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Interactive Data Tracks Evolution of Fair Value Practices

Interactive Data has published the results of its 2013 Fair Value Practices survey, noting a rise since its last report in 2011 in the number of mutual fund firms using fair value practices every day, and a rise in the number of firms using a confidence level threshold at the security level to invoke fair value procedures.

The company’s research into fair value practices was conducted in June and July 2013 among a total of 178 market participants representing 127 mutual fund firms and builds on a series of studies made over a number of years.

Rob Haddad, senior director of evaluated services at Interactive Data Pricing and Reference Data, comments: “How fair value measurements have been incorporated into portfolios has evolved over the years of our research. Despite the trigger or no trigger debate in the market, boards want to know how their firms’ fair value processes match up to those of their peers.”

Interactive Data sourced opinion on fair value practices through eight questions, the first of which focussed on the approach firms take to invoking a fair valuation process for international equities. About 40% of survey respondents said they apply fair value every day (a zero basis points trigger), up from 36% using a zero trigger in 2011. Remaining responses showed 33% using a consistent single trigger and single benchmark, and 22% using either multiple benchmarks or multiple triggers.

Considering trigger levels that are used to invoke equity fair value procedures, the survey found a slight trend towards lower trigger levels over the past couple of years, although this is influenced by the rise in respondents applying fair valuation every day. Other trigger levels ranging up to 100 basis points show minimal change in their use by respondents.

Interactive Data reports that of the respondents using one or more trigger levels to invoke fair value procedures, some 73% are using the S&P 500 index or futures benchmark indicator as one of the indicators for the process. Time is also of the essence, with 31% of survey respondents that use a market indicator to invoke fair value processes saying they measure change between the London close and New York close, 24% saying change between the previous New York close and New York close, 23% change between the Tokyo close and New York close, and 13% change between the New York open and close.

Turning to the confidence level used in fair value pricing for global equities, the survey report shows 24% of respondents using a 0% confidence level, down from 25% in 2011, and 45% using a 90% confidence level or greater, up from 29% in 2011. The report notes that as confidence levels are typically used as a threshold for applying a fair value adjustment at the individual security level on a given day, the increase in confidence level thresholds suggests a tightening of tolerances around the use of fair value adjustments at individual security level.

Noting that this finding contrasts with the survey finding of lower trigger levels, the report states: “Overall, by combining market-based trigger results and security-level confidence level results, we can infer a trend towards invoking fair value procedures more frequently, while simultaneously administering more stringent standards on the securities that are adjusted.”

Making a final foray into fixed income securities, the report notes a pretty even split between firms considering the use of New York close evaluations for international fixed income securities every day to reflect the most up-to-date information available, and those that would take a trigger-based approach and only consider New York close evaluations when there is a substantial market movement from local market close to New York close time.

As the market evolves, Haddad expects to report greater refinement in fair value practices. Meantime, he forecasts short-term trends including growing interest around third-party fair value processes for European funds that are already popular in the US, and a focus on exchange traded funds in terms of improving indicative net asset value calculations by including real-time fair value pricing techniques.

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