Private market valuation practices

This multi-firm review will be of interest to:

• asset managers
• alternative investment fund managers (AIFMs)
• investment and portfolio managers
• investment advisers

The findings may also be of interest to other stakeholders in the sector, including investors, service providers, trade bodies and other regulators. 

Private markets have grown significantly in recent years with the UK continuing to be the largest centre for private market asset management in Europe. Private markets have become an important means for investors to diversify investment and seek new sources of return, and for corporates to obtain long-term capital to finance growth. Increasing numbers of asset managers are investing in private markets capabilities, building organically or via acquisition and joint venture, to meet rising investor demand from individuals and institutions from across the globe.

Supporting the UK’s status as an international investment hub and fostering growth and innovation is a priority for the FCA, in line with the FCA's secondary international competitiveness and growth objective[1]. Robust valuation practices are important for fairness and confidence in private markets. This work will support firms seeking to grow in this space as they invest in capabilities, frameworks and controls. 

Without the frequent trading and regular price discovery present in more liquid public markets, firms must estimate private asset values using judgement-based approaches to meet applicable accounting standards. This introduces a risk that firms could inappropriately value private assets, for reasons including insufficient expertise, focus, or poorly managed conflicts of interest, increasing the risk of harm to both investors and market integrity. 

Investors need fair and appropriate valuations to understand the performance of their investments and make informed decisions, such as on asset allocation and manager selection. Where open-ended fund structures invest in private assets or firms transfer private assets between vehicles, transaction prices can often rely upon valuations, meaning robust valuations are important for fairness between buyers, sellers and remaining investors. In some cases, firms may also use valuations to calculate management and performance fees paid by investors.

We have issued this review at a time when there is interest in valuation practices in private markets globally. In September 2023, IOSCO reported on the emerging risks in private finance[2], highlighting a relative lack of transparency and consistency in approaches to valuations. In June 2024, the Bank of England’s Financial Stability Report[3] highlighted the potential for vulnerabilities in the private equity sector from opaque valuations.   

The scope of this review included firms managing funds or providing portfolio management and/or advisory services in the UK for private equity, venture capital, private debt and infrastructure assets. 

Our review assessed the robustness of firms’ valuation processes and governance, including the checks and balances that help address the risk of poor conduct and harm to investors. We did not seek to independently validate firms’ fair value assessments for specific assets. 

For all firms, including UK MiFID managers and investment advisers, we assessed their processes against the Principles (see Principle 1, Principle 2, Principle 3, Principle 7 and Principle 8 in PRIN 2.1[4]). For UK AIFMs, we also assessed them against our rules in FUND 3.9 Valuation[5] and Articles 67-74 of the AIFMD Level 2 Regulation[6]. While this review did not include UCITS funds, these findings are relevant where UCITS funds hold assets subject to Level 2-3 valuations and should be considered in accordance with COLL 6.3[7].

Accounting standards set requirements for fair value estimates. Firms managing private assets generally use valuation methods using Level 3 inputs: those that are unobservable, with little or no market activity, as defined by the IFRS 13 and ASC 820 fair value hierarchies.

The review had 2 phases. Our firm selection in both phases aimed for broad coverage across business models, asset classes, delegation models and firm size. This helped us understand both good practice and areas for improvement for the entire sector.  

In Phase 1, we sent a questionnaire to a sample of 36 firms asking for information on their private market activity and their approach to valuing private assets. We used these responses to select a subset of firms for Phase 2.

In Phase 2, we conducted an in-depth review of governance and processes through document requests and on-site visits, including data on asset-level valuations to select case studies. These case studies allowed us to understand how firms valued certain assets over time and how firms’ valuation processes worked in practice.

In aggregate, Phase 1 participants reported the following:

Robust valuation processes were those that could evidence independence, expertise, transparency and consistency. 

We were encouraged to find many examples of good practice in firms' valuation processes, including the quality of reporting to investors, documenting valuations, using third-party valuation advisers to introduce additional independence and expertise, and consistent application of established valuation methodologies. Generally, firms recognised the importance of maintaining robust processes. We saw practices that reflected consideration of investor protections given the judgement required and risks present in valuing private assets. 

