UK Review Raises Red Flag on Conflicts of Interest in Private Market Valuations

The Financial Conduct Authority (FCA) recently published the findings of its multi-firm review of valuation processes for private market assets. Some of the deficiencies the review identifies, combined with the current geopolitical and macroeconomic environment, raise a number of red flags about some industry practices.

Judgement calls in the valuation process

In FRA’s opinion, the most concerning areas highlighted by the FCA were on conflicts of interest and application of valuation methodologies, both areas which raise questions over the judgement calls being made in the valuation process. The FCA commented that good practice is to use an independent third-party valuation where a conflict of interest had been identified.

Wherever judgement is required, the risk of misstatement and fraud increases. (Learn more on our recent webinar “Accounting Judgements for Lawyers”, available to watch here.)

Two examples from the FCA report illustrate this:

1. The FCA highlighted the use of unrealised performance in fees, marketing material and employee incentives. Unrealised performance involves judgement as it relies on forecasts.
2. The FCA found that the justifications for changes in valuation assumptions from some firms were vague or lacked adequate documentation. This raises concerns about both the assumptions used and the controls around them.

While interest rates may have peaked in this cycle, the exit environment remains challenging, increasing the incentive for managers to uphold valuations of assets still on their books. If firms are forced to restate or mark down valuations, it could trigger further revaluations and potential regulatory and commercial consequences. Asset managers, investors, financial institutions and their lawyers should be alert to the potential for disputes over valuation methodologies and demand for independent assessments. Ensuring that valuation processes are well-documented, defensible, and compliant with best practices will be critical in mitigating risk. While most valuation disputes may happen behind closed doors, it could only take one or two major cases to hit the headlines for public and regulator trust to erode, leading to wider calls for revaluations across private markets.