The other ad hoc responsibility for the valuation committee is an evaluation of overrides initiated by the front office. Overrides on vendor prices routinely occur in situations where company specific circumstances unknown to vendors cause them to be inaccurate. For example, sovereign debt of a country in the middle of a financial crisis may need to be manually adjusted in the pricing system after valuation committee approval.
Other than these ad hoc responsibilities, we also recommend that the committee meets on a formal basis (at least quarterly) to discuss the overall portfolio, including sourcing of prices, complex positions that require independent assessment by a third-party valuation firm, and back-testing results with a focus on trades that breach predetermined thresholds.
Further, at least annually, a committee should assess results of vendor and broker diligence and any motions to amend the valuation policy (as applicable).
A committee typically consists of:
- Senior accountants, e.g., the CFO and the controller
- Senior members of the pricing operations team
- Independent members of the firm’s board of directors
- A rotating selection of deal team professionals who have a direct relationship with management and can maintain an unbiased approach to portfolio pricing
Decisions are normally made with a unanimous or at least an absolute majority vote. Minutes from meetings should be filed for future use by regulators or auditors, or for review by the committee at a future date.
2) Source prices effectively
In a low-yield, high-valuation environment, accurate pricing is crucial to investors putting their trust in credit managers.
Brokers offer arguably more accurate pricing than vendors. However, cost cutting and an improvement in pricing performance by vendors has led to a sharp increase in their use.
Numerous vendors operate in the credit space and actively seeking two to three vendor sources for each asset type is highly recommended. Periodic back-testing of vendor prices to security transactions, in addition to comparing selected vendor prices with those of independent brokers, can help to validate the accuracy of vendor feeds.
Distressed positions may only be followed by one vendor. In these situations, the fund manager should also compare prices from brokers that trade these positions to ensure accuracy.
If prices cannot be sourced from either a vendor or a broker, a firm’s pricing committee may have to resort to privately valuing the security either in-house or by using a third-party specialist.