However, we also identified areas where firms should make improvements.

While all firms identified conflicts in their valuation process around fees and remuneration, and in many cases had limited these through fee structures and remuneration policies, other potential conflicts were only partly identified and documented. These included potential valuation-related conflicts related to investor marketing, secured borrowing, asset transfers, redemptions and subscriptions and uplifts and volatility. We expect firms to identify, document and assess all potential and relevant valuation-related conflicts, their materiality and actions they may need to take to mitigate or manage them. 

Firms had different levels of independence within their valuation processes. We expect firms to assess whether they have sufficient independence in their valuation functions and the voting membership of their valuation committees to enable and ensure effective control and expert challenge.

Many firms did not have defined processes or a consistent approach for ad hoc valuations to revalue assets during market or asset-specific events. Given the importance of these valuations in managing the risk of stale valuations, firms are encouraged to consider the types of events and quantitative thresholds that could trigger ad hoc valuations and document how they are to be conducted.

In some areas, such as transparency and disclosure, we saw good practice that went beyond existing requirements. Firms should consider these examples and whether they might be of value for their firm.

We expect firms to consider the findings from this review and identify any gaps in their approach, taking into account their size and the materiality of identified gaps. In particular, firms should consider whether they should make improvements in:

• The governance of their valuation process.
• Identifying, documenting, and addressing potential conflicts in their valuation process.
• Ensuring functional independence for their valuation process.
• Incorporating defined processes for ad hoc valuations.

Other actions are also noted for consideration throughout this report. 

Nearly all firms had specific governance arrangements in place for valuations. Over 90% of valuation processes in our Phase 1 questionnaire and all Phase 2 firms had valuation committees responsible for valuation decisions or, in some cases, recommendations to other governance bodies. Firms with committees dedicated to making valuation decisions tended to demonstrate greater independence and oversight of the valuation process.

However, in some cases the independent committee’s minutes failed to record details of how valuation decisions were reached, and when asked, committee members could not describe examples in practice. In these cases, a lack of record-keeping prevented us from having confidence about effective oversight of valuation decisions and we expect that other important stakeholders, such as auditors and investors’ due diligence committees, would also require more detail. 

There are a number of potential conflicts that can exist between the interests of firms valuing private assets and the interests of investors, or between different groups of investors. If not properly identified and prevented or managed, these conflicts may impair judgement applied to valuations and lead to poor outcomes for investors. 

Firms are required to take steps to identify, avoid, manage and, when relevant, disclose conflicts of interest (see the rules in SYSC 10[8], PRIN 2.1[9] and also Articles 33-43 of the MiFID Org Regulation[10] and Articles 30-37 of the AIFMD Level 2 Regulation[11]).

While firms identified conflicts in their valuation process around fees and remuneration, and in many cases had limited these through fee structures and remuneration policies, other potential conflicts were only partly identified and documented.

Many firms were able to discuss these other conflicts to some extent with us, but had not actively considered or documented them in their valuation process in sufficient detail. Where they had documented valuation-related conflicts, their descriptions were often very generic and did not outline specific conflicts or how they varied across products or transactions.

Only a few firms demonstrated strong awareness and control over all potential valuation-related conflicts that we would have expected. These firms actively identified, discussed and documented potential valuation-related conflicts, their materiality and the specific actions they had taken to mitigate or manage them. 

While conflicts are specific to each firm, we identified the following areas where conflicts involving valuations are likely.  

Investor fees

Conflicts can arise when fees paid by investors are linked to valuations. Some fund structures inherently limit conflicts related to fees. For example, closed-ended limited partnerships typically charge management fees on committed capital, or the amount of initial invested capital, and calculate carried interest on realised performance.

Even for these closed-ended limited partnerships, some firms discussed how the write-down of an asset represented a decrease in the value of invested capital and reduced management fees. In this case, managers face a conflict of interest that could dissuade them from taking appropriate write-downs to avoid lost management fees.

