Fund Managers Want "Clear" Explanation of Valuations
Fund managers care just as much about how third party valuation experts are pricing the securities they trade and process as they do about the accuracy of their calculations.
About 75 percent of the 48 buy-side respondents in a survey conducted by data giant Thomson Reuters, cited data quality as the key factor when assessing their valuation and reference data providers. Nearly half want more "market color" on the prices used to make the valuation. That market color reflects reported trades, bids and offers, industry and issuer specific news.
Also significant -- a clear evaluation process which includes explanations of methodologies and assumptions used to come up with a price, according to about a third of the respondents such as operations staff, pricing managers and chief risk officers.
Thomson Reuters, which provides both real-time and end-of-day market data feeds and third party valuation services for over 2.5 million fixed-income securities.
"Fund managers are no longer willing or allowed to accept valuations provided externally at face value," says Milton Miyashiro, head of regulatory compliance for evaluations at Thomson Reuters, whose report was entitled "Bridging the Transparency Gap."
The rationale is two-fold: a combination of bad experience and regulatory mandate. For starters, they got burned during the financial crisis when they blindly relied on prices provided by broker-dealers and banks only to discover that those calculations were based on flawed assumptions. As a result, regulators and auditors -- not to mention investors -- are now insisting on a higher level of due diligence or "independence" which involves validating counterparty prices internally and using third-party specialist firms if necessary.
Knowing just what went into the valuation calculations can help fund managers resolve any differences of opinion and substantiate their decisions. As a rule of thumb, the more illiquid the asset the greater the wider the discrepancy between internal and external calculations; such is often the case with exotic asset-backed and mortgage-backed securities.
A clear evaluation process will be particularly valuable for swap contracts so fund managers can calculate -- and validate -- the initial and variation margin which they must provide clearing brokers to post on their behalf with clearinghouses which process those trades. US and European regulations set to take effect next year will mandate a lot more swaps be cleared through clearinghouses and all but the largest fund managers are likely to select clearing brokers to service them rather than become direct members of the clearinghouses themselves.
Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com)