The Financial Times turned heads this week when, citing internal sources at the Financial Conduct Authority, it reported that the regulator is prepared to launch a review into how private equity funds handle private market valuations.
According to sources, this will involve examining who in a company is responsible for valuations, the process of communicating this information to higher-ups, and assessing the robustness of existing governance practices.
This suggests that the watchdog is concerned about a private market blowout following years of interest rate hikes, which could adversely impact FCA-regulated institutions.
Put simply, if these alternative asset managers aren’t fairly assessing the market value of their portfolios, another liquidity crisis could be on the cards.
However, not all analysts are convinced that this is a genuine issue.
The proof of the pudding is in the eating
“We think that given the nature of listed investment companies, those that do hold unlisted assets have clear procedures in place around their valuation process,” said Stifel analyst Iain Scouller.
Scouller pondered if the as-yet-unannounced review would be “somewhat late given that valuation issues related to the change in the interest rate environment are already likely to be ‘baked-in’ to portfolios, given that rates have been rising for almost two years now”.
In his eyes, investment companies have clear reporting and accountability procedures in place under the international private equity and venture capital valuation guidelines.
Regardless, private market valuations are far more static than those on the public markets, as they are relegated to quarterly earnings schedules whereas public equity price discovery happens on a daily basis.
Additionally, private valuations are objectively more opaque compared to their public counterparts, since fund managers each have their own way of doing things.
That being said, “the proof of the pudding is in the eating” Scouller commented, alluding to the fact that these valuations tend to face the music upon realisation of investment.
SoftBank’s IPO of Arm Holdings was a prime example.
SoftBank initially penned a $70 billion valuation of the British semiconductor architect when it was fully private and approaching a Nasdaq listing.
This was revised down to $64 billion this August when SoftBank valued the firm at $64 billion following an internal transaction.
SoftBank ultimately settled on a $55.5 billion pre-IPO valuation, which the public markets have so far concurred with.
Though private valuations are a murky pond, heavy discounts applied to publicly listed private equity funds are there for all to see.
In this sense, the public markets can very well price these PE funds’ underlying assets on a running basis, even if these funds are less than transparent.
If the FT’s sources are telling the truth, then the FCA plans to commence its review by the end of the year.