity in valuations around complex products. We are seeing a lot of interest in pricing CLOs as the new issue market is back.”
Jones also reported a re-emergence of CLOs as well as the ongoing requirement for OTC derivatives valuations, even though some are now centrally cleared. Summing up these and other developments since the 2008 financial crisis, he said: “We see a greater understanding of the types of pricing and valuation in the market. There is more awareness of what is required and firms are coming to vendors for evaluations as well as for pre- and post-trade pricing data. Since the financial crisis, people are thinking more about where to get prices and how frequently. Regulation means they must also be able to drill down into what is behind a valuation.”
Sachs added: “Clients are looking at data and data behind valuations. Transparency is critical as regulators need to understand how valuations are made.” O’Connor concurred, saying: “Regulators want more evidence of checks performed on valuations and want to see more price sources. Due diligence is also becoming important as clients rely on us for valuations and comparable valuations from difference sources. We carry out due diligence on all the sources we use.”
Turning to the issue of pricing models, Delaney asked panel members when a model-based approach is best used. Referring to Bloomberg’s BVAL fixed income services, Sachs described the need to build models when observed data around fixed income securities is rare. Again, she emphasised the need for transparency, explaining: “This is not a black box function. Clients need to see and agree the inputs and assumptions in a valuation model.”
Returning to the importance of multiple sources of valuation data, O’Connor described how HSBC manages both internal and external sources, saying: “We have criteria for modelling valuations internally or outsourcing them. The cost of building, validating and configuring models depends on their complexity, so we consider whether we have the quant expertise to cover a particular product and whether we have the data in house that drives the model. If we have a significant volume of positions from clients and they need multiple time snaps of valuations through the day we are more likely to make valuations in house, but we will never stop using vendors as we rely on their expertise for some asset classes.”
Considering the equally important issue of independent valuations, Sachs said: “This is one of the biggest issues on the table. When there are incidents with a focus on valuations, the valuations need to be independent to provide credibility and market confidence. Independent valuations are also good for internal checks and balances.”
With the transparency of valuations being a key client and regulator concern, Delaney questioned how transparency is defined in the market. Jones responded, saying: “Transparency means lots of things to lots of people, but it breaks down into transparency of market data and underlying trade and pricing data related to a valuation, and the inputs, assumptions and methodologies used to make a valuation. Transparency also needs to include consistency, with different functions in an institution needing a consistent view of valuations of securities.”
Delaney concluded the webinar with a request for forecasts on the focus of valuations. Sachs suggested the Basel III liquidity coverage ratio will be one focus, but only one among many emerging regulatory requirements for valuation. Jones said interest is growing around MiFID II and the transparency of pre- and post-trade data. Looking forward, he said: “Will there be a European consolidated tape and what will it cover? How will it help us with valuations in an illiquid market, and will it drive a review of pricing in the market?”