By James Hamilton, J.D., LL.M.
The International Organization of Securities Commissions has issued nine principles for the valuation of hedge fund portfolios in an effort to ensure that the values of hedge fund financial instruments are not distorted to the disadvantage of fund investors. The principles are designed to be a transparent practical tool for hedge fund managers and governing bodies, and for those involved in the valuation process. They may also be helpful for institutional and sophisticated investors. The principles, which are applicable across all national boundaries, were issued in the form of a consultation, with public comments invited until June 21, 2007.
The UK Financial Services Authority quickly announced its support for the principles, noting that they will help mitigate conflicts of interest and enhance independent valuations. The FSA noted that some hedge fund strategies involve exposure to illiquid and complex financial instruments that can present valuation challenges. The Hong Kong Securities and Futures Commission encouraged the hedge fund industry and investors to comment on the principles. The Commission’s CEO Martin Wheatley said that valuation warrants the close attention of the market.
The IOSCO principles describe techniques which should strengthen the valuation process, thereby making it more likely that the resulting valuation is appropriate. They emphasize the importance of clear written procedures which are consistently operated and regularly reviewed, and which provide for an appropriate degree of independence to deliver effective checks and controls.
The principles apply to all hedge fund structures, but IOSCO recognizes that
hedge funds are varied in their size, structures and operations. Thus, the governing body of each hedge fund should take into consideration the nature of the fund's structure and
operations when seeking to apply the principles. The challenges of valuing complex and illiquid instruments arise in many hedge funds, wherever located, and however structured.
Similarly, conflicts of interest arise in the case of all hedge funds, wherever located and however structured. The principles are designed to assist hedge funds in valuing their portfolios so as to reduce the structural and operational conflicts of interest that may arise and help ensure that valuations are robust and appropriate.