Fund managers need to improve their asset-valuation practices, particularly when it comes to less-liquid assets and stressed markets, according to a compliance review by the European Securities and Markets Authority (ESMA).

The regulator published a report detailing the results of a review of asset-valuation practices among fund managers.

The review, carried out in cooperation with several other local regulators, found room for improvement in:

  • firms’ overall valuation policies and procedures;
  • their approaches to valuation in stressed market conditions;
  • the independence of the valuation function;
  • mechanisms for detecting errors; and
  • methods for compensating harmed investors.

Among other things, the regulators found that some smaller managers relied too heavily on third-party data providers to price less-liquid assets without adequately checking and back-testing their findings.

They also found issues with valuation policies and procedures that “do not distinguish between normal and stressed market conditions” and don’t systemically incorporate liquidity stress testing.

Procedures for detecting errors early and compensating investors could also be improved, they said.

For less liquid assets, such as private equity and real estate, the regulators noted that “issues arise in the alignment between the NAV calculation, the asset valuation frequency and the availability of up-to-date data,” particularly for funds that offer daily redemptions.

The report noted that, given the tougher economic outlook and tighter financial conditions, it’s particularly important for the shortcomings that were identified in the review to be addressed.

According to the report, supervisors should pay close attention to “potential valuation issues arising from less-liquid assets, whose nature can amplify the structural liquidity mismatches of certain types of investment funds.”

ESMA intends to “facilitate discussions” among local regulators on the issue of asset valuation, particularly under stressed market conditions “to ensure that both market participants and [regulators] are better prepared to address valuation-related challenges in future periods of stress.”