Are alternative investment funds ready for the Directive’s valuation framework? When the European Commission introduced the Alternative Investment Fund Managers Directive (AIFMD), it drafted one of the most ambitious and complex reform agendas ever introduced into the asset management industry.
Amongst many reforms, the Directive provides a detailed valuation framework, including requirements for detailed valuation policy and procedures to be applied consistently across all alternative investment funds (AIFs) and requirements for competence and independence of personnel performing valuation functions. There are a number of challenges Alternative Investment Fund Managers (AIFMs) face in order to satisfy the Directive on valuation. In this article we focus on some of the more pressing areas that will impact AIFMs.
AIFMs are required to ensure that the valuation function pertaining to the investments they manage on behalf of investors is carried out impartially and with skill, care and diligence, either by an independent external valuer or by the AIFM itself.
The requirement for impartiality brings challenges for AIFMs. For instance, for AIFMs undertaking valuations internally, the Directive requires that those responsible for valuation be independent from portfolio management teams, yet have equivalent knowledge, experience and level in management hierarchy as those in portfolio management in order to appropriately challenge key valuation matters.
For each AIF it manages, an AIFM must establish, maintain, implement and review Valuation Policies and Procedures (VP&Ps) that ensure sound, transparent, comprehensive and appropriately documented valuation processes. VP&Ps should be reviewed at least annually and, in any event, before an AIF engages in a new asset type. An AIF may not invest in a particular asset type before a valuation methodology for that asset type has been included in the VP&Ps.
AIFMD requires that the main features of all valuation models be documented in the VP&Ps. Before being applied, a model must be validated by a competent and experienced person who has not been involved in building the model and be approved by senior AIFM management. This presents potential challenges for AIFMs, particularly when investing in more illiquid assets where bespoke and complex models are developed that evolve over time.
Do we have sufficient qualified individuals that are separate to portfolio management in order to deliver impartial valuations?Do we have sufficient governance to support the delivery of objective valuations?
AIFMs that have not already conducted an in-depth AIFM impact and readiness assessment should do so without delay. The timelines to compliance are increasingly short and by undertaking such an assessment, AIFMs can get a better sense of the implications and the scope of the work that needs to be done in order to not only comply with the Directive, but to maintain long-term profitability under these new rules.