Introduction

Malta was the first EU Member State to complete the transposition of the AIFMD into national law and started accepting applications from start-up AIFMs as of the date the AIFMD entered into force.

Article 19 of the AIFMD establishes a rigorous valuation regime that requires close scrutiny by AIFMs. Reliable and independent asset valuation is crucial, particularly as European markets are set to experience a return to volatility in the New Year. The AIFMD provides that the AIFM is responsible for the proper and independent valuation of all assets in each AIF under management. This valuation function may be performed in two ways: by the AIFM itself or by one or more external valuation agents appointed by the AIFM.

We focus on the following key issues of the AIFMD valuation framework:

  • Internal Valuation;
  • External Valuation;
  • Valuation Procedures; and
  • The Liability of the AIFM and External Valuer.

Internal Valuation

Where the AIFM elects the internal valuation route, the task must be functionally independent from the portfolio management and remuneration policy. The AIFM must also adopt measures to ensure that conflicts of interest are mitigated. Put simply, procedures are required to separate the AIFM’s internal valuation personnel from any deal-making and front-office activity.

The requirement of “independence” has not proved taxing for institutional managers already boasting sizeable and knowledgeable resource. Smaller firms have experienced otherwise. The AIFMD has required them to reorganise (or even expand) their internal structures or appoint an external valuer in order to ensure compliance.

External Valuation

The external valuer may be a natural or legal person. Independence is once again key. The external valuer must be independent from the AIF, the AIFM and any other person with close links to the AIF or AIFM. Several other requirements must be satisfied should the AIFM choose to outsource the valuation function. The external valuer is prohibited from delegating the valuation function to a third party. Furthermore, the external valuer must be professionally recognised, provide professional guarantees that it is capable of effectively valuing the assets of the AIF and is subject to appropriate, ongoing due diligence procedures.

The AIFMD distinguishes between the valuation of assets and NAV calculation. A fund administrator that is responsible for calculating the NAV is not regarded to be an external valuer, provided that it does not value individual assets and only incorporates the values acquired from other sources.

The segregation of roles between the fund administrator and external valuer was recommended by ESMA in its technical advice to the EU Commission. It is an arrangement that has pleased many fund administrators throughout EU Member States that were not keen to assume the potential liability accompanying the role of the external valuer. As set out below, the external valuer is liable to the AIFM for any losses arising due to its negligence or intentional failure to perform its tasks.

The niche fund administration industry in Malta, particularly those supporting private equity and real estate funds, has definitely not been discouraged by the potential liability towards the AIFM. A number of Maltese fund administrators are now readily offering one, comprehensive service that also incorporates the external valuer’s role. This has contributed to Malta’s growth and reputation as a mature, well-established fund domicile.

Valuation Procedures

For each AIF under management, AIFMs must implement and review written procedures for the valuation of all assets. An AIF may not invest in a particular type of asset unless an appropriate valuation methodology has been identified for that asset type. The objective of the AIFMD is to ensure that transparent and comprehensive valuation processes are in place to enhance overall market quality and investor protection.

The Level 2 Regulation fleshes out the matters to be included in the Valuation Policy, most notably:

  • the roles and obligations of all parties involved in the valuation process, including the senior management / directors of the AIFM;
  • the competence and independence of the personnel who are effectively carrying out the valuation;
  • the AIF’s investment strategy and the assets it may invest in;
  • the escalation channels for resolving issues in asset values;
  • the times for closing the valuations; and
  • the frequency of valuations.

For each AIF, the valuation of assets and NAV calculation must be carried out and disclosed to investors at least annually. Open-ended AIFs are required to perform more frequent valuations and NAV calculations depending on the type of assets; whereas closed-ended AIFs must do so each time there is an increase or reduction in the AIF’s capital.

The Valuation Policy must be reviewed at least once a year or before the AIF engages with a new investment strategy or a new type of asset.

The Liability of the AIFM and External Valuer

The AIFMD assigns responsibility for the valuation of assets, the NAV calculation and the publication thereof to the AIFM. This effectively means that the AIFM’s liability in respect of the AIF and its investors is not affected by the fact that the AIFM has outsourced the valuation function to an external valuer. The AIFM remains liable at all times.

The external valuer will however be liable to the AIFM for any losses that the AIFM incurs as a result of its negligence or intentional failure to perform its tasks. The liability of the external valuer will subsist notwithstanding any contractual arrangements providing otherwise.

Conclusion

Article 19 of the AIFMD draws heavily on the UCITS and MiFID regimes. Managers operating within these frameworks are probably well acquainted with the workings of the AIFMD valuation provisions. Those firms that are yet to carefully consider the AIFMD valuation provisions would be well advised to do so – without delay – since the repercussions may be significant.

Compliance with the AIFMD is bringing about a shift in the domicile of both managers and funds. Finding the ideal balance between regulation and flexibility is by no means a simple task for fund jurisdictions. The increasing interest in Maltese AIFMs and AIFMD-compliant funds is a testament to Malta’s continued success in the fund industry.

 

This article was published in Italian in MondoAlternative, Gennaio 2015.