www.pwc.lu/aifm
Valuation
AIFMD Newsbrief
A closer look at the impact of
AIFMD on Valuation
Edition March 2013
Introduction
On 19 December 2012 the European Commission finally published its adopted Level 2
Delegated Regulation (Level 2) for the Alternative Investment Fund Managers
Directive (AIFMD). In this Newsbrief, we take a closer look at the requirements
surrounding valuation.
The text for AIFMD was adopted by the European Council and Parliament in
May 2011, and came into force on 21 July 2011. EU Member States have until 22 July
2013 to transpose AIFMD into their national law. AIFMD seeks to regulate AIFMs but
not the alternative investment funds (AIFs) that are in scope of AIFMD. The scope is
wide, capturing nearly all collective investment vehicles that are not UCITS. Further,
AIFMD captures not just EU AIFMs (whether they manage AIFs established inside or
outside the EU) but also non-EU AIFMs that market AIFs in the EU. Whilst AIFMs
may need to spend a lot of time and effort to prepare for the new requirements
introduced by AIFMD they will in future be able to market across the EU with use of a
passport, similar to that offered for UCITS.
AIFMD aims to provide greater investor protection, ensure investors receive regular
and comprehensive information on the AIF they invest in and ensure regulators
receive detailed information on AIFs and AIFMs to enable them to identify any
potentially systemically significant trends or events that may impact market stability
so they can take action.
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Whilst the Directive provides the overriding regulatory framework that AIFMs must
act within, the detailed implementation requirements are set out in the Level 2
Delegated Acts Regulation, adopted by the European Commission on
19 December 2012. Level 2 follows 18 months of debate and discussion, including
provision of technical advice by the European Securities and Markets Authority
(ESMA) and includes detailed rules on:
 Use of leverage
 Operational requirements (including the risk management function, valuation
and delegation)
 Role of the depositary
 Contents and frequency of reports to regulators
With the adoption of Level 2, we are publishing a series of Newsbriefs to set out the
requirements that AIFMs and depositaries will need to meet, and issues they need to
consider, in more detail.
This note will examine the following areas of the valuation provisions more closely:
 The framework;
 The benefits (and costs) of internal and external valuation;
 The responsibility and liabilities of the valuer and the AIFM.
This note is a summary of the valuation provisions and should not be viewed as
definitive advice. It is one in a series which we have produced focusing on specific
aspects of AIFMD. Please visit www.pwc.lu/aifm to access the full suite of our
Newsbriefs or contact us via the details supplied in the “Contacts” section of this
brochure.
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The framework
Recognising the divergent valuation practices within various jurisdictions, fund
agreements and asset classes, the Directive focuses on ensuring that valuations are
proper and independent so that the principles can be applied to a variety of funds.
Level 2 reflects these considerations and identifies general principles which should
guide the industry in creating policies and procedures to achieve proper and
independent valuation of assets. Valuation reporting to investors is governed by the
Directive’s transparency requirements and fund governing documents.
Methodology
Though the guidance acknowledges requirements under AIF operational documents
and national law, it stresses that the AIFM must have written policies and
procedures which detail the methodology for each type of asset in which the AIF
may invest. Level 2 clarifies that the methodology does not need to be consistent
across an AIFM’s entire asset base in all circumstances and that different funds may
use different methodologies where appropriate.
AIFMs must identify an appropriate valuation methodology before investing into a
particular type of asset for the first time. Once a methodology is chosen, documented
and implemented, it must be applied consistently unless a situation arises
requiring a change.
Policies and procedures
In addition to identifying the valuation methodology, the policy must describe all
parties involved in the valuation process. After defining the policy, an AIFM must
develop related procedures that reflect the standards set out in the policy. The policy
must also describe instances when a change in policy or methodology may be
appropriate and the related process to effect such change. Since the AIFM has the
ultimate responsibility for the valuation, if any differences arise when the AIFM
reviews the values, the policies and procedures must include an escalation process to
address the differences.
When a model is used to value assets, it must be explained in the policies and
procedures. This explanation must describe the data, assumptions and rationale for
selecting the model. Additionally, the model must be approved by senior
management and validated by someone who did not build the model. This
validation can be performed internally or by an external party such as an auditor. The
AIFM must review the valuation methodology, policies and procedures and their
application no less than annually. If any changes are deemed necessary, senior
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management must review and approve such change. Details of these valuation policies
and procedures must be made available to investors before they invest.
In addition to maintaining policies and procedures for valuation, the AIFM must also
document the procedures for calculating the net asset value per unit or share of the
fund.
Frequency
To ensure accurate investor transaction processing, the requirement to apply these
policies and procedures depends on the frequency of issues, subscriptions,
redemptions or cancellations of shares or units, the type of assets and the type of fund.
For open-ended funds containing those assets which are “financial instruments” as
defined in the Markets in Financial Instruments Directive (MiFID), the instruments
must be valued each time the net asset value is determined for the fund. The
calculation of net asset value is required to be carried out and disclosed for openended funds when an issue, subscription, redemption or cancellation of units or shares
