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For administrators of hedge funds valuation issues have always been an area demanding close attention, and this is as true today as ever. Over the past year service providers have been grappling with a number of issues regarding financial reporting principles. In particular the treatment of portfolio assets under the new International Financial Reporting Standards is having a widespread impact.

IFRS require the use of bid and offer prices rather than mid-market prices in determining the fair value of investments. This change initially posed challenges to administrators simply to be able to produce the required data, although these have mostly been overcome by now. However, most fund prospectuses normally stipulate use of a mid-market price for the purposes of net asset value calculation. 

This has frequently resulted in a mismatch between the two different approaches to valuation of the same fund portfolio. Most funds have responded by providing a reconciliation between the  two valuation approaches, although in some cases they have changed their prospectuses to alter the basis of the NAV calculation to the bid price. In many cases, especially in respect of  liquid securities, the difference (i.e. the bid-offer spread) is not particularly significant. However, there may be material differences in cases where funds are investing in more complex and hard-to-value illiquid instruments.

This issue ties in with a dialogue already underway in Dublin and other hedge fund industry centres about valuation processes and practices, both from a service provider point of view and from an auditing standpoint. Harder-to-value securities do pose challenges in this regard, in particular in the fund of funds area, where mismatches and timing  issues can arise in relation to the provision of valuations by the underlying funds.

In these circumstances achieving an independent valuation can be extremely challenging. The use of valuation models or counterparty valuations is always a topic of debate and administrators are now acquiring greater modelling capability. However, there will still be instances where prices are sourced through the investment manager.

Ultimately it's always down to achieving a good level of disclosure and seeking to ensure that investors fully understand precisely on which basis the underlying investments are being valued. Consistency is really the key point, in order for funds to be fair to both incoming and outgoing investors. The Irish Stock Exchange is now expected to come out with a guide to best practices in the area of OTC derivatives, which is likely to mirror views on best practice in the US. At the same time, the decision by the UK regulator, the Financial Services Authority, to look actively at hedge fund valuations as a topic for investigation will have a significant impact on the Dublin  market as well. There is a feeling that, to date at least, the big problems with valuations have mostly affected US-based rather than European funds and managers, but the regulators clearly share the same concerns about consistency and disclosure.

Another regulatory issue currently preoccupying administrators is Ireland's relatively recent extension of its anti-money laundering regulations. Work is currently underway to establish best practices that will affect funds administered in Ireland even if they are domiciled in another jurisdiction. Under the new rules, administrators could face significant difficulty if  they accept investments without having cleared all the AML procedures, potentially leading to a delay in redemptions until the paperwork is in place.

By Ronan Nolan - partner in charge of investment management services with Deloitte & Touche in Dublin


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