Global banks, asset managers and insurance companies are adopting innovative approaches to valuing high-yield corporate credit in response to regulatory and client demand for transparent, defensible and timely evaluated pricing. Instruments under particular scrutiny include high-yield bonds, leveraged loans and collateralised loan obligations, all of which can be hard to price and all of which have their own idiosyncrasies in liquidity, transparency and pricing methodologies.
As regulations such as ASC 820/IFRS 13, Basel III, Solvency II and AIFMD come into effect over the next 12 months, requiring greater transparency in valuing illiquid cash and hard-to-price derivative instruments in fixed income portfolios, many firms are looking beyond in-house pricing processes to third-party, specialist valuation services that can offer independent and timely pricing based on relative value mark-to-model approaches.
A-Team Group has been working with Bloomberg to identify the difficulties of valuing high-yield corporate credit in an increasingly regulated market and to propose solutions to the problems. A White Paper authored by A-Team Group and sponsored by Bloomberg can be downloaded free here.
The paper describes the classification of all traded instruments into three levels depending on the amount of observable market data that is available to derive a valuation. In terms of corporate credit instruments, high-yield corporate bonds are generally the most transparent and straightforward to value. Leveraged loans are more difficult and are often valued on the basis of indicative market quotes from major dealers. The market for collateralised loan obligations is even more opaque, making them very difficult to value with any accuracy.
These instruments are prime targets for third-party specialist services, such as the Bloomberg Valuation Service, that can offer the transparency of market data inputs and pricing methodologies needed to defend valuations in response to queries from regulators, auditors and investors. Vendor services also have the scope to value a wide range of asset classes, expert teams to tackle hard-to-price instruments, sophisticated systems for timely delivery of valuations, and independence – elements of evaluated pricing that are becoming increasingly critical to regulatory compliance.