Valuations are no longer merely a concern for the back office; recent events have meant that they have finally hit the mainstream, according to research by A-Team Group, publisher of this news service. High profile failures and frauds relating to the mis-pricing of assets have made valuations headline news, says Ian Blance, author of the report.
“If you need further proof how important robust valuation systems and controls are, then we need look no further than Credit Suisse, who were fined £5.6 million by the UK Financial Services Authority (FSA) in August for failures in this regard relating to US$2.7 billion of mispriced trades announced by the bank in February,” Blance explains.
The report, OTC Valuations: Pricing Assets in the Post Credit Crunch World, examines the key methods and issues surrounding valuations approaches, provides a review of the impact of various regulatory and accounting initiatives on valuations practices and an overview of the vendors in the space. Also included are findings of an in-depth survey conducted by A-Team Group of decision makers across buy and sell side firms involved in OTC product valuations strategy. It explores how institutions are approaching the sourcing of valuations and how they rate suppliers of data across asset types. And it presents the various offerings from independent valuations data providers.
Blance comments: “I think that the most interesting finding in general was the higher profile that valuations were now receiving from regulators, accountants and institutions. Asset valuation is no longer a back office backwater, but is now centre stage at the highest levels.”
The increase in the importance of valuations has been driven by the development and use of more complex financial products such as derivatives by the industry as a whole, which has incurred the scrutiny of regulators, accountants and industry bodies. These products are no longer the province of specialists, they have been adopted by the more traditional end of the market, bringing with them complex valuations procedures into the mainstream.
“The main driver for investment in this area will be the desire not to lose money – either due to regulatory sanctions such as experienced by Credit Suisse or due to losses incurred by mispricing either deliberately and fraudulently or in error,” adds Blance. Reputational and financial risks have therefore made investment in valuations a compelling argument.
“I think most people recognise the issues and, excluding those who set out to deliberately mislead, want to get it right to avoid troubles and potential losses,” continues Blance. “The problem is that there are a number of interpretations of what ‘right’ is and some kind of subjective judgement is usually required.”
The challenge in the market is to choose the right method of valuation for the right asset, A-Team Group contends. To this end, the report, more details of which can be found at www.otc-valuations.com, highlights the many different sources and methods for asset valuations and explores the pros and cons of each.
“There has been a long term trend to increasingly rely on external, ideally independent, sources for valuations but this still has some way to run,” says Blance. “In the newer asset types and derivatives for instance, such an external source may simply not exist.”
The main contributing factors to the choice of valuations provider include regulatory requirements, accounting standards, industry best practices, internal risk and compliance policies and, most importantly in this financial climate, cost. “The primary challenge for institutions required to value assets is using the most appropriate valuation method for each asset based on external constraints and internal requirements and budgets. This is made even more problematic by these variables continually changing such that the process is under constant review,” adds Blance.
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