Everything of value is calculable
“Everything of value is vulnerable.” Lucebert wrote this line in a poem in 1974, and it can still be seen in neon letters on the front of a building in Rotterdam today. Value as a symbol of life’s vulnerability.
Fixing the value
In the financial markets it is less prosaic; the ‘exact’ value of shares and instruments is crucial. With shares listed on the stock exchange, defining their value is relatively simple, as long as the price is a result of supply and demand. Fixing the value of unlisted financial instruments, and/or off-balance sheet agreements between different parties, often seems more difficult.
Correct valuation is really crucial for adequate balance sheet management. Accountants have therefore set out a number of directives in the International Financial Reporting Standards (IFRS) to determine a correct valuation. For example, on the basis of mark-to-market comparisons with similar instruments. If that doesn’t work, then a mark-to-model approach offers a solution.
Investing in mortgages
In the news recently, it was reported that a number of Dutch pension funds are again going to offer mortgages. Investing in mortgages is quite attractive now that the return on lending on bonds has hit an all-time low. These pension funds provide mortgages via a mortgage fund which takes over a part of the business from a market player. Before a fund manager is able to offer this, a whole range of things have to be set up. Such as working out the legal and fiscal framework, but also an impartial validation of the initial model to determine the value of the mortgage portfolio. As soon as they are invested, the mortgages are then valued periodically (on the mark-to-model basis).
Independent valuation of financial instruments is increasingly required by the financial regulation frameworks, Markets in Financial Instruments Directive (MiFID) and the IFRS. Our valuation desk, a fully independent market operator, carries out model validation and instrument valuation for authorities, companies and investment managers. Valuation can be done on a daily basis, but usually it’s monthly, annually or once only.
For example, for investment funds, periodic valuation is necessary. These include mostly interest rate and currency swaps, but also all sorts of exotic options or embedded derivatives. An interesting example of a one-off requirement for valuation concerns a businessman who had an issue with the tax inspector about the value of an out-performance right to sold development land. If the value of the land rose above x% of the purchase price, then this entrepreneur was entitled to a percentage of the extra value. The value of this call option has direct tax consequences. Our task was to calculate an adequate and independent valuation of this option right for him.
A solid foundation for the valuation assessment was of vital importance as it had to stand up in court in the event of fiscal arbitration. The valuation desk differs from other pure application information suppliers in its valuation of financial instruments by price-change analysis and instant services on technique and input. By determining which parameters bring about a change in value, the manager and controllers pick up important signals whereby the overall picture, insight and therefore more clarity are obtained. “Everything of value is calculable”: on the valuation desk, that’s what we know.