occurs; otherwise it must be carried out at least annually. For open-ended funds with
assets not deemed to be “financial instruments”, the valuation must take place when
there is evidence that the prior value is no longer fair, but again not less than annually.
For closed-ended funds, assets must be valued at least annual and in case of
an increase or decrease in capital. What ultimately constitutes an increase or
decrease in capital will significantly impact the valuation burden of closed-end fund
managers. While the implementing measures do not address this particular matter
that will be left at the appreciation of national regulators, we can expect that capital
call on committed capital will not be considered a capital increase for the purpose of
the valuation.
The Level 2 measures also require an AIFM to ensure that the number of units or
shares is verified as often as the share price is calculated. Most managers of open-end
funds verify and reconcile the outstanding capital with fund service providers such as
transfer agents.
The benefits (and costs) of internal and external
valuation
An AIFM may choose to perform the valuation function internally or appoint an
external valuer.
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Internal valuer
When an AIFM performs the valuation function it can use, or, indeed separately
contract with third parties for the performance of some of the tasks involved, provided
it retains responsibility for the valuation function itself.
L2 distinguishes between the valuation of investments and the calculation of the NAV
which it considers an administrative function. Level 2 further clarifies that as long as
an external party does not provide subjective judgement on the value of assets, it will
not be deemed to be an external valuer. Simply using values from the AIFM, pricing
sources and external valuers to calculate the net asset value does not cause a party,
such as an administrator, to be deemed an external valuer. Similarly ESMA’s advice
noted that a “price provider” is not considered an external valuer. While
there is no formal definition of a “price provider”, we can expect that vendors
providing unadjusted quoted prices in active markets that are readily accessible, or
prices for investments where all inputs to valuation techniques are observable, either
directly or indirectly would qualify as “price providers”.
We can expect that the majority of AIFMs will want to retain the valuation
function in house while using third parties such as the fund administrators to
“gather” prices from pricing vendors and from the AIFM itself to calculate the AIFs’
net asset value. By retaining such function, the AIFMs will maintain the flexibility and
ability to act when deemed necessary.
When performed internally, safeguards will need to be implemented to ensure the
valuation function is independent from the portfolio management
activities. Conflicts of interest must be mitigated and the internal valuation task
must also be independent from the remuneration policy. No detailed guidance is yet
available to guide AIFMs in proving functional independence of an internal valuation
function. It will be challenging for smaller AIFMs with a complex private asset base to
prove independence of valuation from its portfolio management/remuneration
functions. Furthermore, the lack of proportionality in the valuation requirements may
make implementing an internal valuation function difficult without more guidance.
Finally, while the Directive allows an internal valuation function, national regulators
may still require additional verification of internally valued assets.
External Valuer
As mentioned above, an AIFM may also choose to use an external valuer to perform
the valuation function. The Level 2 is clear that an AIF may have several external
valuers. When using an external valuer, the AIFM must notify its national regulator.
The appointed depositary of an AIF may not be the external valuer unless conflicts of
interest are managed and the valuation function is “functionally and hierarchically”
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separate from the depository function. Once the function is delegated to an external
valuer, that valuer may not further delegate the responsibility.
External valuers must provide a professional guarantee. The guarantee must be a
written statement signed by the valuer or a legal representative and include the
following:
 Evidence of sufficient resource corresponding to the AIF strategy and specific
assets;
 Evidence of qualifications and capability to perform role corresponding to the
AIF strategy and specific assets;
 Adequate knowledge and understanding corresponding to the AIF strategy
and specific assets.
National regulators may require that the valuer have mandatory professional
registration, but each national regulator will determine what they consider as
adequate. The external valuer must also have policies and procedures in place similar
to that of the AIFM, including procedures to address the identification, monitoring
and mitigation of conflicts with the AIFM or itself.
In the Hedge Fund world, many managers currently rely upon external administrators
to value funds. This role is typically determined contractually and another party, such
as the Board or General Partner or Manager, is responsible for the proper valuation.
Administrators may gather prices from vendors or may obtain prices for difficult to
value assets directly from the manager. If an administrator does undertake the role of
external valuer, it will have a greater responsibility than most contractual
arrangements currently require and conflicts with those currently responsible for
proper valuation (Board, General Partner or Manager) may arise. As mentioned
previously, we would expect that the majority of such AIFMs will retain the valuation
function in house. Furthermore, it remains to be seen whether administrators will be
willing to accept this responsibility and the liability attached. If they do, we can
certainly expect that the price of their service will rise.
In the Real Estate world, many managers already use qualified external appraisers to
value their real estate assets as a best practice or as required by regulation. Some use
the valuation as determined by external appraisers and others use the external
valuation as one source along with internal valuation to determine the value of the
assets in the fund’s net asset value. In the first instance, the external appraisers may
