Shortly before publishing its findings in connection with the Valuations Review, the FCA announced on 26 February 2025 in a Dear CEO letter addressed to asset managers that it will be conducting a multi-firm review of conflicts of interest at firms managing private assets (Conflicts Review). In addition to a review of conflicts practices, the Dear CEO letter also announced:

(i) A multi-firm review of the application of the Consumer Duty in model portfolio services,

(ii) Review of private funds’ financial crime systems and controls,

(iii) Continued focus on liquidity risk, and

(iv) Engagement with firms that offer sustainability-related products in connection with sustainability disclosure and anti-greenwashing rules.

This alert focusses on the conflicts aspects and provides an overview of the current conflicts rules, the reasons for the Conflicts Review and the potential implications on businesses that hold private assets. It will be relevant to institutional investors and managers of private assets including private credit and private asset funds.

Current conflict rules

The key principles applicable to alternative investment funds (AIF) in the UK are set out in Chapter 10 (Conflicts of Interest) of the FCA’s Senior Management Arrangements, Systems and Controls sourcebook (SYSC). By way of summary, the key requirements with which AIF managers need to comply include:

• Taking all reasonable steps to avoid conflicts of interest, including those arising between the AIF manager and the AIF, among AIFs, and between clients of the AIF manager;
• Maintaining and operating effective organisational and administrative arrangements to identify and prevent or manage conflicts of interest; and
• Disclosing any conflicts of interest to investors where the AIF manager does not have reasonable confidence that any risk of damage to the interests of the client will be prevented.

Reasons for FCA action

The FCA is concerned about the impact poorly managed conflicts of interest may have on asset valuations. In its Valuations Review, the FCA found that valuation-related conflicts were often documented generically rather than identifying specific conflicts in respect of particular products or transactions (Section 21.2.2). The FCA highlights six areas, further summarised below, which firms should focus on improving:

1. Inflation of fees and remuneration

The FCA is particularly concerned with situations where valuations are used to price transactions or to calculate fees, which incentivises firms to inflate valuations and charge investors inappropriately. For example, a direct link between the current net asset value (NAV) calculated using valuations and the fees paid by investors (Section 22) increases the potential for conflict between the interests of the manager and those of investors.

Fees linked to unrealised performance also may lead to an indirect conflict of interest with employee remuneration where such remuneration is based on a profit-sharing scheme or if valuations affect the perception of an individual’s performance (Section 29).

2. Asset transfers

The Valuations Review also highlights valuation-related conflicts arising in a transfer of value between investors where the manager’s valuation determines the transfer price (Section 23). One example given by the FCA in its letter of such transfers of value is the increased use of continuation funds. A firm may transfer assets owned by one of its funds to a continuation fund to realise any investment returns for investors of the first fund. However, as the firm also manages the continuation fund, it may be incentivised to value the assets being transferred at a lower price to maximise the appeal of an investment in the continuation fund.

The FCA’s Valuations Review suggests that, going forward, the FCA will focus on the access to information on price and valuation given to incoming and exiting investors. Although asset prices are frequently determined by incoming investors submitting a bid to existing investors, the FCA suggests that it will focus on the information provided by firms to guide this process (Section 23).

3. Redemptions and subscriptions

In its Valuations Review, the FCA criticises firms for failing to identify products that offer redemptions and subscriptions as carrying an increased risk from a conflicts perspective: Such conflicts can easily arise between exiting and remaining investors, especially where the frequency of valuations is not aligned with the dealing frequency (Section 24).

In addition, investment trusts were categorised as higher risk by the FCA due to the reliance placed on NAV calculations by buyers and sellers of investment trust shares and by other stakeholders.

4. Investor marketing

A further area of risk the FCA identified is using the unrealised performance of existing funds in marketing of new vehicles (Section 25). The FCA found that firms do not adequately address the risk that unrealised performance could be presented more favourably to increase fundraising. To address this, firms should separate unrealised and realised investments in marking materials, comment on the approach used to value unrealised performance and present the components of unrealised value.

5. Secured borrowing

Few firms identified the potential conflict of interest arising where borrowing is secured against a fund’s portfolio of assets, the regulator noted. Valuations may be inflated to attract a greater amount of available borrow or to avoid triggering LTV ratio clauses in facility agreements (Section 27).

6. Volatility

In case studies before the FCA, certain firms applied valuation methodologies to provide a less volatile valuation profile over time with a better opportunity for an uplift on exit (Section 28).

Conflicts Review focus

In its Dear CEO letter, the FCA identifies more general concerns about conflicts of interest:

1. Firms with multiple product lines

The FCA is focussed on firms that operate multiple intersecting business lines, continuation funds, co-investment opportunities or that partner with other financial institutions, thereby creating an increased likelihood that a conflict of interest could arise.

2. Investor decision-making

As stated above, the FCA is concerned with the implications of inaccurate price valuations and the impact this has on investor decision-making. Obscuring price transparency is detrimental to informed decision-making by investors, which increases investor risk across the market both in terms of the severity and likelihood of adverse consequences.

In particular, the FCA states that the Conflicts Review will focus on the use of governance bodies and reviews by the “three lines of defence” to ensure policies are effectively implemented. In its letter, the FCA emphasises its expectation that conflicts policies must evolve to meet requirements of increasingly complex private markets.

Potential implications

The FCA notes in its Valuations Review that it expects firms to consider the valuation-related risk areas it has identified and, where relevant, focus on documenting and mitigating or managing conflicts arising in such areas (Section 32).

When conducting its Conflicts Review, the FCA is likely to select firms that operate intersecting business lines which may give rise to conflicts of interest including firms that have in-house valuation functions and make use of continuation funds.

The precise implications of the Conflicts Review will depend on the FCA’s findings. Potential outcomes could include the issuance of fresh guidance on conflicts or a consultation on amendments to the conflict rules.

Next steps

Mangers of funds should act now to review and evaluate conflict-of-interest risks to improve their current governance and control processes in line with the FCA’s Valuations Review recommendations.

The FCA will conduct follow up work with firms that performed badly in its Valuations Review. It has identified the independence and expertise of valuation committees as one specific area of follow up.

The FCA has put firms on notice that it will be following up with firms where senior investment professionals were voting members in valuation committees, to understand how their position as voting members is consistent with the independence of the decisions made and whether their role compromises independent oversight and challenge.

Any firms currently operating in ways that are inconsistent with the FCA’s expectations, including in particular those that were subject to the Valuations Review and have performed poorly in relation to their peers, should take action to ensure that they take steps to improve performance in this area. Firms may find the following questions helpful when considering how they manage the conflicts risks that they face:

• Are valuation-related conflicts of interest identified in sufficient detail for products and transactions, with consideration of their materiality and specific mitigations?
• If valuation processes are carried out in-house, is there sufficient and appropriate independence and segregation between the valuations team and portfolio managers?
• Is there an independent valuations committee to oversee and review the valuations process?
• Are internal conflicts policies implemented effectively and adhered to by employees? Is evidence recorded and available that will demonstrate the effective implementation of the conflicts policies?
• Are effective “three lines of defence” in place for all areas of the business?

If you have any questions about the FCA’s Dear CEO letter or its Valuations Report, please contact our financial regulatory team.

Client Alert 2025-038