Why Valuation Risk?

In the last few years there have been a large number of new and revised regulations, guidelines and recommendations governing the practice of financial firms and markets, much of which focuses on the approach to asset pricing and valuation risk.

Valuation Risk Event Page - More Video and Comment

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According to the International Organization of Securities Commissions (IOSCO), the three key objectives of regulation and accounting oversight of financial institutions are:

1. The protection of investors; The fair and efficient operation of markets; The reduction of systemic risk in the financial system as a whole.
2. The fair and efficient operation of markets
3. The reduction of systemic risk in the financial system as a whole.

It is in this light that the complex regime for asset valuations should be seen. Whilst the sources of the regulatory or accounting guidelines vary according to the type of institution in question, the purpose of the valuation or the geographic location in which it operates, there are a number of recurring themes which are increasingly seen as sound practice for valuations regardless of what type of institution or to what purpose or location:

• Principles of fair value or mark to market, consistently applied;
• Independence and objectivity to avoid conflict of interest;
• Transparency of process and approach.

Broadly, the sources of regulations and guidelines which govern firm’s valuation processes can be classified into four areas:

1. Securities and Banking Laws – The regulatory regime under which a firm operates will often set rules or principles for valuations to which regulated firms must comply to do business.
2. Accounting Standards – The financial accounting framework that firms must abide to when producing reports and accounts will have views on the valuations used as inputs in these accounts.
3. Industry Bodies – Associations and lobby groups for various types of firms in the financial industry frequently produce guidelines for sound practice in areas of their member’s activities, including valuations.
4. Internal Standards – In most cases the firms themselves are responsible for interpreting the various rules and guidelines to implement an appropriate valuations system.

The short review articles in the Voltaire Advisors 2014 Valuation Risk Handbook cover more on the the key regulatory issues currently presenting a challenge to valuation practitioners.