Private Assets Scrutinised

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Private Assets Scrutinised

7 minutes
March 21, 2025 12:02 pm
 |
Tim Whittaker

The growth in private assets

Since 2012, EY estimates that private assets increased their Assets Under Management (AUM) from US$9.7 trillion to US$24.4 trillion by the end of 2023.1 This growth, has seen private managers tap different sources of capital. Starting with traditional investors such as endowments, pension funds and insurance companies, the managers have innovated, identifying permanent sources of capital such as captive insurance companies to fund their investments. Private managers are looking to continue growing, through finding different pools of capital. The most recent is to tap retail pools of capital through the ETF structure. The SPDR SSGA Apollo IG Public & Private Credit ETF (otherwise known as PRIV) is the first private credit ETF. The ETF, run by State Street, sources private debt from Apollo Global Investors and this allocation was expected to range between 10-35% of the fund.2

This ETF is not without criticisms. Firstly, the SEC raised concerns about its liquidity structure, given that traditional ETFs invest in highly liquid assets, it is possible to re-balance these to ensure there is no difference between Net Asset Value of the underlying asset and the price of the ETF. With up to 35% of total assets invested in unlisted assets, the ETF is highly reliant on Apollo to provide liquidity to the ETF to ensure valuation gaps do not arise. This leads to the second concern that the SEC raised, that of the valuation of the underlying debt investments put into the fund. The prospectus does not provide much detail on the valuation methodology, as described below3:

How are the private securities valued? In calculating PRIV’s NAV per Share, PRIV’s investments are generally valued using market valuations. A market valuation generally means a valuation (1) obtained from an exchange, a pricing service, or a major market maker (or dealer) or (2) based on a price quotation or other equivalent indication of value supplied by an exchange, a pricing service, or a major market maker (or dealer). Pursuant to Fund Board approved valuation procedures, the Board has designated SSGA as the valuation designee for PRIV. These procedures address, among other things, (1) determining (a) when market quotations are not readily available or reliable and (b) the methodologies to be used for determining the fair value of investments, and (2) the use and oversight of third-party pricing services for fair valuation. Every security held by PRIV is reviewed and valued daily as part of its NAV calculation process.

This ambiguity is concerning not just for the SEC. Other regulators are starting to take notice, and this is discussed in the next section.

Regulators are taking notice

In recent months, regulators around the world have been consulting with investors with regards to private assets. In what could be the first stirrings of action around the major issues detailed above, ESMA in the EU and the UK’s FCA both have separately conducted reviews into private asset managers, advisors and portfolio managers. Meanwhile APRA, Australia’s prudential regulator in charge of its pension funds, was conducting a review into valuation governance and liquidity management for unlisted assets.

Each regulator had a specific focus. It is clear however, that given the regulators’ focus on the topic of valuations of private assets, there are significant concerns around industry practice. We will quickly cover what each regulator was investigating and their findings in this section. Starting with ESMA, then FCA and finally APRA.

ESMA, the European Security and Markets Authority, in collaboration with national regulators examined asset valuation rules in 2022 for unlisted assets. These regulators examined several key areas, these were4:

  • The appropriateness of valuation policies
  • How the valuations were stress tested
  • How independent the valuation function was within the fund structure
  • How valuation errors were detected and corrected

ESMA, with the assistance of country level regulators, found that there is room for improvement in the valuation policies and procedures, specifically improving the valuation model that is to be applied and how it is validated, as well as documentation around the responsibilities for valuation within the asset manager. Additionally, ESMA found that there were some cases where the valuation function was not independent from the portfolio management function, which is a clear conflict of interest. Furthermore, smaller managers appeared to over rely on third-parties for the pricing of illiquid assets without the manager checking the results.

These findings indicate that in the EU, there is clear room for improvement for private asset managers in both the practice of valuation of unlisted assets and the transparency of the policies around these valuations. This review, whilst finding that there was no wide-scale divergence from current accepted practice, showed that the regulator was clearly uncomfortable with the appropriateness of the valuation models currently employed.

We turn now to the most recent regulator review, that of the FCA’s review of unlisted assets conducted over 2024. The FCA’s review examined several areas of interest around the role of valuations in unlisted funds. Specifically, they were looking at how conflicts of interest were managed around remuneration, investor fees, asset transfers (to other funds), redemptions and subscriptions, marketing to new investors, and secured borrowings by the fund. This laundry list of areas of concern highlights the FCA’s concern that, without stringent regulatory oversight and robust internal controls, unlisted funds could be exposed to systemic conflicts of interest. These vulnerabilities not only threaten the integrity of the valuation process but also have the potential to erode investor confidence and distort market pricing.

