Through an auditor’s lens: structured products valuation

Industry standards in valuation

In the financial reporting ecosystem, the valuation of Level 2 and 3 assets is a high-wire act requiring a meticulous balance of precision and insight. The importance of implementing industry standards to guide the valuation process cannot be overstated, as they serve as a bulwark against the risks of valuation inconsistencies and the subsequent domino effect on audit reviews.

A well-documented, auditable valuation model is the cornerstone of an efficient process. It serves as a safeguard against excessive audit inquiries, providing a clear trail of assumptions, methodologies and data sources that auditors can follow. This degree of documentation is particularly vital for Level 3 assets, for which the lack of observable market data means valuations are often based on internal models or estimates. Here, transparency is not just a buzzword — it’s a rigorous requirement that can make or break the credibility of a valuation.

Moreover, the importance of controls testing cannot be overstated. It acts as a quality check, so that the valuation model and methodologies are not only theoretically sound but also practical and reliable. Assessing these controls is a meticulous task. For many organizations, the complexities and the need for specialized knowledge lead them to seek external support. Third-party valuation professionals can bring a wealth of experience and knowledge to the table. By outsourcing these critical functions, companies can alleviate the pressures associated with controls testing and improve the robustness of their valuation processes.

Conclusion

The valuation of structured products is a critical component of financial reporting and investment decision-making. As we have explored, it is a complex process that requires a deep understanding of the underlying assets, market dynamics and regulatory frameworks. The three-tiered system of asset valuation presents varying degrees of difficulty, with Level 3 assets requiring the most sophisticated estimation techniques due to their reliance on unobservable inputs.

The guidance provided by ASC 820, with its emphasis on the income, market and cost approaches, is essential for achieving accurate valuations. DCF analysis, in particular, is a powerful tool for Level 2 and 3 assets, but it is heavily dependent on the selection of credible and verifiable market-based assumptions and robust validated models. Auditors play a crucial role in scrutinizing these assumptions and establishing that they are grounded in empirical evidence and reflective of market conditions. Challenges arise when valuations are influenced by subjective client-centric perspectives rather than objective market participant views. This can lead to discrepancies that are costly and time-consuming to reconcile.

To mitigate these risks, industry standards should be followed. A well-documented and auditable valuation model is fundamental, providing a clear path for auditors to pressure-test assumptions and methodologies. Controls testing further safeguards the reliability and applicability of valuation models, with many organizations turning to third-party professionals for their specialized knowledge and experience.

To sum up, through the lens of an auditor, the valuation of structured products is a nuanced and intricate process that is integral to the integrity of financial reporting. Companies must prioritize precision, transparency and adherence to industry standards to uphold confidence in their financial assessments and strategic decisions. As stakeholders navigate this complex terrain, they are encouraged to engage with valuation professionals who can offer the right depth of insight and knowledge. By doing so, they will not only streamline the valuation process but also reinforce the robustness of their financial reporting — ultimately driving informed investment choices and strategic growth.