(The article featured
below is a selection from Hedge
Funds and Private Equity: Risk Management and Regulatory Update, which is
available to subscribers of that publication.)
Industry Concerned with Working Group's Valuation Recommendations for Fund
Managers
The hedge fund industry has significant concerns with recent best practices
recommended by the President's Working Group on Financial Markets regarding the
disclosure of the valuation of managed assets centered on FAS 157 fair value
accounting. In a letter
to the Working Group, the Managed Funds Association said the ambiguities of fair
value accounting work against achieving a consensus on proper valuation of a
hedge fund's portfolio assets. The MFA also noted that the recommended
disclosure goes beyond the requirements of FAS 157.
The Working Group issued complementary sets of best practices for hedge fund
mangers and investors in the most comprehensive effort yet to increase
accountability for participants in the industry. The Working Group called on
hedge fund managers to adopt comprehensive best practices in the critical areas
of disclosure, valuation of assets, risk management, and conflicts of interest.
Specifically, the Working Group said that fund managers should provide financial
information supplementing FASB Standard No. 157 to help investors assess the
risks in the valuation of the fund's investment positions.
Depending upon the extent to which the fund manager invests in illiquid and
difficult-to-value investments, noted the Working Group, the disclosures should
occur at least quarterly and include the percentage of the fund's portfolio
value that is comprised of each level of the FAS 157 tripartite valuation
hierarchy. Level 1 is comprised of assets with highly liquid market prices,
while Level 2 assets have no quoted prices, but there are similar assets with
quoted prices. Level 3 is for illiquid assets that have to be priced using
models.
The group also said a best practice would be to set up a Valuation Committee
with ultimate responsibility for reviewing compliance with the fund manager's
valuation policies. Further, the group said that independent personnel should be
in charge of the valuation of the fund's investment positions.
While broadly agreeing that investors would benefit from disclosure of hedge
fund valuation policies, the MFA noted that there is much ambiguity and a lack
of consensus among managers, counterparties and accounting professionals as to
the appropriate treatment of a number of products under FAS 157 such that the
Working Group's recommendations may not be achievable. Further, the lack of
consensus is likely to result in inconsistent disclosure across the industry,
which could be both confusing and potentially mislead investors.
Until a greater consensus exists with respect to implementation of FAS 157, the
MFA asks that this recommendation be deleted. The MFA noted that fund managers
will still be required by their independent auditors to follow the procedures
specified in FAS 157, as the industry continues to develop consensus on the
implementation of those procedures.
The committee also recommended that hedge fund managers disclose the percentages
of a fund's portfolio value for which a manager relied on one dealer quote and
multiple dealer quotes. The MFA believes that this disclosure could also be
misleading to investors since there are certain types of products for which one
dealer quote is used in valuing the asset, even though there is a liquid and
deep market for the product, such as certain types of OTC products. There may
also be products for which multiple quotes are available, but for which there is
not a particularly liquid, active and deep market. While the availability of
multiple dealer quotes may be an indication of the level of market activity for
an asset, said the MFA, it may be misleading in certain instances. As such, the
group was urged to delete this recommendation.
While agreeing that the valuation function should be independent of the
portfolio management function in order to reduce conflicts of interest, the MFA
believes that the recommendations are confusing when read in conjunction with
the make-up of the proposed Valuation Committee. The Working Group said that the
Valuation Committee may include members of senior management who have portfolio
management responsibilities. However, the recommendations also discuss
segregation of valuation personnel from portfolio management personnel. To the
extent that a Valuation Committee is partially comprised of senior portfolio
managers, reasoned the MFA, then the desired segregation of personnel does not
seem possible.
|