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Northern Trust Providing More Data for Fair Value, Adds New IFRS Valuation Toolkit

Custodian bank Northern Trust has been ramping up its efforts over the last 12 months to improve transparency for its end clients around fair valuation measurement, says Judson Baker, derivatives product manager at the bank. To this end, this week it has launched a new IFRS Valuation Toolkit aimed at providing a broad range of data to help its global custody clients meet their IFRS 7 financial reporting disclosure requirements.

According to Baker’s colleague Debra Clayton, who is client reporting product manager for Northern Trust, the toolkit has been designed to automate the process of delivering this extra data to the regulatory community. “This delivers assurance of data integrity and enables the client to collate data for their IFRS reporting with greater ease, freeing them from the labour intensive and potentially complex tasks,” she contends.

The toolkit is available via Northern Trust’s single, global operating platform and has been fully integrated into client reporting packages. It consists of customisable level determination reports and various pricing related documents that provide clients with details related to the securities within their portfolios. According to Clayton, an important element is the Level 3 roll-forward reporting, which shows activities and current year change in unrealised gains or losses for Level 3 securities held at the end of the year.

In March 2009, amendments to IFRS 7 introduced a three level pricing hierarchy to frame disclosures of fair values, which have recently been the topic of much debate within the regulatory community. The effect of this focus has meant that custodian banks such as Northern Trust have been compelled to provide their clients with much more data around a price than ever before. This is because reporting entities are required to analyse their investment portfolios, classify securities into three levels, disclose movements of securities between levels and provide reconciliation from beginning to ending balances related to transactions for Level 3, or hard to price, securities.

“The identification of valuation source is critical,” notes Baker. “Northern Trust takes it a step further to not only provide valuation source reports, but also to provide transparency reports indicating the model used, source of market data, assumptions and key valuation drivers. We feel that this information is suited towards business unit controllers, risk officers, audit and regulators alike.”

Baker indicates that the custodian bank has also witnessed a growth in the demand for independent and unbiased valuations of bilateral instruments from its clients. This has been in the form of mid-level market data, such as credit spreads and volatility surfaces, as well as through third party valuation specialists, he explains.

The way that firms use valuations data in general is evolving in order to better understand enterprise-wide risk, adds Baker. He believes that valuation source comparison, where vendor data is compared to that received from a counterparty or produced by the trading desk, is an example of an area that needs constant attention to help identify valuation inaccuracy, collateral management, and liquidity concerns.

There is also no doubt that the third party valuations market has become much more competitive, with many new entrants on the scene. Baker reckons these firms should differentiate themselves on the basis of their breadth of instrument coverage across all asset classes and their track record for accuracy compared to other valuation sources. “Within the asset servicing industry, valuations are a core area of the offering so I would hold those companies to high standards on the service they can provide,” he says.

He continues: “There are many organisations leveraging their access to market data or technology to provide independent valuations for OTC derivatives. Competition in this area will continue to drive down fees to the buy side and asset servicing firms. In my view, the differentiator will be for firms to offer accurate, transparent and deep instrument coverage across all asset classes.”

The introduction of central clearing counterparties (CCPs) to the OTC credit derivatives market is also forcing these firms to adapt, although Baker reckons there is much more to come. “The true impact to the valuations service providers will come in the near future as more single name and sovereigns will become centrally cleared. Transparent market data and other observables will become readily available and is always going to have a positive impact on derivative trading organisations. At this time, however, the products centrally cleared are very liquid where the market data is already accessible,” he says.

Baker is confident that investment into the valuations space will continue from all players in the market. “The key driver for investment in pricing and valuations technology will be related to the data sourced and how this data, as well as output valuations, are used in a meaningful manner. The main justification for investment is simply the cost of trading OTC derivatives. However, end users have more choices to derive valuations, through: subscribing to periodic valuations from revaluation vendors, buying software, or developing valuations technology in-house,” he concludes.

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