Room for improvement? Special report on valuations

Private credit valuations are coming under scrutiny, forcing GPs and service providers to ask what a good valuation process actually looks like. Kathryn Gaw finds out…

The recent popularity of private credit funds has come with enhanced scrutiny, and valuations are currently in the regulator’s crosshairs.

In March, a Financial Conduct Authority (FCA) review of private market valuation processes found that there was some room for improvement, and called on firms to enhance their processes for ad hoc valuations in times of market disruption. The regulator noted that robust valuation practices are particularly important as more retail investors begin to enter the market via new fund structures such as long-term asset funds.

The FCA said that it was pleased to see many firms showing evidence of independence, expertise, transparency and consistency in their valuations process, but added that “there is still more to do.”

Industry stakeholders have been largely supportive of the regulator’s intervention, and some have already begun to offer solutions to the valuation conundrum. These range from adopting enhanced transparency around in-house valuation processes; to using third party valuers; to adopting new technologies which can provide up-to-the-minute data to investors and GPs.

“I can understand the FCA’s concerns,” says Karun Dhir, founder and managing director of Aurelius Finance Company (AFC). “Marking your own homework is never a good idea. The only way to give all stakeholders the necessary comfort is for the process to be carried out by independent valuers.”

AFC is one of the many GPs which already use independent third party valuations, as well as assessing its collateral in-house on a daily, weekly and monthly basis. Dhir believes that this strategy has removed subjectivity in the valuation process.

The use of third-party valuation advisers was highlighted as an area of ‘good practice’ by the FCA. In fact, the regulator has even suggested that there may be a need for GPs to establish their own independently-managed in-house valuation committees, in addition to using third party valuation providers.

“The absence of true independence within firms’ own valuation processes is often a symptom of a shortage of expertise and valuation committees being saturated with investment professionals,” says Ryan McNelley, managing director and portfolio valuations leader at Kroll.

Read more: FCA to ease regulatory burden on smaller alts firms

“Addressing this problem will certainly be easier if firms appoint independent valuation committee members, vetted according to their expertise in asset valuations.”

Myles Milston, co-founder and chief executive of Globacap, believes that enhanced use of technology is the only way to meet a high standard of valuation details.

“To adhere to the FCA’s requests, GPs must employ new technology, such as blockchain-based securities infrastructure, which can provide a more reliable and transparent approach to pricing private assets,” he says.

“Blockchain and distributed ledger technology offer a way to embed compliance, price discovery and reporting directly into private market workflows. Using a decentralised and immutable ledger means that valuation data can be recorded in a way that is both transparent and auditable, ruling out manipulation or bias.

“Additionally, automated data collection and AI-driven analytics can enhance the accuracy of valuations by aggregating real-time market data and comparable transactions. These innovations can help establish independent and standardised pricing mechanisms, ensuring consistency across the industry.”

There is currently no universal industry standard process by which private market valuations are calculated, although most GPs take inspiration from existing frameworks such as IFRS 9 and IFRS 13, ASC 820, the International Private Equity and Venture Capital Valuation Guidelines (IPEV) and the Alternative Investment Fund Managers Directive (AIFMD).

“As a general rule, the best valuation processes are those that show tangible evidence of independence, expertise, transparency and consistency,” says McNelley.

“While we can see some variation on a firm-to-firm basis, those adhering to best practices generally demonstrate clear accountability and oversight and maintain accurate records of how valuations are reached.”

Private credit valuations estimate the fair value of privately issued debt. They consider borrower risk, market conditions and interest rates, along with other variables. Loan terms are also a major factor in the accurate valuation of private credit funds. Semi-liquid funds typically offer quarterly liquidity, so the valuations are done on a monthly basis which allows fund managers to more quickly adapt to macro-economic events such as the recent US tariff war. However, it is a different situation for closed-ended funds, which can have terms of five to 10 years.

“I think the situation on closed-ended funds could be improved to get better transparency,” says Francesco Filia, founder and chief executive of Fasanara Capital.

“Of course, transparency can be improved, but I think it is more of a specific problem with the closed-ended funds.”

Across private markets, private debt assets have the highest valuation frequency, given that valuation inputs such as yield spread can be more easily determined than for other asset classes.

