What's wrong with private market valuations and why do UK pension funds care?

Britain's Financial Conduct Authority said last week a review of risks in markets for unlisted assets would check how valuations are being undertaken and whether any risks could spread into banking.

WHY IS THE REGULATOR WORRIED?

Stock markets and prices of government bonds have been hit by expectations of higher interest rates for a longer period than initially anticipated. Prices of private, unlisted assets have remained relatively high, raising questions about how valuations are conducted and if a reckoning is due.

WHY UK PENSION SCHEMES?

The value of assets in the 1.5 trillion pound ($1.83 trillion) UK defined benefit, or final salary, pension fund sector has mainly fallen in the past year. But as private market valuations have stayed the same, the funds are now overexposed to those riskier assets which are hard to sell in a hurry.

Some pension funds are breaching the limits on illiquid assets that their trustees say they can hold, consultants say.

Some funds also need to sell as their employer sponsors want to transfer the pension scheme to an insurer, and insurers are reluctant to take on some of these assets.

HOW ARE PRIVATE MARKETS VALUED?

Many private assets such as real estate can only be accurately valued when they are sold. In a time of low transactions such as in the current high interest rate environment, this makes things tricky. Some companies also use external firms to estimate the value of their assets. Internal and external valuers may look at the sale price of comparable assets to aid those estimates.

HOW DOES THIS DIFFER FROM PUBLIC MARKETS LIKE STOCKS?

Listed instruments like stocks are traded several times a minute. Private market valuations may only be released once a quarter or even once a year. There is little consistency in the way they are valued.

WHO ELSE IS WORRIED?

Global securities watchdog IOSCO said in a report last month that private market prices were "inevitably stale" because of the lag in valuation times.

HOW FAR OUT ARE VALUATIONS?

Some UK pension schemes are selling illiquid assets at a discount of up to 40 per cent of their net asset value, consultants say. Private equity firms who specialise in these markets see lower discounts.

WHO ELSE IS IMPACTED?

Banks who lend money to real estate developers or private equity firms may find their customers' credit is worse than they thought. It is also hard for banks to price commercial real estate mortgages, for example, without accurate valuations.