well become external valuers. In the second instance, the valuation function will most
likely need to remain internal as an external appraiser will not take responsibility for a
value (in the fund’s net asset value) which differs from the valuation it has determined.
In the Private Equity world, the valuation function is often performed internally. In
smaller PE houses, individuals involved in the portfolio management, those best
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knowledgeable of the assets, are significantly involved in the valuation process. This
will no longer be possible. As described above, the valuation function must be
independent from portfolio management. If these houses are unable to fulfil the
segregation requirements, they may need to reach out to external valuers. This will
inevitably increase costs.
Regardless of who is the external valuer, the AIFM must still develop appropriate
policies, procedures and control processes around the transmission of information.
Many regulatory provisions require other parties to remain responsible for the
valuation of certain funds. Any conflicts or inconsistencies in responsibility will have
to be addressed.
The Responsibility and Liability of the AIFM
The Directive emphasises that regardless of the valuation being performed internally
or externally the AIFM remains responsible for the valuation policies and procedures,
the calculation of the net asset value and the appointment of any external valuer.
When an external valuer is appointed, the external valuer becomes liable to the AIFM
for negligent and intentional acts and the AIFM remains liable to the AIF and its
investors. The liability of the external valuer cannot be limited regardless of
contractual arrangements to the contrary.
Oversight
Given the overarching governance and liability requirements, the AIFM must maintain
documentation regarding valuation that is subject to regular verification and risk
management should review the policies and procedures in place as part of their
independent function. The AIFM must ensure all values are fair and
appropriate. The AIFM must document this assessment. Level 2 includes some
forms of testing which could be incorporated, such as reviewing trends from pricing
sources, back testing/acid testing values, and assessing the source of the value. As part
of their review, the manager should assess material risks in the valuations. These
material risks will be specific to the methodologies applied for various instruments.
Material risks may include difficult to value complex instruments, illiquid instruments,
instruments with only one source of value, and instruments which present conflicts of
interest. While there may be a risk based review approach, the guidance emphasises
that all assets must be reviewed for proper valuation.
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Delegation
If an external valuer is used, AIFMs must conform to the detailed delegation
provisions of the Directive. To delegate any function, the AIFM needs to have an
objective reason for such delegation.
The AIFM should be able to demonstrate that delegation is done for the purpose of a
more efficient conduct fund. To assist the industry in understanding what features
may be considered in making this assessment, the following factors were given:
 Optimising of business functions and processes;
 Cost benefit analysis;
 Specialised knowledge and expertise;
 Access to investment opportunities and capabilities on a wider scale.
We expect that these conditions will easily be met.
Within any delegated function, the AIFM is obligated to assess the sufficient resource
and repute of the delegate and its employees. It is clear from this standard that AIFMs
will be expected to perform a fairly detailed due diligence analysis. Due diligence
must include an analysis whether the delegate employs sufficient personnel with the
skill, knowledge and expertise necessary for the discharge of the tasks delegated to it
and the appropriate organisational structure for the delegated tasks. The AIFM must
assess whether the persons who effectively conduct the business of the delegate have
sufficient experience, appropriate theoretical knowledge and appropriate practical
experience in the relevant functions. The professional registration or regulatory rules
implemented by the national regulators and professional guarantees required of
external valuers may help the AIFM in assessing the expertise of the valuer. This due
diligence process may lead to external valuers undergoing external certification by
third parties and third party assurance reviews to decrease the repetitive due diligence
processes by AIFMs.
Conclusion
Each AIFM will need to carefully consider the current valuation process and practices
in light of the requirements and take the necessary actions to ensure compliance. At
the core of these requirements is the obligation for an independent valuation function.
In this regard, the players most impacted will be AIFMs of private equity funds and, to
a lesser extent, AIFMs of real estate funds. All players will most likely need to step up
their current documentation over valuation, increase their due diligence and on-going
oversight when using delegates.
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While not a revolution, the valuation requirements will require future AIFMs to, at
best, enhance their current processes and documentation and others to undergo
organisational changes.
Our service offering
The AIFMD is a complex piece of legislation. It contains many technical requirements,
some of which may require significant modifications to your current organisation.
PwC has a multi-disciplinary and multi-industry team of professionals in business
strategy, operation and structuring, risk management, regulatory compliance, tax,
global fund distribution and assurance services, all specialists in the authorisation
space, and are ready to assist you identify and assess the many impacts of the Directive
on your organisation and develop an integrated response to the AIFMD.
As part of the wider PwC network in Europe, you will have access to industry experts
across relevant territories, who regularly work together when required, to provide a
seamless line of service on a pan-European basis.
We will use our collaborative methodology to establish a framework for your AIFMD
solution, tailored to your business requirements, by helping you with:

