The insurance-linked securities (ILS) and reinsurance linked investments market may be one of the better positioned for any additional scrutiny the U.S. Securities and Exchange Commission (SEC) decides to place on managers of illiquid assets.
This weekend the Financial Times highlighted ILS as one of the asset classes which has seen an increasing level of scrutiny of fund managers in Europe from the U.S. regulator as it tries to respond to concerns about the valuation of illiquid assets.
The FT says the additional scrutiny is a result of a new push to increase oversight of funds which conduct business in the U.S. but are registered abroad. In particular funds which invest in illiquid or less liquid assets are particularly targeted by the SEC.
There have been some scandals regarding asset valuation in other alternative asset classes. This is something which is expected to become more common as new, alternative asset classes emerge which link investment returns to assets which are particularly difficult to value and which often lack any secondary liquidity.
Of course ILS is considered a relatively illiquid asset class, except for the catastrophe bonds which have secondary market transferability and because, as is the nature with reinsurance risks, valuation is not a simple procedure. However the ILS market has been working hard to ensure that valuations are performed regularly, actuarial reviews are also conducted and investors are kept as appraised of asset values, as well as any issues which could impact them, as is possible.
The FT’s article could be read as the SEC making a push to apply scrutiny to ILS alone, but we don’t believe this to be the case. Rather, investment managers we’ve spoken with at some London-based hedge funds have reported that the SEC is looking at many illiquid and alternative asset classes and that ILS has not been singled out alone. It seems the FT perhaps had more luck getting a comment from an ILS manager than anyone else for this story, perhaps a testament to this markets willingness to be transparent.
The SEC is said to be focusing on the valuation of assets which, while technically marketable, have little in the way of secondary trading making deriving a current, fair price more challenging. ILS of course fits this area of the hedge fund market quite nicely, so no surprise to see it a target. Other assets in areas such as collateralized loan obligations and alternatives like infrastructure and timber have also seen increased scrutiny in recent weeks it is reported.
Ever since the ILS asset class developed, managers and investors have been acutely aware that valuation of their assets is critical to keeping investors and attracting new ones, meaning that if they want to be taken seriously and grow their assets under management they need to have robust and defensible valuation strategies in place.
As a result the ILS market has specialist firms that offer specific ILS valuation services, large global consultancies offering valuation reviews, auditors keeping track of valuation processes as well as the more typical actuarial providers of reinsurance portfolio valuations which most use as well. In fact, gaining an independent verification of their ILS funds asset values is a key part of every ILS manager’s internal process, at least for those we speak with.
Given the sophistication of the global reinsurance market, it’s likely that insurance linked funds may actually be much more robustly valued, so as a result better positioned to receive this additional scrutiny, than a lot of other alternative asset classes. Many alternative asset classes do not have the same wide range of service providers targeting this key valuation offering for their markets.
Of course, as with any investment fund market, there will be differences between the valuation processes of different ILS managers and some may have a much greater proportion of illiquid assets than others. As such there is no one-size fits all solution to valuation meaning that some sort of suggestion for best practice could be the most likely move by the SEC if it wants to minimise concerns over asset valuation.
It will be interesting to see whether the SEC comes out with any new regulatory requirements, such as mandated maximum intervals between valuations, after this (reported) heightened level of scrutiny. ILS managers, with their use of valuation service providers, actuaries and auditors already firmly embedded in their funds due-diligence processes, are likely among the best positioned to respond to any increase in regulatory oversight.
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