On 24th March, the Malta Financial Services Authority (the “MFSA”) issued its findings and observations identified during the European Securities and Market Authority (“ESMA”) Common Supervisory Action (“CSA”) on Valuation of Undertakings for the Collective Investment in Transferable Securities (“UCITS”) and open-ended Alternative Investment Funds (“AIFs”). In particular, the CSA focused on UCITS and open-ended AIFs that invest in less liquid assets such as unlisted equities, unrated bonds, corporate debt, high yield bonds, emerging markets, illiquid listed equities, and bank loans.
The main findings and observations which emanated from the circular were the following:
- Governance structures – Certain weaknesses regarding the robustness of governance arrangements including the failure to formalise all the roles and responsibilities and reporting lines of those involved within the valuation process.
- Oversight of illiquid assets – Lack of assessments and probing by the Board with respect to valuation risks emanating from less liquid assets.
- Valuation updates – Lack of sufficient justifications and explanations for valuation issues.
- Valuation policies and procedures – In some cases there was complete reliance on the valuation disclosures within the offering documentation and no formal documentation of valuation policies and procedures. In other cases where there were valuation policies and procedures, there were severe deficiencies regarding the proper definition of roles and responsibilities and the pricing methodology. Deficiencies were also found regarding the procedure for the calculation of the valuation model and the choice of external valuers, the handling of exceptions to the pricing methodology and the identification and escalation of price differences.
- Early escalation mechanisms – Lack of formal policies and procedures laying down the price reconciliation process and the procedure for the compensation of investors in case of NAV and valuation errors.
- Validations of model-based valuations – General lack of clarity within the valuation policies and procedures on who performs the validation tasks. There were also instances of reliance on external auditors to perform a review of any non-financial assumptions without providing sufficient justifications on whether the external auditor had sufficient expertise to carry out this review.
- Due diligence on external valuers – Lack of periodic declarations of professional guarantees and specific controls in place to manage and mitigate conflicts of interest arising from the outsourcing arrangement when engaging an external valuer.
- Appointment of external valuers - Failure by fund managers to either inform the MFSA of an appointment of an external valuer or only inform the MFSA once the external valuer has already been appointed.
- Ongoing monitoring – Lack of provision of sufficient detail about the checks and tests relating to the valuation process or lack of inclusion of a review of key requirements emanating from relevant legislation, leading to cases where the requirements were not being checked and effectively complied.
The MFSA concluded by stating that all fund managers should assess their governance structures to address any deficiencies in line with the applicable regulatory regime and the strategies of the fund. They also indicated that they shall continue their supervisory work on valuation matters to assess whether the indicated shortcomings indicated in the Circular have been rectified and they also did not exclude the possibility of taking appropriate regulatory action in the future for Fund Managers which do not show significant progress to have adequate controls and governance arrangements.
Should you have any queries on any of the findings and observations or should you need help with the rectification of any deficiencies emanating from a bilateral engagement with the MFSA, kindly get in touch with Andrew Caruana Scicluna (andrew.caruanascicluna@camilleripreziosi.com) or Alexander Cachia Zammit (alexander.cachiazammit@camilleripreziosi.com).