Defining your target business model;

Assisting you in assessing and identifying potential opportunities;

Completing impact assessments and gap analysis;

Designing and constructing solutions;

Implementing agreed actions;

Ensuring effective operation, validation and ongoing review;

Filing authorisation application with CSSF and;

Through our dedicated cross border fund distribution services, Global Fund
Distribution, filing notification for the EU passport, assisting you complying
with local marketing requirements and meeting your ongoing regulatory
reporting and tax obligations.
By working with you through the AIFMD analysis, we can assist you in managing its
potential cost and resource requirements, to best exploit the opportunities presented
by this new regulatory environment.
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Integral to this assistance is our deep industry knowledge in Luxembourg and Europe
and our expertise in the AIFMD. Our team of experts has followed each step of the
Directive’s development and its related implementation measures and has been
engaged in on-going dialogues with key stakeholders, including asset managers,
service providers, trade associations and regulators. You can profit from this
knowledge and so transform this challenge into your benefit.
If you would like to discuss any of the areas covered in this paper as well as the
implications for your business, please feel free to contact your usual PwC contact or
one of our AIFMD specialists listed below:
……………………………………………………………………………………………………………………............
Marie-Elisa Roussel-Alenda
Partner, AIFMD Leader
+352 494848 5738
[email protected]
……………………………………………………………………………………………………………………............
Xavier Balthazar
Partner, Regulatory Compliance Advisory Services
+352 494848 2543
[email protected]
……………………………………………………………………………………………………………………............
Olivier Carré
Partner, Regulatory Compliance Advisory Services
+352 494848 4108
[email protected]
……………………………………………………………………………………………………………………............
This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
© 2013 PricewaterhouseCoopers, Société coopérative. All rights reserved.
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