Wed, Nov 8, 2023

ESMA's Common Supervisory Action on Valuation: What Investment Manager Need to Know

The European Securities and Markets Authority (ESMA) launched a Common Supervisory Action (CSA) with National Competent Authorities (NCAs) on the valuation of Undertakings for Collective Investment in Transferable Securities (“UCITS”) and open-ended alternative investment funds (“AIFs”) in January 2022. The CSA aims to assess the compliance of investment managers with the valuation requirements set out in the AIFM level 1 Directive and to ensure greater supervisory convergence among NCAs with respect to valuation policies and procedures, valuation methodologies and valuation risks.

The CSA covers the following main areas of focus:

Appropriateness of Valuation Policies and Procedures

ESMA observed that while most investment managers have valuation policies and procedures in place, they are not always sufficiently comprehensive and detailed to reflect the valuation process and the specificities of the assets under management. In particular, ESMA noted sometimes a disconnect between the valuation model and the valuation policy in terms of valuation methodologies, inputs and assumptions.

ESMA expects investment managers to have clear and consistent valuation policies and procedures that cover all aspects of the valuation process, such as roles and responsibilities, frequency and timing, data sources, models and methods, pricing errors and adjustments, escalation and reporting, documentation and record-keeping, review and validation, etc. The valuation policies and procedures should also be tailored to the nature, complexity and liquidity of the assets under management and should be regularly updated to reflect any changes in market conditions or regulatory requirements.

Valuation Under Stressed Market Conditions

ESMA found that some investment managers lack adequate coverage of stressed market conditions in their valuation policies and procedures. ESMA emphasized the importance of ensuring that the valuation methodologies used by investment managers are robust and reliable under normal and stressed market conditions, especially for less liquid assets such as private equity and real estate.

ESMA recommends investment managers to conduct regular stress testing of their assets, inputs and assumptions and to document the results and actions taken. ESMA also advises investment managers to consider alternative valuation methods or sources of information in case of market disruption or illiquidity and to disclose any material uncertainties or limitations affecting the valuation of their assets.

Independence of the Valuation Function and Use of Third Parties

ESMA highlighted the importance of ensuring the independence of the valuation function from the portfolio management function, as well as from any potential conflicts of interest or undue influence. ESMA also stressed the need for investment managers to exercise due diligence and oversight when using external valuers or third-party pricing providers, especially for less liquid assets.

ESMA expects investment managers to implement appropriate measures to safeguard the independence of the valuation function, such as segregation of duties, remuneration policies and internal controls. ESMA also expects investment managers to conduct an independent analysis of asset prices provided by external parties and to verify the reliability and accuracy of their valuation methods, data and assumptions.

Early Detection Mechanisms for Valuation Errors and Transparency to Investors

ESMA identified that while investment managers have early detection mechanisms for NAV/valuation errors in place, they are not always sufficiently detailed or effective. ESMA also observed that some investment managers do not provide adequate disclosures to investors regarding their valuation methodologies, and valuation risks.

ESMA expects investment managers to have robust early detection mechanisms for NAV/valuation errors that include clear definitions, thresholds, procedures, responsibilities, reporting and remediation. ESMA also expects investment managers to provide transparent disclosures to investors on their general valuation policies and procedures, valuation methodologies and methods used for each asset class or fund, any material changes or deviations from their valuation policies or methodologies, any material uncertainties or limitations affecting their valuations, any significant NAV/valuation errors detected and corrected, etc.

Focus on Open-Ended Funds Investing in Private Equity and Real Estate Assets

ESMA noted that open-ended funds investing in private equity and real estate assets pose specific challenges for valuation due to their less liquid nature and their redemption features. ESMA expressed concerns about the potential mismatch between the liquidity offered to investors and the liquidity of the underlying assets.

ESMA expects investment managers to enhance their justification and objectivity around their valuation methodologies for private equity and real estate assets. ESMA also expects investment managers to implement appropriate liquidity management tools and mechanisms to ensure that they can meet redemption requests without compromising the fair value measurement of their assets or disadvantaging other investors.


The CSA on valuation is a significant supervisory initiative by ESMA that reflects its increased focus on asset valuation as a key area of investor protection. The CSA will have important implications for investment managers in terms of compliance with the regulatory requirements on valuation, as well as enhancing their valuation policies and procedures, methodologies, models, data sources, governance arrangements, etc.

Investment managers should take this opportunity to review their current practices on asset valuation against the expectations and best practices outlined by ESMA and to identify and address any gaps or weaknesses. Investment managers should also be prepared for potential inquiries or inspections from their NCAs as part of the CSA and to demonstrate their compliance with the valuation requirements.

Kroll can assist investment managers in complying with the increased regulation on valuation by providing independent and objective valuations, as well as advisory and support on valuation policies and procedures, methodologies, models, data, governance arrangements, etc.

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