A recent report from Macfarlanes predicted that the FCA guidance would lead to a movement towards even more frequent valuations, especially if net asset value is used for financing or subscriptions and/or redemptions, or if the fund is accessible to retail investors.

“Given the volatile markets and unclear economic environment ahead, private credit valuations will certainly come under the microscope,” says McNelley.

“Expect a real focus on establishing robust, credible and independent valuation frameworks, both to meet regulatory concerns and – just as importantly – investor concerns.

Read more: Calls for UK policy changes to boost pension investment into private capital

“It’s important that the FCA continues to engage with firms and industry bodies on good practice, so that all parties are aligned on how the industry can achieve greater consistency in the year to come. And ad hoc valuations as a topic is not going to go away any time soon.”

Ad hoc valuations in private credit are unscheduled, situation-specific assessments of a loan’s value, often triggered by material events, portfolio reviews, or borrower-specific developments affecting creditworthiness. Last month, Trump’s tariff war sparked fears of a global recession, which raises the risk of credit defaults in the medium term. In a post-tariff analysis, KBRA predicted that private credit exit opportunities, company valuations, and market multiples will be reduced as a result of the market volatility caused by trade and tariff uncertainties. However, KBRA added that the ultimate impact on borrowers will vary significantly, driven by their unique exposures to the tariffs.

“Geopolitical tensions can lead to unpredictable shifts in market sentiment and asset values,” warns Regina Marinina, chief risk officer at Mount Street.

“These uncertainties can particularly affect leveraged borrowers who are more sensitive to economic fluctuations.

“Given the heightened volatility, there may be a growing need for more frequent valuation updates. While quarterly updates are becoming standard, some clients are considering more frequent assessments to ensure valuations remain accurate and reflective of market conditions.”

Marinina adds that despite these challenges, the inherent flexibility of private credit should sustain demand. In fact, some believe that enhanced regulation of the valuations space could make private credit even more appealing to investors.

“Robust and independent valuations should further enhance the attractiveness of private credit as an asset class,” adds Dhir.

“We are overall very positive on the outlook for private credit in the medium to long term, but the unpredictable and fast-changing political landscape on both sides of the Atlantic is doing its very best at the moment to stifle deal making in the short term.”

In this sense, the FCA’s review is particularly timely, as private credit assets under management are tipping into the trillions, while the economic backdrop is shifting dramatically.

“While there is room for improvement, it’s important to acknowledge that there’s a lot of good work going on in the valuations space and the FCA review shouldn’t be seen as a net negative reflection of our sector,” notes McNelley.

“It’s clear that firms generally recognise the importance of maintaining robust processes and have demonstrated that they understand the importance of investor protections. However, firms can certainly act on the FCA’s findings to improve, whether by identifying all potential valuation-related conflicts of interest, maintaining functional independence in valuation processes, or establishing clear procedures for ad hoc valuations.”

The FCA has been clear in its guidance that it expects firms to be able to identify, document and assess all potential and relevant valuation-related conflicts, their materiality and the actions they may need to take to mitigate or manage them. This includes the need for better identification and documentation of potential conflicts of interest in the valuation process, and increased independence within firms’ own valuation processes. This guidance is largely in line with recent assessments from other European regulators, signalling a wider trend for enhanced disclosure in the space. As such, firms are being urged to look at their valuations processes now, and start making improvements in anticipation of upcoming rule changes. GPs can do this by obtaining valuation services from regulated providers, and  committing themselves to adhere to higher professional standards, processes and best practice.

Read more: Private credit investor predicts more regulatory scrutiny of systemic risk

“If not outsourced to an external provider, in order to address conflicts of interest, I expect GPs to adopt internal policies identifying potential biases, for instance, separating the valuation function from portfolio management or investor relations and ensuring independent valuation committees regularly review these risks, with minutes evidencing discussions,” adds Marinina.

“While there is a possibility that some investors might be concerned about the increased scrutiny and potential costs associated with these improvements, I believe that implementing these improvements will enhance trust, traceability and transparency, thereby attracting investors rather than deterring them.”

As private credit continues to attract a broader investor base, the integrity of valuation practices has become a central focus for regulators and market participants alike. But by embracing best practices and preparing for forthcoming regulatory developments, the industry has an opportunity to build deeper investor trust and cement private credit’s role as a robust and transparent asset class for the future.