Preparing for an Audit in the New Regulatory Regime

Jayme Fagas, head of evaluated pricing for the Americas at Thomson Reuters.

The 2008 financial crisis continues to drive major change in the regulatory landscape. More stringent requirements for disclosure, oversight and control are shaping how business is conducted and what is demanded of buy-side and sell-side firms. By Jayme Fagas

Nowhere are the changes more impactful than in valuations. Transparency into the underlying methodologies and assumptive drivers that determine evaluated prices are key to addressing the new requirements.
But preparing for an audit of your valuations entails more than just transparency ─ it requires an understanding of the regulatory climate as well as ensuring that senior management, compliance, risk, accounting,
legal, pricing, and other groups are aware of their responsibilities and possess the knowledge, training and resources to execute those responsibilities.

Regulatory Drivers
Recognizing that capital charges, margins, spread and basis risk, volatility, counterparty risk and other inputs rely on asset valuations, the SEC and PCAOB continue to raise the bar for disclosure and documentation around the valuations process as established by Topic 820. In particular, they are increasing scrutiny of auditors and the evidence collected and documented to support their audit opinions. As a result, companies are spending a great deal of time to deliver documented audit trails, independent valuation inputs, additional supporting data and detailed disclosures for pricing decisions. Firms should also be prepared to explain processes and valuation dynamics to both auditors and regulators, who may not have experience with or a deep understanding of those elements.

Quest for Transparency
Transparency has become the holy grail of valuations. Organizations seek information as "evidence" and/or protective "armor" for audits. Obtaining and providing transparency into the underlying assumptions and inputs that drive evaluated pricing ─ and being able to substantiate prices to regulators, auditors, stakeholders and end-users ─ is a key element of the ongoing valuation due diligence process. Valuations of securities are often obtained from independent third-party providers. However, responsibility for valuations cannot be delegated ─ it falls squarely on the shoulders of senior management, who are ultimately accountable for the accuracy and reliability of financial statements.

Demand More From Your Evaluated Pricing Provider
Transparency is critical to understanding the dynamics, inputs and challenges of evaluated pricing. But the ability to demonstrate that sound due-diligence procedures have been fully executed is equally important. Vendors that cannot adequately meet the heightened due diligence and documentation required expose all participants, including shareholders, to risk. With so much at stake, companies can and should expect more from their pricing and reference data providers in the way of clearly defined processes, documentation and an auditable justification of prices. This also includes being apprised of pricing methodology, policy or other changes in a timely fashion.
On a daily basis, pricing vendors typically provide security identifiers and a price. The SEC's and PCAOB's increased emphasis of auditor review of fair values means more information will be required, including, but not limited to, specifi c security details such as ongoing performance data, trade history, rating actions and market color.
In the spirit of full transparency, it is critical for pricing vendors to work with their clients through due diligence meetings and supplying the necessary additional information in a timely fashion.

The dynamics of the market will continue to drive regulatory change, impacting the type and amount of information firms are required to provide to regulators, auditors and stakeholders. This is no time for complacency. Reach out to your evaluated pricing vendors to learn about their processes, models and assumptions. Educate auditors so that they understand the input criteria that influence fair value. Communicate with senior management and shareholders. Imbue your operation with a "culture of compliance" that provides a greater level of
end-to-end control, support and transparency. 

Jayme Fagas is head of evaluated pricing for the Americas at Thomson

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