Following Brexit, the UK government has brought the EU's Alternative Investment Fund Managers Directive (AIFMD) into national legislation. However, there are now signs that amendments are being considered to address a problem in the original directive on the way valuations are commissioned.
The AIFMD responded to perceived problems in the sector exposed by the global financial crisis of 2008. An important aim was to ensure greater protection for investors. The directive came into effect in national laws across the EU by July 2013.
Article 19 of the AIFMD deals with the valuation process. It requires a fund manager to ensure that appropriate and consistent procedures are established to ensure a 'proper and independent valuation' of the fund's assets.
At first sight this seems a sensible provision. However, as the authors of the RICS Red Book discovered long ago, defining what is meant by an independent valuation is far from straightforward.
The only explanation in article 19 is that the required independent valuation is to be performed by either an external valuer or the fund manager itself. However, in the latter case the work must be functionally independent from the organisation's other operations.
Many fund managers do not have the appropriate internal valuation expertise, or the capacity to establish functionally independent valuation departments. Using external valuers may then have seemed the obvious option. However, article 19(10) had a sting in the tail: an external valuer faces unlimited liability.
'AIFMs [alternative investment fund managers] are responsible for the proper valuation of AIF assets, the calculation of the net asset value and the publication of that net asset value. The AIFM's liability towards the AIF and its investors shall, therefore, not be affected by the fact that the AIFM has appointed an external valuer.
'Notwithstanding the first subparagraph and irrespective of any contractual arrangements providing otherwise, the external valuer shall be liable to the AIFM for any losses suffered by the AIFM as a result of the external valuer's negligence or intentional failure to perform its tasks.'
Many valuers, including RICS-regulated firms, are required to hold professional indemnity insurance (PII). However, such cover is not available with unlimited liability. Even where PII is not mandatory, many reputable valuation providers will not accept unlimited liability. If they do, they demand a significantly higher fee to compensate for the risk. A consequence is that many fund managers are unable to find external valuers to provide the required independent valuations, or can only do so at a significant additional cost.
Many real-estate funds in the UK have worked around this by appointing firms as appropriate valuers, as defined in the Financial Conduct Authority (FCA) Collective investment schemes handbook (COLL). While the valuer advises a fund manager, the fund manager remains responsible for the values provided to the fund and its investors.
The FCA also take this approach in its rules for long-term asset funds (LTAFs) in COLL 15, which became effective in November. An authorised fund manager undertaking the valuation itself of real estate under the AIFMD may appoint an appropriate valuer or a standing independent valuer as defined in COLL 15.2.6(4). However, this does not help fund managers obtain external valuation advice for funds other than LTAFs that fall under AIFMD.
The Association of Real Estate Funds, the British Property Federation and the European Association for Investors in Non-Listed Real Estate made a joint submission to the FCA in May advocating reform of article 19(10). In an LTAF policy statement issued in October, the FCA indicated that it is comfortable with fund managers using valuation advisers to support the valuation of individual assets. The fund managers must remain responsible for carrying out the overall valuation, though, and ensure it is done impartially.
However, the authority also said independent valuation of illiquid and hard-to-value assets are important in protecting investors. It added that it would like the market for external valuers to work better. The liability standard derives from AIFMD and the FCA is unable to change it at this stage. But it has signalled that it is working with the Treasury to consider the function of the external valuer.
In this context, we suggest the removal of the second paragraph of 19(10) altogether.
Contractual liability limits are commonplace in the legal and auditing professions. A prudent fund manager will ensure that the limit agreed with any professional adviser is proportionate to the risk of receiving incorrect advice. This will protect the positions of fund investors, fund managers and professional advisers. It makes little sense to restrict a fund manager's discretion to make appropriate arrangements with an external professional.
We hope that reform of article 19(10) may in time prompt an equivalent reform in the EU directive, although this will take more time. The proposed EU AIFMD reforms issued in November do not extend to article 19(10). However, in its response to the preceding review of the directive, the European Securities and Markets Authority did recognise that there was a problem with external valuer liability. A satisfactory resolution in UK legislation may well influence future discussion in the EU.
In the meantime, the profession needs to focus on UK reform, given that this issue is now being considered by the FCA and Treasury. Valuation firms with a stake in the fund valuation market need to make sure their voice is heard by both authorities.
RICS also has a role to play in emphasising that it is in the public interest to ensure that fund managers can seek the best valuation advice available.
The RICS Standards and Professional Development team welcomes this article and the coverage of the issues it highlights. RICS will continue to engage with the UK FCA on this subject and has been active in responding to relevant consultations such as the FCA consultation on the long term asset fund. RICS is also engaged on this subject at an EU level. If you would like to contact RICS in respect of the issues raised in this article, please email Charles Golding MRICS.
Dr Paul Beckett 22 May 2023
Fiona Mannix 18 May 2023
David Marshall 12 May 2023