Views on Fair Value…
November 17, 2009
Busy week last week for events in London, this time over at the Goodacre / Six Telekurs on Thursday morning. Guy Sears of the IMA was chair of the event, and the event did have a "buy-side" focus to it. Richard Newbury of Six Telekurs started the event and made the following points on the current state of regulation:
- UCITS IV – Richard cited the stats that there are around 37,500 funds in the EU with average value of approximately $180M each as compared to only 8,000 funds in the US with average value over $1B. Richard said that such a proliferation of funds was costly and the more EU could standardise funds and their ability to be transacted everywhere in the EU the better.
- Reg NMS – Richard took a little humorous dig at US regulators when he reminded us that Congress authorised the SEC to form a "National Markets System" in 1975 and so this had taken around 30 years to implement. Whilst Reg NMS is often compared to MiFID, he said that Reg NMS had led to consolidation in the US while obviously MiFID has led to fragmentation in the EU.
- Hedge Funds – Both EU and US regulators are looking at the hedge fund industry. He mentioned the battle the UK was having with some of the (misguided?) regulation that the EU is trying to introduce with over 30,000 HF related jobs in London. The new regulation is likely to increase reporting requirements leading to more need for regular, standardised fair value reporting.
- Credit Rating Agencies – Richard mentioned how there will be more ratings and more ratings types, and the regulation introduced to ensure the CRA do not fall into the conflict of interest trap.
- Data Management – He mentioned the importance of data management within what is happening in the industry and noted how the profile of data management was on the increase.
Mike Jenkins of Ernst & Young tried his best to make the accountancy treatment of derivatives interesting and didn't do too bad an effort but I only took the following few notes from his talk:
- Unlike US GAAP with FAS 157 there is no single standard Fair Value (FV) definition in IFRS, and unsurprisingly IASB are addressing this.
- Mike spent some time mentioning Level 1(quoted), Level 2 (observable) and Level 3 (unobservable) pricing inputs for securites, taken from the IASB exposure draft ED/2009/5 (also see Rowe in earlier post)
Matthew Cox of BoNY Mellon Security Services then gave his presentation on the difficulties/challenges of providing a valuation service to their asset management clients:
- His division often have a "2 hour" window to produce valuations for NAV reporting, often for a 12 midday valuation
- Data exceptions for investigation went through the roof this year due to increased volatility (comment: didn't get chance to ask whether the validations set were "normalised" for market volatility i.e. a price movement threshold would not be fixed but rather be multiplied by a factor relating to recent volatility levels)
- Matthew was very complimentary about the efforts his team put in to cope with this increase in data exceptions.
- He mentioned how many of his clients of established "Fair Value Committees" over the past couple of years, comprised of staff from compliance, risk management, portfolio management etc.
- Matthew mentioned the importance of time zones in valuation and the timeliness of data, with the availability of intraday CDS prices contrasting with bonds who price only from the evening close of the day before.
The panel debate was moderated by Guy Sears, and included the above speakers plus Nigel Reynolds from TD Waterhouse):
- Matthew said that his division sometimes shared the "consensus" price from other clients when one client is looking for some guidance.
- He mentioned that a key timeframe in establishing FV was establishing what is a "reasonable" time frame for sale of a security.
- Nigel Cox said that "suspended stocks" had been a real issue over the past year, where the client "context" (position, situation etc) would very much determine what value a client would want assigned to a holding.
- Guy Sears suggested that valuations should be provided with a confidence interval and not just as a single price
- Mike of E&Y said that this is what full disclosure now requires, other memberrs of the panel suggested this was realistic but not what clients (humans?) expect to receive – they want a single number.
- Guy wondered whether it was an issue that one entity might value an asset at a value X whilst another would value the liability at Y (not equal to X)
- Mike of E&Y pointed out that this was an issue in that current accountancy rules allow a security to be reclassified from "fair value" pricing to "historic cost" basis – this discretion is being removed in future rule implementations
- One member of the audience pointed out that Bloomberg, Reuters and Markit were all trying to extract more revenue from data used for valuation purposes.
- Matthew advocated that the market needed more competition between niche data vendors such as Markit and SuperDerivatives to ensure innovation in service and more competitive pricing.
- The audience asked Guy of the IMA whether the association should have offered more guidance on fair valuation process and best practice.
- Guy said they have provided some, but he advocated that trade associations should not have opinions, since it was not healthy to have the asset management industry collectively herding towards the same valuations.
Well attended event with some good speakers, particularly Guy Sears as host was funny, knowledgeable and kept the other speakers on their toes. I would say the most interesting point was still that "opinions" form prices, opinions formed in the investment/funding "context" of the party with an interest in valuing a security – conceptually this seem to make the asset servicing companies a little uncomfortable since what they are contracted to do is to provide the "right" set of numbers by their clients. Human beings feel more comfortable fixating on a single number than a range of possible outcomes/results it would seem!…