Investment companies have room for improvement in how they calculate the value of unlisted investments, the UK financial watchdog has warned.
The Financial Conduct Authority (FCA) has called for continued focus on valuation practices in private markets following its latest review.
Areas where firms "need to improve", it said, suggesting that potential conflicts of interest in the valuation process have been lacking in how they are identified and documented.
There needed to be more independence within firms’ valuation processes, the FCA said.
Other areas for improvement for some firms is a need for enhanced processes to make 'ad hoc' valuations in times of market disruption.
Due to their less liquid nature, doubts about valuations of private investments held in the portfolios of major funds has led to criticism in the past for the likes of the Woodford Equity Investment fund and, to a lesser extent, Scottish Mortgage Investment Trust.
Overall, the regulator found good practices across the sector, which is of particular importance to the UK as the largest centre for private market asset management in Europe, with investor demand driving significant growth.
Private assets include private equity, venture capital, private debt and infrastructure.
As they lack the frequent trading and regular price discovery seen in public markets, this makes strong valuation processes crucial for fairness and investor confidence, the FCA noted.
Camille Blackburn, director of wholesale buy-side at the FCA, said: "Good valuation practices are key to maintaining fairness and confidence as the market grows. We were pleased that firms could usually evidence independence, expertise, transparency and consistency in their valuation process.
"There is still more to do, and we expect firms to carefully consider our findings."
Andy Peterkin, partner at law firm Farrer & Co, noted that the FCA is increasingly focusing on private markets as it believes they can help support its growth agenda.
"Private market valuations have been a source of concern to the FCA, given how much subjective judgment they require. In particular, the FCA expects managers to carefully manage conflicts of interest that can arise around the interaction between valuation methodology and fees charged to investors," Peterkin said.
"Given the current prominence of fund finance in all its forms in the FCA’s current strategic thinking, the FCA’s focus on the impact of fund finance, and in particular secured NAV financing on valuations and the potential flowthrough to performance fees is worth noting."
He noted that the FCA is also carrying out a linked review of conflicts of interest in the sector.