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News & opinion

27 8月 2018

Who is responsible for the valuations?

Shortly after the 2008 global financial crisis, the U.S. Securities and Exchange Commission (SEC) confronted the valuation profession in the United States, demanding that the profession improve the quality and consistency of fair value measurements for financial statement reporting valuations for SEC-registered companies.

Specifically, the SEC questioned whether individuals conducting fair value measurement estimates had the requisite training, qualifications, experience and expertise to perform this type of work.

Although the SEC’s criticisms were directed to valuation professionals performing fair value measurements for financial reporting, these criticisms can be also pointed to all valuation professionals and all other professionals involved with the valuation.

Hong Kong regulator expressed concerns in valuation quality

The SEC’s comments sparked a trend worldwide of regulators criticising the valuation profession and other professionals involved in valuations and calling for improvements to protect the public interest by providing consistent, supportable, and auditable valuations.

The Hong Kong Securities and Future Commission (SFC) has expressed similar concerns to those put forward by the SEC. With a market capitalisation of approximately HK$33.9 trillion, the Hong Kong Stock Exchange (HKEX) is the third-largest stock exchange in Asia and the sixth largest stock exchange in the world. The SFC was established in 1989 to maintain order, protect investors, and promote Hong Kong as an international financial centre. The Commission is also responsible for setting and enforcing market regulations.

Over the past few years, the SFC has become increasingly concerned that some companies traded on the Hong Kong Stock Exchange have acquired assets at unreasonably high prices or sold assets which were substantially undervalued. This impacts companies as well as company shareholders. Furthermore, the SFC was concerned by a pattern of responsibility shifting between the various parties involved in a valuation.

Guidance notes for listed companies' valuation stakeholders

To address these concerns, in May 2017 the SFC issued three documents, each targeted to a different audience responsible for a component of the valuation.

Guidance note on directors’ duties in the context of valuations in corporate transactions

The guidance note issued by the SFC reminds directors to perform independent due diligence regarding the subject interest (asset or company). Directors should not simply accept financial forecasts and assumptions provided by management of the target company or third-party adviser. Instead they should take all reasonable steps to verify the accuracy and reasonableness of material information that is likely to impact the valuation of the subject assets or target company. In addition, directors should not use valuers as a shield when it comes to valuations. They are responsible for engaging a valuer, ensuring valuers are qualified to perform the work and provide quality and independent valuations, and making sure to provide all relevant information to valuers.

Circular to Financial Advisers in relation to their advisory work on valuations in corporate transactions

The circular issued by the SFC, reminds financial advisers to conduct their own assessment and undertake reasonableness checks on the company forecasts, assumptions, qualifications and methodologies of the valuation and the directors’ decision on whether or not to appoint a business valuation professional. If the company forecasts are deemed to appear unjustifiably optimistic, the financial adviser should bring this to the attention of the directors for consideration and appropriate action.

Statement on the liability of valuers for disclosure of false or misleading information

The SFC also issued a ‘statement on the liability of valuers for disclosure of false or misleading information.’ The SFC said that is likely to investigate valuers if: (1) the valuer has carelessly accepted or should have known that certain assumptions are not fair and reasonable, (2) the valuer has made a clear mistake in the valuation, (3) the valuer has not exercised a degree of skill and care ordinarily exercised by reasonably competent members of the valuation profession, and (4) the valuer is not independent or impartial when performing the valuation.

These three documents reinforce the idea that all parties, including company directors, financial advisors and valuers, involved in the valuations are accountable and need to act with professionalism. In addition, consistent, transparent and quality valuations will help management boards, company directors and other third parties to accurately assess the value of assets and companies in the decision-making process. Moreover, to ensure the public maintains its confidence in the HKEX, all parties that manage, advise or provide valuation services have an obligation to protect shareholders and the public.

IVS and CEIV provide quality assurance regime

The criticisms expressed by market regulators, in Hong Kong, the US, and other markets, have been a wake-up call to the valuation profession. The valuation profession has an opportunity to set a path for the future of the profession by developing an infrastructure and placing quality as its primary objective through the International Valuation Standards (IVS) 2017 and a new credential, known as the Certified in Entity and Intangible Valuations (CEIV), which both aim to guide the valuation profession on this journey.

The International Valuation Standards Council (IVSC) is responsible for developing IVS for valuations on which investors and other stakeholders rely. The objective of IVS is to increase the confidence and trust of users of valuation services by establishing transparent and consistent valuation practices such as the development of fundamental valuation principles and concepts and identify commonly used methods for valuing a subject interest.

To address criticisms by the SEC, RICS representatives have collaborated with representatives from the ASA and the AICPA, the Appraisal Foundation, the International Valuation Standards Council and several international public accounting firms to develop the shared CEIV credential for the business valuation profession. It is expected that the new CEIV credential will help unify the valuation professionals with a common framework called the Mandatory Performance Framework (MPF). This framework would reduce expectation gaps between the valuation professional and regulators, auditors and company management/directors.

CEIV addresses Hong Kong regulator concerns

Company directors, valuers, and other professionals in Hong Kong may find the MPF useful and can use it as a guide to ensure they address certain concerns raised by the SFC in its guidance note. The MPF addresses certain topics (but are not limited to):

  • Forecasts or prospective financial information — evaluate for reasonableness.
  • Professional scepticism — regularly question information provided by management.
  • Contrary evidence — explanation of how this information was considered.
  • Professional judgment — supported by objective evidence.
  • Discount rate — support for the alpha or company specific risk adjustment.
  • Attrition — avoid unsupportable representations by management.

In addition, professionals seeking this credential will have to meet rigorous education and experience requirements which include demonstrating competencies in valuation of entities and intangible assets, and fair value measurement through training and passing a two-part CEIV certification exam. More importantly, the credential adds an additional layer of quality control strengthening public trust and regulator confidence. CEIV credential holders are required to submit to an annual, proactive engagement-level Quality Monitoring Program. The program’s goal is to ensure that high-quality valuations are performed in accordance with the new Mandatory Performance Framework. Notwithstanding the CEIV name, the ‘CEIV framework’ stands for standards, qualifications and quality assurance.

The IVS and the CEIV will help inspire confidence in the quality and consistency of the valuation work performed and improves market confidence and brings a higher level of professionalism and accountability to those committed to enhancing audit quality, consistency and transparency in valuations. Although the CEIV is a credential and specific for business valuation professionals performing fair value measurements for SEC-registered companies, other markets can use and adjust this ‘framework’ or develop a similar ‘framework’ for other asset classes and many other valuation purposes to ensure quality valuations are performed to protect the public interest.

The above article was published in the summer 2018 issue of the Chamber of Hong Kong Listed Company Magazine.

It was originally written by RICS Global Business Valuation Standards Director Steve Choi.