FSA issues ‘Dear CEO’ letter on valuation and product control

UK regulator hopes letter will prompt firms to improve controls

LONDON – The UK Financial Services Authority (FSA) has issued a ‘Dear CEO’ letter to individuals responsible for the apportionment and oversight of valuation controls in connection with large and/or complex principal trading operations within banks and investment firms. In the letter, Hector Sants, the FSA’s chief executive officer, urges firms to ensure the observations in this letter and its appendices are considered part of a firm’s continual development and improvement of its valuation control policies and processes.

Over the past 12 months, review work done by the FSA has found firms’ valuation processes and controls have become stretched, and in some instances are substantially flawed or inadequate. The regulator is concerned about the large number of material mis-marking cases that have taken place, as well as the failure of firms to implement processes to evaluate their position in relation to the FSA’s “prudent valuation principles”. It has also seen a tendency for firms to seek to cut costs in middle- and back-office functions as well as in front-office functions, and recommends firms consider carefully any headcount reduction exercises that will affect valuation control functions at this sensitive time.

The letter states valuation control processes will continue to be a focus area for the FSA and that it intends to conduct a number of visits to banks and investment firms with material trading operations in the first half of 2009 to evaluate progress in the application of the FSA’s prudent valuation principles.

The letter contains two appendices setting out the common drivers of recent mis-marking incidents, some observations about good practice that would assist in mitigating the risk of these incidents being repeated, and information on the FSA’s prudent valuation principles, including the steps the FSA expects firms to have taken to develop systems and processes to apply these principles to their trading businesses.

Click here for a copy of the letter