In other fund structures there was a direct link between the current net asset value (NAV), calculated using valuations, and fees paid by investors. These included:

• Open-ended Funds: A number of firms managed funds with open-ended characteristics, such as ‘evergreen’ funds, calculating management fees, and occasionally performance fees, based on the fund’s NAV.
• Closed-ended investment companies: These invest in private assets either as a dedicated investment strategy or as part of the overall portfolio. Those in our review, including venture capital trusts, typically calculated management fees based on the fund’s NAV.

All firms managing such funds had identified and documented the valuation conflict around fees but did not always document how this varied across different product types.

Asset transfers

Conflicts of interest in the valuation process will often be present where assets are transferred, such as when the manager’s valuation determines the transfer price affecting the interests of buyers, sellers and remaining investors. This conflict increases if the manager receives carried interest due to the transfer using unrealised performance. Even where conflicts are limited, managers must perform valuations impartially and with all due skill, care and diligence to reduce harm as value is transferred between investors.

In our Phase 1 questionnaire, some firms reported relying on their in-house valuation process for asset transfers while others described putting additional controls in place where transfers occur. These included obtaining a third-party valuation or opinion, establishing separate teams or committees to represent client interests, or conducting market testing.

Phase 2 firms with continuation funds described standard practices that take place with asset transfers. Firms moving assets to continuation funds first sought agreement to asset transfers from the existing fund’s limited partner advisory committee and always obtained an independent fairness opinion for the price at which assets were transferred.

Firms noted that the actual transfer price was decided by incoming investors submitting a bid to existing investors that they could accept to exit the investment. Alternatively, existing investors could choose to keep the investment by exchanging it for a stake in the continuation fund. These firms felt that incoming investors would take their own view on price and valuation when determining their bid, rather than relying on manager valuations. The fairness of this arrangement for incoming investors is heavily dependent on whether they have sufficient access to information to form their own view on price and valuation.

Redemptions and subscriptions

A number of firms in Phase 2 managed open-ended funds investing in private assets, offering either quarterly or monthly dealing or periodic fundraises.

These vehicles priced redemptions and subscriptions using the fund’s NAV. With periodic and judgement-based valuations there is greater potential for harm and conflicts between new, exiting and remaining investors, who could be transacting at prices that do not always reflect the value of the fund’s investments. This potential for harm is also greater where the valuation frequency does not align with the dealing frequency, as we discuss further below.

While investment trusts do not offer redemptions and subscriptions, they are traded continuously on recognised markets and their announcements on NAV, calculated using valuations, are important for investors buying and selling investment trust shares as well as other stakeholders who might use this information, and so can also have a form of this valuation-related conflict.

Most firms had actively identified, but had not documented, that these products had greater risks around valuation.

Investor marketing

Where firms use the unrealised performance of existing funds to support fundraising for new vehicles, they may have an incentive to show positive and stable movements in value over time.

In Phase 2, firms we spoke to often included both realised and unrealised performance in their marketing materials.

Only a few firms identified and documented conflicts around marketing unrealised performance. Many argued that their investors are sophisticated, and firms would risk their reputation if they were found to provide inappropriate valuations. While investor sophistication and reputation risk are relevant, using unrealised performance in marketing can create an incentive to present favourable valuations when valuing private assets, especially when firms are fundraising and do not have a track record of realised performance.

Secured borrowing

For borrowing secured against a fund’s portfolio of assets, such as NAV financing, common covenants include a minimum level of diversification within the portfolio and a maximum loan-to-value (LTV) ratio. The NAV depends on how the borrower values their unrealised investments. This can lead to a potential conflict of interest where valuations could be inflated to attract a greater amount of initial borrowing or avoid breaching an LTV covenant.

Responses to our Phase 1 questionnaire showed that most firms had used some form of NAV financing. In Phase 2, most firms we asked about NAV financing argued that a market practice of low LTV ratios reduced the risk of breaching a covenant and so the incentive to inflate valuations. In some cases, firms with more restrictive covenants noted the scrutiny lenders gave to valuations and other underlying portfolio metrics as a control over this conflict.

Most firms did not proactively identify and document this potential conflict.