This review appears to indicate that the FCA were establishing a base-line for investigation to ensure that current practice is acceptable. This is evidenced by the list of expectations the FCA now has which involves managers improving the following5:

  • The governance of their valuation process
  • Identifying, documenting, and addressing potential conflicts in their valuation process
  • Ensuring functional independence for their valuation process
  • Incorporating defined processes for ad hoc valuations

This list of expectations is very similar to the expectations of APRA which conducted a review of valuations practices following the update of prudential standard SPS 530 in 2023. APRA examined 23 superannuation (pension) funds with high exposure to unlisted assets. In total, these funds managed approximately AUD$2 trillion. Of the 23 funds, APRA found that 8 required improvement in their valuation processes for unlisted assets. APRA cites two key areas, firstly, in conflicts of interest, the team overseeing the valuation should not include members whose compensation is linked to the valuation, for example either the deal team or investment management team. Secondly, APRA highlighted that taking the valuation at face value from external managers is not considered appropriate. It now expects licensees to develop a capability to interrogate these valuations.

As a result of the review, APRA has stated that it expects all licensees to improve the following:

  • Board oversight and conflicts of interest management
  • Revaluation frequency
  • Revaluation triggers
  • Valuation control
  • Fair value reporting

These valuation issues are very similar to that identified by the FCA in the UK. It is interesting to note that these issues are universal.

Where the FCA did not venture was an examination of the liquidity issues involved with investing in private assets. APRA has a real concern with liquidity provision given that the funds it regulates allows daily liquidity on illiquid assets. This is of concern, as obviously in times of stress, it can result in a ‘run on the fund’ if this risk is not managed correctly. In the review, APRA found that of the 23 funds it examined, 8 had inadequate liquidity risk management practices. This inadequacy has resulted in APRA putting the funds on notice that it is going to particularly focus on the monitoring frameworks for liquidity stress, the management process the funds put in place for liquidity issues and finally ensure that the funds develop contingency plans for the management of illiquid assets when there is liquidity stress.

Where might this lead?

It is our belief that with regulators now starting to examine the governance and methods employed by asset managers to value private assets, we are at a turning point in the acceptance of current practices. The private asset industry has been very successful in gathering assets to invest, and this has resulted in regulators awakening to the risks involved in allowing more and more pension plans to invest in the industry.

Whilst these initial studies by regulators have essentially been ‘fact-finding’ missions, we envisage more frequent check-ups by the regulators as to the appropriateness of the valuation methodology. Asset managers are on notice and regulators will not accept sub-standard practices going forward.

The next major movement now is the regulators examining the actual methods to value assets, as well as timeliness and transparency around these valuations. No investor wants to reveal the marks at which they hold an asset, but increased transparency is going to be a necessary trade-off for private asset managers if they seek to obtain increased fund flows from pensions in the future. This will require more frequent valuations than quarterly, regular updates and increased provision of the underlying assumptions used to support the valuation and improved independence of the valuation function as APRA has implemented at Australian Superannuation funds.

What should investors do?

We now know that major regulators are targeting the following areas:

  • Transparency
  • Valuation
  • Conflicts of interest

Investors should be considering improving their policies and processes in these areas. For too long, the lack of transparency around the valuations and processes has been lacking. Investors should demand, before the regulators make them demand, a full understanding of how unlisted assets are valued, how often, and what triggers are required that force an out-of-cycle revaluation.

Valuation is a particular concern for all concerned. The methods employed need to be clearly disclosed and modernised. The use of asset pricing models that are historical relics (the CAPM) to discover ‘discount rates’ to value an asset is not the way forward. This is not the place to critique the CAPM, but its use for valuation with the addition of other ad-hoc ‘risk premia’ based on unquantifiable factors is a fudge. Another valuation fudge is the use of market multiples to value the assets. Identifying a peer group, obtaining the average of their multiples and applying that to your investment is fraught with subjectivity and able to be gamed.

Finally, everyone knows that investment managers should avoid conflicts of interest, especially ones which they are in a position to benefit from. The reports described above detail that regulators are aware of these issues and are ready to act if they observe any poor behaviour.

The private assets industry is now too big to ignore. With significant AUM and a view to increase this further, regulators have started paying a lot more attention all around the world. Whilst there is no glaring illegality identified, there were deficient practices. These were clearly transparency, valuation methodologies and how they are implemented, and policing conflicts of interest. Improving these practices in private assets creates value for everyone and should be the focus of everyone, investors and asset managers.

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