The 2008 financial meltdown created a credit crisis not seen in decades. Overleveraged equities, subprime mortgage failures and bankruptcy filings caused many shops to face diminishing resources and unprecedented runs on redemptions. These difficulties have generated elevated concerns and a cloak of uncertainty within the financial industry. Additionally, regulation surrounding enhanced disclosure—including Summary Prospectus, FASB Statement No. 157, FASB Staff Position (FSP) FAS 157-3, FASB Staff Position (FSP) 133-1 and FASB Statement No. 161—has increased reporting complexity and forced funds to rethink valuation and pricing due diligence.

2009 Playbook: A Return to the Basics
With multiple pricing vendors operating in the marketplace and the regulatory mandate for greater transparency in governance, funds are demanding more detail from their service providers regarding the process and data employed in circumstances where fair market values are not readily available. Add to this backdrop the pricing of derivatives and other nontraditional investments, combined with the absence of readily available market quotations and increased pressure on funds themselves to adhere to tightening corporate governance standards, and the valuation challenges facing mutual funds become even more complex.

“Because the objective of fair value pricing is not standardized or clearly delineated, the manner and degree to which funds make fair value adjustments can vary widely among funds,” says Peter Donatio, Executive Director, Fund Accounting and Administration.

The SEC’s guidance on fair value pricing and the decisions implemented by regulators in 2009 will be magnified by the need for risk management, transparency and independent valuations across asset classes.
At a recent industry conference, the associate director of the SEC’s Office of Compliance Inspections and Examinations (OCIE) outlined several key governance areas in 2009:
• Valuation process and oversight
• Securities lending
• Funds and illiquid positions
• Risk management of fund liquidity/illiquidity

With these regulations come many compliance challenges, including monitoring and documentation, fully understanding the challenges and opportunities, having the ability to craft all disclosure in plain English and having the resources to review disclosures for inaccuracies and omissions. To this end, fund managers should consider five best practices as cornerstones of their valuation processes:

1. Process
Well-documented procedures, including a hierarchy of pricing sources and flexibility in the process for judgment
2. People
A balanced mix, including finance and accounting, investment, and legal and compliance professionals
3. “Lessons learned” program
Post-meeting reflection that captures valuable insights on how the procedures are operating and key changes or updates needed
4. Documentation
Board reporting that explains any inconsistent evidence
and reasons behind pricing challenges
5. Diligence
A testing plan for monitoring quoted versus actual prices, and due diligence from the board to ensure valuation questions are answered satisfactorily

“In lieu of the aforementioned regulations and best practices, mutual fund boards and chief compliance officers rely heavily on service providers’ expertise to help them navigate security valuations,” Donatio says. “With the requirement for increasing scrutiny, greater transparency and proactive risk management, having the right provider is key to staying in the game.”

J.P. Morgan works with mutual fund clients to confront these challenges head-on. We leverage the multidimensional capabilities of the entire J.P. Morgan franchise to assist clients in onboarding new processes, procedures and technology to manage and solve their valuation challenges.

We developed our FAS 157 Fair Value Hierarchy through a committee of experts from our accounting product management, operations, pricing and financial reporting teams, along with risk management, legal and our corporate accounting policy group—in partnership with external pricing vendors, audit firms and the Investment Company Institute. Donatio stresses the importance of providing customized solutions. “Our structure and philosophy have enabled us to provide a significantly higher degree of flexibility and value to our fund clients through a process that shares and implements best practices more rapidly and seamlessly.”

J.P. Morgan’s customizable pricing platform emphasizes the ‘science’ of pricing and eliminates the ‘art’ and provides, among many services:
• An accounting system that assigns and tracks FAS 157 Level data
• Policy analysis and a ‘default’ for FAS 157 leveling
• Processes to ensure compliance with the valuation hierarchy
• Procedure documentation to support audit requirements
• Identification of the data requirements for disclosure reporting
• Client reporting capabilities to support disclosure requirements
• Updates (if necessary) to our FAS 157 solution based on changes initiated by FASB and/or   from feedback from clients, industry practitioners and audit firms

This approach to FAS 157 supports our clients in meeting their requirements under the regulation. Enhanced functionality gives J.P. Morgan the capability to assign the Levels of the Fair Value Hierarchy to securities in clients’ portfolios and provide reporting to support the required disclosures. This program provides clients with the necessary transparency into the values applied to portfolio holdings.

The depth and breadth of J.P. Morgan’s expertise provide a unique advantage for the firm’s mutual fund clients. The firm’s prominent presence in most global markets offers close access to best practices in valuation from a multitude of sources. And because the J.P. Morgan businesses are highly integrated, consistent implementation across the organization is easily facilitated.

“The marketplace is evolving daily, and J.P. Morgan’s global reach allows us greater market access to assist our clients in the future challenges they face,” says Donatio. “In essence, our ability to consult with our clients and customize solutions for them is a tactical way of leveraging our global reach, every day.”