Uplifts and volatility

There is a potential conflict in the valuation process where firms consider investors prefer valuations that display a certain return profile, such as a smooth return profile over time.

In Phase 2, many firms discussed the importance of reputation risk and noted that investors often preferred an ‘uplift’ on exit, as well as stable valuations over time.

We saw some examples of conservative adjustments in valuation case studies that provided a less volatile valuation profile over time and/or a better opportunity for an ‘uplift’ upon exit. While conservative valuations limit the risk of overvaluation over time, exaggerating the stability of valuations can also harm investors by obscuring the true level of investment risk and the current value of their investments.

Valuation methodologies that are applied consistently over time can give investors greater confidence that their assets are being valued fairly, even when this would lead to less stable valuations. We discuss the application of valuation methodologies further below.

Firms that demonstrated a strong awareness of conflicts proactively discussed these issues in valuation committees and had identified the risk of overly conservative and stable valuations. We saw evidence, such as in case study meetings and committee minutes, that they had considered the risks such an approach presented when making valuation decisions.

Employee remuneration

Where remuneration is linked to valuations, this can create a conflict. In most cases, we found that employee remuneration was not directly linked to valuations. Variable pay awards were most often linked to employee performance assessments which evaluated performance against financial and non-financial metrics. Investment staff often received bonuses, such as carried interest allocations, on realised performance.

However, in a few cases we observed a link between remuneration and unrealised performance for investment staff. Their variable pay was linked to the change in NAV over a defined period. Here, firms had procedures to ensure the investment team’s views were considered, but were formally separated from valuation decision-making.

Valuations also have indirect links to remuneration, with resulting risks of conflicts. These could include instances where firms offer profit-sharing schemes while managing vehicles charging fees using valuations or where valuations affect the perception of individual performance.

Most firms had identified and could discuss the measures in place to reduce the materiality of valuation-related remuneration conflicts. While remuneration policies in the sector typically state that staff remuneration should not conflict with client's interests, as more asset managers build stronger private markets capabilities it is important to check that remuneration incentives remain appropriate for private markets and private asset valuations.

Valuation policies

All Phase 2 firms’ valuation policies outlined the valuation process objective to ensure each asset is appropriately and fairly valued. All set out the roles and responsibilities of all parties involved in the valuation process, the governance arrangements, the frequency of valuation, the methodologies used and the relevant investment strategies and accounting standards (Article 67(2)[19] of the AIFMD L2 Regulation). 

However, not all firms provided detail on the rationales for selecting methodologies and their limitations, nor the required inputs and data sources (Article 67(2)(c)[20] and Article 68(1)[21] of the AIFMD L2 Regulation). 

Most did not include a description of the safeguards for the functionally independent performance of the valuation task (Article 67(4)[22] of the AIFMD L2 Regulation) nor the potential conflicts in the process. Only some described the periodic review of the policies and procedures (Article 70[23] of the AIFMD L2 Regulation), escalation measures (Article 71(4)[24]) and the need for consistency (Article 69(1)[25] of the AIFMD L2 Regulation). 

Valuation models

All Phase 2 firms documented the valuation models used (Article 68(1)[26] of the AIFMD L2 Regulation). 

In some cases, the recorded rationales given for key assumption changes, such as adjustments in discount rates, were vague. Where we observed a lack of standardisation and structure, it was harder to identify the key changes in inputs or assumptions and therefore the robustness of decisions reached. These limitations would also be unhelpful for reviews by governance oversight bodies or auditors and any due diligence undertaken by investors. 

Auditors

In Phase 2, firms explained that external auditors typically reviewed valuations for all assets, while others said auditors would conduct tests on a sample of assets. They noted that typically discussions with their auditor would focus on changes to key assumptions and backtesting results. 

Backtesting

Backtesting is an important process that can generate meaningful insights about the valuation of an asset in different market conditions. It involves firms comparing the realised value of an asset upon exit to the last valuation estimate to assess the accuracy and precision of the valuation process, and identify any limitations of the valuation model and approach.

