Ian Blance is head of evaluated pricing business development at SIX Financial Information, a major supplier of valuations and pricing services across global financial markets.
Why are valuations such an important aspect of the data business?
The valuation of assets is fundamental to the functioning of the financial system. Without an appropriate value, mission-critical activities would simply not be possible – fund NAV calculations, client reporting, book P&L, performance measurement, risk measures, company accounts, collateral management … the list is endless. Many of these valuations are collected or calculated and then disseminated by the data industry, which makes the data vendors key players in this piece of the business. When it comes to exchange-traded asset classes, the collection and delivery of valuation prices is relatively uncontroversial. But when it comes to illiquid or thinly traded instruments, the challenge – to vendors and to users – is much greater.
What’s driving the current industry attention to valuations quality?
Two things. First, regulatory and audit oversight of valuation sources and processes has increased markedly since the financial crisis. The G20 placed valuation – in the sense of the essential need to know the true value of assets – at the centre of the turmoil, and initiated a programme to ensure that the issues highlighted by the collapse or bail-out of financial institutions were addressed. The way financial firms value their asset holdings has come under unprecedented scrutiny. Second, those institutions have themselves learned many lessons from the crisis and are determined not to have their fingers burned again!
Which markets and classes are best served by current industry offerings? Which are worst served?
For regular corporate and sovereign fixed-income securities, there are a number of well developed evaluation services, driven by the data strengths of the main data vendors, which have accepted methods and a good track record. There are fewer participants in the markets for mortgage products, and there is certainly more to take into account here from a data management and model calibration perspective. But the vendors in this space also have proven services.
Stepping outside of the fixed-income space, OTC derivative and structured product evaluations have more recent provenance. There are some newer vendors, as well as smaller niche providers, involved in this segment, but Big Data has yet to come up with a truly comprehensive response here. The specialist nature of the methodology and data, as well as the sometimes highly subjective calibration and input assumptions, make the evaluation of these asset classes a more uncertain business. OTC structured retail products, in particular, do not yet have a robust source.
When assessing third-party valuations services, what are the key parameters financial institutions should assess?
There are the usual questions relating to independence, reliability, consistency, etc. (and from a user perspective, cost is a much more important factor than many like to admit!). But we believe that in today’s world, the most important factor to judge is the defensibility of evaluations. The fundamental question a user needs to ask is: ‘Can I defend the use of this evaluation to anyone who may ask?’
To SIX Financial Information, ensuring defensibility means two things. First, the user must fully understand how the evaluation was produced. This implies that the full details of the methodology, data inputs and assumptions need to be provided to the user – full transparency. A user should never have to ask ‘how’ an evaluation was generated.
Second, the user must be able to justify the use of the evaluation to any external party – client, regulator, auditor, risk group, etc. Having all of the necessary information to understand the evaluation is part of this. But so is having the comfort and assurance that there has been some kind of review and oversight of the vendor models and process.
In the case of SIX Financial Information, we felt that it was appropriate to have our Evaluated Pricing Service reviewed and assured by a major international audit firm, and their report on our service is available to our clients.
How important is transparency of methodology, both for suppliers of valuations data and for consuming organisations, who need to assure their own clients of the robustness of their models?
We believe that this is fundamental to the acceptance of an evaluated price; not only transparency of methodology, but its suitability for the job (preferably judged by a source independent of the vendor) and also the data inputs and assumptions that drove the model, operational process and controls. The age of the black box is dead! Above all else, the user needs to trust the robustness of the service and be comfortable recommending it to their clients.
Another factor here is the delivery of transparency not only to the users, but also to their end-clients. Connecting the vendor, the user and the end-client with the same amount of information greatly improves the quality and timeliness of resolving any queries or price challenges.
What about timeliness? Are we heading toward real (or near real)-time valuations pricing?
Given that the asset classes that lend themselves to evaluated prices are, except in some limited areas such as on-the-run US Treasury benchmarks, not real-time tick-by-tick markets, the notion of a real-time evaluation seems a little unusual. There are some services promoting this concept, but it is still new and remains to be seen whether it will develop into the orthodoxy.
Having said that, it is clear that many users now require multiple snap times and this trend is accelerating. The availability of this for all asset classes, however, is patchy. For some complex markets and OTC derivatives, an overnight batch valuations service, which allows the collection of all the required market data prior to evaluations, remains the norm. It is possible that this might improve with increasing access to liquid market data when some of this trading moves on-exchange.
Is there cross-over between valuations services designed for front office applications like trading and those geared toward portfolio valuations in the middle/back office?
This is the Holy Grail: front to back consistency on valuation. But it is surprisingly difficult to achieve in practice.
The whole approach to valuation differs in the front and back offices. In the front office, valuation tends to be forward looking – a trader or a fund manager will have a view, and possibly a position, in a specific instrument and, within reasonable limits, their assessment of the value will be informed by this view.
In the back office, and for vendors who service this market, the approach to valuation is essentially backward looking. A value is produced that reflects all the known market information relevant to this instrument at the time of the valuation. There is no attempt to second-guess this information or to tweak it to reflect a proprietary market or security-specific viewpoint. It would certainly be useful – and arguably sound practice – if the prices used in the front and back office were broadly aligned, but there are no guarantees.
What will be the next major developments in the valuations business?
We have already mentioned defensibility, which we believe will be the major driver for evaluations over the next few years. Increasing frequency of snap times and further expansion of coverage into previously poorly served areas are also likely.
One of the more interesting developments, though, relates to the requirement that many hitherto OTC-traded derivatives be exchange-traded and/or centrally cleared. This raises the prospect that much more market data on these rather opaque markets will become publicly available and consequently available for use in the evaluation process. One can expect that this will greatly improve the process for valuation of these asset types, but could it also be the spark for Big Data finally to get seriously involved in this segment?
