The US Securities and Exchange Commission (“SEC”) has adopted new rules (2a-5 and 31a-4) under the Investment Company Act of 1940 (1940 Act) on 3 December 2020 with an effective date of 8 March 2021. The final rules have a compliance date of 8 September 2022 and would work to serve common fund valuation framework across all fund groups. Jorge Revilla Fernandez and Francisco Jimenez of our Asset Management team explain.
While we believe that the final rule aligns with market practices in different industries today, it is under our consideration that many funds and companies would find it challenging shifting towards the rule. This paper will further breakdown and analyse the 212-page release by SEC and its impact on fund valuation reporting.
SEC’s final rule provides requirements for determining fair value in good faith with respect to a fund for purposes of section 2(a)(41) of the Act and rule 2a-4 thereunder. The following are required to determine the fair value of fund investments in good faith:
To achieve the above, SEC has set out specific requirements with respect to the 1940 Act:
This requires the periodical assessment for any material risks associated with the determination of the fair value of the fund’s investments, including material conflicts of interest, and to manage those identified valuation risks.
This requires that a board or valuation designee must:
This requires that the board or valuation designee, as applicable, to identify the testing methods to be used and the minimum frequency with which such testing methods are used, but will not require particular testing methods or a specific minimum frequency for the testing.
This rule requires that the board or valuation designee, as applicable, establish a process for initiating price challenges as appropriate.
Based on rule 2a-5(b), the final rule permit boards to designate the to the fund’s adviser to perform fair value determinations or, if the fund is internally managed, an officer of the fund. However, SEC believes this should not be a passive activity and boards should maintain their oversight of the fair value determinations with a sceptical and objective view that takes account of the fund’s particular valuation risks, including with respect to conflicts, the appropriateness of the fair value determination process, and the skill and resources devoted to it.
Under 2a-5, the valuation designee is required both periodic and prompt notification and reporting.
Under periodic reporting, the final rule requires the valuation designee to make both annual and quarterly written reports to the board.
The quarterly reports must include:
The annual reports must include an assessment of the adequacy and effectiveness of the valuation designee’s process for determining the fair value of the designated portfolio of investments. This must cover:
If the valuation designee becomes aware of matters that would materially affect the fair value of the designated portfolio of investments (defined as “material matters”). The board should be promptly notified regarding the matter (no event later than five business days after the valuation designee becomes aware of the material matter). Material matters would include:
We are here to help. KPMG Ireland works to provide industry-leading professional services across various markets with our experienced expertise, valuation models and platforms. Facing the changing environment and complicated market regulations, we are keen to help our clients perform more efficiently and effectively for challenges ahead. To find out more, get in touch with our team below. We'd be delighted to hear from you.