Most Phase 2 firms conducted backtesting and found it valuable. Those who did not noted its limitations for some asset classes, such as private credit, where most assets are held to maturity rather than sold. 

A less frequent valuation cycle risks stale valuations – a valuation that no longer reasonably reflects the current conditions of an investor’s holdings.

Full-scope UK AIFMs must ensure they calculate the NAV at each issue or subscription or redemption or cancellation of units or shares and at least once a year (Article 72(1)[27] of the AIFMD L2 Regulation).

Where firms use valuations to charge fees or price redemptions and new subscriptions, stale valuations can lead to greater harm, such as inappropriate fees and investors redeeming at inappropriate prices. For open-ended funds, the NAV must be calculated whenever units or shares are issued, redeemed or cancelled and at least once a year (articles 72(1) and 74(1)[28] of the AIFMD L2 Regulation), and also every time there is evidence that the last determined value is no longer fair or proper (Article 74(2)[29] of the AIFMD L2 Regulation). 

Frequency

In our Phase 1 questionnaire, we observed:

In Phase 2, firms discussed that for most alternative assets, the industry had converged to quarterly valuation cycles, although debt assets also had monthly valuation cycles. These firms argued those frequencies were usually appropriate, noting that more frequent valuations might present challenges, given the resource-intensive nature of valuing private assets and that valuations are aligned with financial reporting frequency for the underlying asset. Some also noted more frequent valuations may be unnecessary as most assets would not have sudden valuation changes.

Some firms had invested in technology to reduce operational burden and make data collection easier and more accurate. 

Ad hoc valuations

Ad hoc, or out-of-cycle, valuations are those made outside the regular valuation schedule. They can reduce the risk of stale valuations if material events cause significant changes in market conditions or how an asset performs. 

An ad hoc process demonstrates that a firm has appropriate procedures in place where there is a material risk of an inappropriate valuation (Article 71(2)[30] of the AIFMD L2 Regulation). This allows the firm to demonstrate that all assets held by a fund are fairly and properly valued and that the portfolios of funds are properly valued (Article 71(1)[31] of the AIFMD L2 Regulation) at all times. 

In our Phase 1 questionnaire, only a minority of firms reported having defined quantitative or qualitative thresholds for triggering ad hoc valuations.

Phase 2 confirmed that most firms did not have a formal process for conducting these valuations. We discussed previous market events, such as the COVID-19 pandemic and the Russia-Ukraine conflict, where ad hoc valuations may have been expected. Most firms did not conduct ad hoc valuations and waited for changes to flow through at the next valuation cycle. Some noted that they would conduct an internal analysis and update investors about the event and its impact, but the reported value of their holdings would remain unchanged. 

Only a few firms formally incorporated ad hoc valuations into the valuation process, such as explaining the types of events that would trigger these and having defined thresholds. We heard examples of asset-level triggers, such as significant moves in the comparable set’s average multiple or company-specific events, and fund-level triggers, such as moves in a fund’s ‘unofficial’ NAV as tracked by the firm. These triggers are especially important where the fund’s NAV is reported more frequently than it is valued. 

Greater transparency to investors increases confidence for their decision making around private assets. Clear and detailed reporting enables investors to better understand judgements in the valuation process, allowing investors to make more informed decisions and provide greater scrutiny. 

Full-scope UK AIFMs must ensure they inform investors in the fund of the valuations and their calculations (FUND 3.9.6R[18]). All FCA-regulated firms must also pay due regard to the information needs of their clients (Principle 7[15]). 

In our Phase 1 questionnaire, we found that reporting varied across firms:

In Phase 2, we again found different approaches. Some firms highlighted barriers limiting their ability to share information with investors. Some noted that non-disclosure agreements prevented them from sharing data on portfolio company financials and others noted the commercial sensitivity of sharing valuation models. 

Choosing methodologies and assumptions requires judgement. For valuations to be appropriate and fair, full-scope UK AIFMs need to apply the designated valuation methodologies consistently, taking into account the investment strategies and asset types (Article 69[32] of the AIFMD L2 Regulation).

