Central Bank of Ireland’s Dear Chair letter on asset valuation

ESMA's 2022 CSA on asset valuation

In 2022, along with other EU NCAs, the Central Bank of Ireland (the Central Bank) took part in ESMA's Common Supervisory Action (CSA), which reviewed how managers of UCITS and AIFs approach the issue of asset valuation. For an overview of the CSA's subject matter, see our article here.

For its part of the CSA, the Central Bank investigated whether Irish Fund Management Companies (Firms):

• comply with the UCITS and / or AIFM Directives and Regulations on asset valuation;

• adhere to applicable valuation principles and methodologies to reflect a true and fair view of their financial positions both under normal and stressed market conditions; or

• evaluated how their policies and procedures worked during the COVID pandemic.

This work consisted primarily of a questionnaire issued to a sample of 30 Firms. Each submission was then subject to a desk-based supervisory review, with 40% of the Firms being subject additionally to inspection calls and on-site inspections.

ESMA's Final Report, published in May 2023, set out its findings from the CSA. Our summary of the Final Report can be found here.

On 14 December, the Central Bank published a Dear Chair letter (the Letter) in which it:

• highlighted the main findings of the CSA;

• set out the Central Bank's observations on the issues it revealed; and

• set out key actions to be taken by all Firms in respect of the issues identified.

The Central Bank notes that the findings and observations which it outlines in the Letter are "an important reference for Firms in reviewing their valuation arrangements" and reminds Firms of the need to be proactive in identifying and implementing any improvements required to mitigate against key risks to which the Firm and its investors may be exposed.

The Letter should be read alongside the ESMA Final Report.

What did the Central Bank find?

General findings

The overall level of compliance was good - most Firms demonstrated adherence to the relevant legislation and supervisory expectations.

However, a significant minority of Firms could not evidence compliance with Central Bank expectations - a number of these Firms were issued with Risk Mitigation Programmes (RMPs).

However, deficiencies in the quality and detail of the information provided by "the vast majority" of Firms in response to the CSA questionnaire meant that the Central Bank had to follow-up to gather further evidence and information.

The Central Bank reminds Firms that they should ensure that Senior Management review all information before this is submitted - in future, issues with the quality of submissions will be taken up directly with Firms through their Central Bank Supervision teams.

Specific findings

Group asset valuation policies and procedures

Some Firms still rely on group valuation policies or procedures with limited or no reference to their Irish operations.

As this risks failing to capture the local regulatory environment or the operational roles and responsibilities of those involved in valuing the Irish assets, it could result in inaccuracies in the valuation process at the Irish entity.

Lack of formal asset valuation error procedures

Some Firms lacked stand-alone asset valuation error procedures, which would outline what controls and escalation measures should be applied where there was an error in valuation or calculation of the NAV.

Error procedures provided by other Firms failed to sufficiently outline how the Fund would revalue, recalculate and resettle affected transactions and gave no, or very limited, detail on how investor compensation would be determined or processed.

Poor quality of asset valuation policies and procedures

The asset valuation policies and procedures of a minority of Firms fell below the level of detail that would be reasonably required to cover the valuation process.

The asset valuation process should be supported by documented policies and procedures, clearly outlining the operational tasks and responsibilities for all parties involved, so a true and fair representation of the fund's financial position is reached.

Periodic reviews

Most Firms were unable to demonstrate that they held periodic reviews of their asset valuation policies and procedures - there was no documented evidence either of reviews having taken place or that there was a clear governance process to conduct these reviews.

Even for Firms which could provide evidence, this was in the form of either documented board minutes or evidence of version control captured on the documents, which could lead to deficiencies in valuation methodologies or models being utilised and incorrect valuations of assets being produced.

The Central Bank's observations on the findings

Liquidity Stress Testing

All Firms confirmed that they carry out stress testing and scenario analysis.

The Central Bank, though, reminds them that they should incorporate their results into liquidity management frameworks and use them to manage and inform decision making, risk management and risk mitigation, formally documenting any decisions taken as a result of this work.

Independence of the Asset Valuation Function at Firms

The asset valuation policies and procedures at some Firms failed to set out clearly how operational tasks and responsibilities in the asset valuation function are allocated. This can lead to conflicts of interest arising and Firms are reminded that they should ensure a clear segregation of roles and independence within the valuation function.

What action should Firms be taking?

The Letter sets out a number of key actions for Firms to take.

Firms should ensure that the Letter is brought to the Board's attention for consideration and that any appropriate action is taken without delay.

They should also review their asset valuation frameworks by the end of Q2 2024 to ensure they continue to be fit for purpose and adhere to all relevant legislative requirements and expectations.

Where a Firm fails to comply with the issues raised in the Letter, the Central Bank may have regard to how far the Firm has considered such issues in the course of its future supervisory engagement.

In addition, the Letter notes that all Firms should:

• have asset valuation policies and procedures which are documented, comprehensive and entity specific and which clearly outline the operational roles and responsibilities for all parties involved in the asset valuation process;

• ensure that there is clear ownership for asset valuation policies, procedures and the review process and that these are adhered to and embedded in the Firm's asset valuation process;

• subject their asset valuation policies and procedures to review by senior management at least annually to ensure they remain fit for purpose. Those undertaking the review should have appropriate knowledge and experience. The approved methodologies and models should be applied consistently across all the Firm's funds;

• have in place a formal and comprehensive errors procedure to ensure that remedial action is taken where there has been a valuation error or incorrect NAV calculation. These procedures should be reviewed at least annually and updated where required; and

• consider the above points to determine if any action is required in relation to existing arrangements.