Enhancing governance in private investment valuations: A strategic framework for non-executive directors

In the Financial Conduct Authority's (FCA) review of private market valuation practices, they propose a comprehensive framework for NEDs to effectively oversee and challenge investment valuations. The surge in private investments has heightened the necessity for rigorous valuation processes. NEDs are instrumental in providing independent oversight, ensuring that valuation methodologies align with best practices and regulatory standards.

Challenges in Private Investment Valuations

The FCA's multi-firm review highlighted several challenges faced by firms in valuing private assets:​

• Identification of Comparable Assets: Determining appropriate comparables is complex, especially when assets possess unique characteristics. Firms often employ various methodologies, such as weighting multiple comparable sets or using a limited number of directly relevant comparables. ​
• Adjustments for Public Market Volatility: Inconsistent approaches exist regarding the reflection of public market fluctuations in private asset valuations. Some firms adjust discount rates to mitigate the impact of public market movements, citing factors like macroeconomic uncertainties or differences between private assets and public peers. ​
• Valuation Methodologies: Diverse practices are observed in the application of valuation models, including Discounted Cash Flow (DCF) analyses. While some firms refrain from using DCF due to its subjective nature, others apply it as a primary approach, emphasising the importance of clearly outlining assumptions. ​

A Framework for NEDs to Enhance Valuation Oversight

To address these challenges, NEDs should consider the following strategic actions:

• Comprehensive Skills Assessment: Utilise annual board evaluations to identify skill gaps in valuation expertise. This assessment informs decisions on training, potential new appointments, and the engagement of third-party experts. Ensuring that directors allocate sufficient time to thoroughly review and challenge complex valuation reports is crucial. ​
• Establishment of a Dedicated Valuation Committee: Forming a valuation committee comprising members from the valuation and finance teams, along with at least one board member, facilitates a direct link between management and the board. This committee should be responsible for reviewing and approving valuations, ensuring that NEDs can effectively evaluate the design and implementation of valuation controls. ​
• Consistent Application of Valuation Methodologies: NEDs should ensure that valuation methodologies and assumptions are applied consistently, with adjustments made solely on the basis of fair value. Scrutiny of valuation committees and independent functions is essential to uphold robust decision-making processes (​FCA).
• Engagement with Independent Valuation Experts: Utilising third-party valuation advisers can enhance independence and bring specialised expertise to the valuation process. NEDs should oversee the engagement of these advisers, ensuring that potential conflicts of interest are identified and managed and that the nature and limitations of their services are transparently communicated to investors. ​
• Alignment with Industry Guidelines: Adherence to industry standards and guidelines ensures that valuation practices are in line with market expectations. NEDs should advocate for the adoption of such guidelines and consider secondary methodologies to corroborate judgment, enhancing the credibility of valuations. ​

Conclusion

As stewards of investor interests, NEDs must be proactive in overseeing private investment valuations. By implementing the outlined framework, NEDs can strengthen governance, mitigate risks associated with valuation inaccuracies, and uphold investor confidence in an increasingly complex investment environment.

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