While we did not seek to independently validate firms’ fair value assessments, we reviewed the consistency of how firms applied valuation methodologies and assumptions, including where they made significant adjustments.

Across firms, the methodologies used were mostly consistent by asset class, however we observed different methodologies for private equity and other areas, such as comparable sets and discount rate components, where firms could reasonably justify the use of different assumptions. These observations raise questions around the ability of investors to compare valuations across firms.

During our scoping work, many market participants highlighted the importance of industry guidelines in supporting convergence on best practice and driving consistency. In our Phase 1 questionnaire, which covered a range of private asset classes, 70% of firms reported adhering to the International Private Equity and Venture Capital Valuation (IPEV) Guidelines[-109].  

Methodologies used

In our review, the methodologies firms used varied by asset class and the nature of the asset. In Phase 1, we observed that:

• Most common methodologies: The market approach and the income approach were the most reported primary valuation techniques.
• Private equity: Most firms used the market approach as their primary methodology. Half of these firms used only the market approach while the other half used the income approach as a joint primary or infrequent secondary approach. Only a few firms used the income approach as their primary methodology.
• Venture capital: All firms used the market approach as their primary methodology.
• Infrastructure equity: All firms used the income approach as their primary methodology, with a small number also using the market approach.
• Private debt: Firms used both the income and the market approach as their primary methodology. In Phase 2, we found this often referred to a coverage test and a yield analysis.
• Infrastructure debt: All firms used the income approach as their primary valuation methodology. 

Consistency

In Phase 2, we found firms often applied the designated methodologies consistently for the case studies we reviewed. Changes to this were most often to move from the initial investment cost or the latest market transaction price to the designated methodology, and when the asset had achieved milestones such as revenue-generation.

For the market approach, where multiples were most often used, firms were mostly consistent over time with the comparable sets used. They made changes mostly due to listings or de-listings, new market transactions, or idiosyncratic events that reduced the similarity of a comparable company or asset. We often saw significant changes in how they applied a discount, or premium, to a multiple. Firms calibrated this at acquisition, and then adjusted based on the similarity of the comparable set.

For the income approach, firms updated cash flow projections using management forecasts and were mostly consistent with calculating components of the discount rate. We observed firms use significant judgement in calculating the terminal value and changes in the asset-specific risk premium. This was often calibrated at acquisition and then adjusted based on uncertainty around cash flow projections.

For private credit, firms were mostly consistent with the comparable companies used for testing enterprise value coverage, and with the comparable debt instruments used to estimate a yield. Where the credit quality of the asset had deteriorated, we saw firms apply their judgement more and make significant assumption changes.

For venture capital, firms typically used the last available transaction price, typically from recent funding rounds, as the basis for valuation, before using multiples where assets achieved revenue-generation.  

Challenges

Some firms discussed the challenge of identifying comparable companies or assets, particularly when the portfolio company or asset had unique attributes. Firms might weight multiple comparable sets representing different sectors or business characteristics or use a small number of directly relevant comparable assets. 

We also saw different approaches to reflecting public market volatility. In a few case studies, we observed firms make discount rate adjustments that resulted in limiting the impact of public market movements. Firms gave rationales for these adjustments including the uncertainty around current macroeconomic changes, the asset not being ready to list or differences between the asset and public peers. 

We also saw other differences in firms’ approaches. These included areas such as weighting comparable companies, calculating components of a discount rate, and views on discounted cash flow (DCF) models for private equity investments. Some firms did not use DCF models, arguing it required too much judgement, some occasionally used it for corroboration and others used it as a primary approach, arguing it was more specific in outlining assumptions.

Third-party valuation advisers can provide additional independence and expertise. The value of their services as an additional control will depend on how firms use and engage with these providers. As third-party valuation advisers provide different levels of service, firms should make their investors aware of the specific nature of the service provided, its strengths and its limitations.

Full-scope UK AIFMs must use external valuers when not performing the valuation themselves (FUND 3.9.7R[33]). We found that this arrangement was rare, and instead many firms used the services of third-party valuation advisers while retaining responsibility for valuation.

In our Phase 1 questionnaire, we found the following: