During the Covid-19 pandemic fund groups were forced to reimagine their valuation policies and procedures. On top of the shift to remote and hybrid work, which for many, continues to challenge traditional operating models, the SEC implemented the adoption of Rules 2a-5 and 31a-4 under the Investment Company Act of 1940, throwing a wrench into the sector’s already evolving state.
Rule 2a-5, Good Faith Determinations of Fair Value (Rule 2a-5) was adopted to provide a common fund valuation framework across all fund groups and represents the first significant rule change in fair valuation guidance in over 50 years. While the new rule has undoubtedly impacted how fund managers approach their overall end-to-end fair value processes, the shift also presents an opportunity for change.
Looking beyond the goal of regulatory compliance with the rule to opportunities companies have to strengthen the valuation operating model by adopting technology and data tools that will become the “spinal-cord” of operational valuation processes and provide long-lasting efficiency, control, and oversight. The fair valuation end-to-end process requires collaboration with the fund board as well to provide comfort and evidence that the funds are in a position to achieve active oversight and manage their regulatory risk.
With agility and resilience at the forefront of today’s business models, fund groups have the opportunity to seize the rapid expansion of digital technology-based tools to use to their advantage. The key to success, however, lies in choosing the right tools to drive businesses forward.
To understand where the market can go, it is important to see where it stands today. Some of the largest fund groups are still relying on manual and time-consuming fair value processes that straddle a number of teams and processes. In fact, a recent Deloitte survey reports that 90% of fund groups are still relying on spreadsheets as their primary technology to support the fair value process1. From what we are observing in the market, today’s fair value operating model is not only manual and time-consuming but also prone to errors and inconsistencies in the end-to-end fair value process. Further, teams are spending far too much time mired in this one operational activity, taking them away from much higher priorities across the operation. Lastly, in the absence of a formal framework and infrastructure (i.e., an enterprise-strength solution) there is generally no automated process management, detailed audit trail, or formal reporting mechanism.
With the introduction and adoption of Rule 2a-5, fund companies will be required to:
- Periodically Assess and Manage Valuation Risks
- Establish and Apply Fair Value Methodologies
- Select and apply appropriate fair value methodologies
- Periodically review the appropriateness and accuracy of the methodologies selected and make any necessary changes or adjustments thereto
- Monitor for circumstances that may necessitate the use of fair value
- Test Fair Value Methodologies for Appropriateness and Accuracy
- Pricing Services
- Determining fair value in good faith requires the oversight and evaluation of pricing services
- Fund board or valuation designee establish a process for approving, monitoring, and evaluating each pricing vendor
We know from experience that new regulations present new challenges. How does a firm monitor a fund’s universe of security prices as efficiently and as accurately as possible? How do they ensure that valuation methodologies are applied consistently and fairly across the board? How do fund boards and pricing committees ensure appropriate evidence of fair value determinations? And how will they meet the increased demand for reports in an area that is already bogged down in existing regulatory and board reporting requirements? These are legitimate areas of concern and fortunately, Milestone Group has the solution.
Milestone Group, in collaboration with a leading fund company, recently introduced the industry’s first enterprise-strength solution for fair value control. The pControl Fair Value Control™ solution facilitates the end-to-end fair value process by receiving daily feeds containing security prices from market data providers as well as third-party accounting agents to increase the speed and efficiency of the fair valuation process. The data is validated in order to highlight where a security's valuation may not be consistent with policy and identifies pricing anomalies that may require fair valuations. These exceptions are then presented via dashboards to the teams responsible for the oversight and administration of the valuation process. Recommendations are made to the pricing committee when action needs to be taken to ‘fair value’ an asset on a given day. Integrated into the solution is a collaboration capability that enables pricing committee members to vote on these fair value recommendations from their PC, tablet, or mobile device. And finally, the solution comes with an out-of-the-box integrated and flexible reporting capability which will help speed up the report-building process to meet compliance with the new regulatory requirements.
The days of home-grown databases, spreadsheets, and other user-defined tools are over. With the right solution, critical fair value data no longer exists in silos, but instead in one unified industrial strength environment. Say goodbye to error-prone, tedious processes and say hello to the future of fair value reimagined.
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1 Paul Kraft, Tom Wines, Rajan Chari (2023). Fair valuation pricing survey, 21st edition, executive summary Answering the bell: Responding to new requirements. Deloitte LLP., https://www2.deloitte.com/us/en/pages/financial-services/articles/annual-fair-valuation-survey.html