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SEC Rule 2a-5: A Modernized Framework For Fund Valuation Practices

You’ve probably been hearing a lot about SEC Rule 2a-5 since last December, when it was first announced, sparking a period of intense discussion. Essentially, SEC Rule 2a-5 establishes new requirements for determining fair value in good faith—requirements that could have far-reaching implications for many asset managers.

Primarily, the new rule calls for a “Valuation Designee” who will oversee and adjust fair value determination processes as well as regularly report any material changes to the board. The new rule also expands on which quotes can be considered Readily Available Market Quotations, using the fair value hierarchy found in the US GAAP (level 1/2/3 input system).

The rule goes into effect on March 8, 2021, a date that marks the beginning of an 18-month period for alignment and compliance that ends on September 22, 2022. In other words, all registered investment companies under the 1940 Act, as well as business development companies and unit investment trusts (UITs) whose initial date of deposit (or rollover) falls on or after the effective date of the rule, will need to comply with the rule by the September date.

Let’s talk about the Valuation Designee first, because it is the biggest change in the rule. This person must have fiduciary duties towards the fund. So, for example, they could be the fund adviser or a trustee/depositor (for UITs only). However, the Valuation Designee cannot be a portfolio manager and may not exert influence on the fair values of assets in the portfolio.

The Valuation Designee has a wide range of new responsibilities. The Valuation Designee (along with the board of directors) must actively oversee all of the following:
  • Periodic assessment and management of valuation risks
  • Establishment and application of fair value methodologies
  • Testing of fair value methodologies for appropriateness and accuracy
  • Oversight and evaluation of pricing services
  • Board reporting
  • Recordkeeping

One key point to keep in mind, however, is that the rule is not rigorously prescriptive. It establishes broad goals for fair value determination, but it does not dictate how asset managers meet these goals. For example, it does not establish one approach for making fair value determinations. It does not identify specific valuation risks for periodic assessment or indicate a specific frequency for reassessment.

That being said, the rule features more than a dozen new responsibilities firms will need to implement and manage in order to be compliant.

Fortunately, many of the steps involved in fair value determination—as well as the new responsibilities asset managers need to manage—can be handled or made more efficient through process automation.

IVP PRICING AUTOMATION,  is capable of handling a variety of these tasks, including:

  • Automation of pricing and valuation with a pricing engine that supports daily, weekly, monthly, and quarterly pricing needs, and can be set up with custom pricing rules and tests
  • Sourcing of evaluated prices from pricing vendors, broker dealers, MSG-1 services and valuation agents
  • Production of standard pricing reports, including a valuation committee package, as well as custom pricing reports for fund-specific needs
  • Automation of pricing for Mark to Model securities with support for native Valuation models and integration with spreadsheet-based models and pricing agents
  • Independent price verification with a built-in pricing audit feature as well as a time series view that shows all sources for a given price
  • Data quality checks that can be customized for various attributes
  • Analytics for pricing information, with key metrics on quality of quotes, attached market standard models for price computations, and calculated ASC 820 levels for securities

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