ImPACT ON THE CAIssE’s INvEsTmENTs
The Caisse believes that these fair value standards provide a coherent framework, but that they must be applied with discernment. These highly restrictive standards ignore the fact that, given the very long investment horizon of its major depositors, the Caisse has the resources and the intention to hold certain investments until their optimal value is reached. As a result, the fair value determined as at December 31, 2012, for less liquid investments, such as real estate, private equity, infrastructure, commercial debt and commercial mortgages, reflects the overall volatility of the financial markets and therefore may differ from the economic value of such invest- ments over the long term.
EsTABLIsHINg FAIR vALUE AT THE CAIssE
The fair value of investments is established first as a function of real transactions involving identical or comparable assets in active markets. But if there are no observable data or the markets are inactive, that is, no purchases or sales are taking place, the Caisse must establish fair value using valuation methods. The main valuation methods currently used are discounting of cash flows and the earnings multiples of comparable companies. The main variables used by these methods are cash flows, discount rates, financing and illiquidity premiums, EBITDA multiples and price-earnings multiples. These variables involve a degree of subjectivity that may differ from one valuator to another.
Liquid investments
The fair value of liquid investments is established from prices quoted on major stock exchanges and prices or data provided by securities dealers or other recognized specialized organizations, and from valuation methods used on capital markets, such as discounting of cash flows, which is based on directly or indirectly observable data. Twice a year, the fair value of all portfolios of unlisted liquid products is reviewed by independent external firms. Valuation of these products, which include bonds and over-the-counter derivative financial instruments, is based on valuation models and input data.
Less liquid investments
Private equity and infrastructure
The fair value of private equity and infrastructure investments is determined semi-annually, at June 30 and December 31, unless significant circumstances require a change in the value of an investment at another time during the year.
Fair value is established by an internal valuation team, independent of the investment units. Investments whose fair value exceeds a predetermined materiality threshold must be submitted to an independent valuation committee or an external valuator. The committee, which reports to the Caisse’s Audit Committee, is composed of independent valuation profes- sionals. The co-auditors attend the committee’s meetings as observers. The process is complemented internally by regular and one-time valuations, as events occur.
Fair Value
Real estate investments
For the preparation of the combined financial statements, the fair value of real estate investments is determined semi- annually, at June 30 and December 31, unless significant known circumstances require a one-time investment valuation adjustment. External chartered appraisers certify the fair value of the Real Estate portfolio’s assets. In addition, the real estate subsidiaries’ external auditors audit fair values during prepa- ration of audited financial statements.
Furthermore, IFRS were early adopted in 2012 for the Real Estate portfolio. According to IFRS, this portfolio is consi- dered an investment entity and the new accounting standard requires that the subsidiary Ivanhoé Cambridge be valued and presented as an investment that reflects the fair value of the business. This value was determined by independent external appraisers and reflects, among other things, the fair value of the real estate assets, the quality of the portfolio and the integrated management of the platform.
The fair value of mortgage loans and securities is established monthly from the discounted value of future contractual cash flows at the market interest rate. The rate is that which could be obtained for loans or securities with similar terms and maturities. In cases where the timing of cash flows cannot be estimated with reasonable reliability, fair value is either the fair value of any asset given as collateral, net of expected costs of realization and any amount legally owed to borrowers, or the mortgages’ observable market price. The fair value of these investments is reviewed semi-annually by independent external firms.
ABTNs
Asset-backed term notes (ABTNs) are financial instruments with an average maturity of four years. To provide an economic hedge so as to reduce the risk of loss inherent in changes in the ABTNs’ fair value and of possible collateral calls, the Caisse uses derivative financial instruments, such as credit default swaps and interest rate swaps.
The MAV 1 ABTNs and some ABTNs excluded from the restructuring agreement are essentially composed of credit default swaps and pledged assets. The fair value of the credit default swaps is established with valuation techniques that are based as much as possible on observable market data, such as credit spreads, correlation factors and an illiquidity premium, which is calculated from the spread between the bid and ask prices of similar financial instruments traded on the market. For the other ABTNs, the Caisse established fair values using a valuation technique based on a financial model whose assump- tions use observable market data, such as interest rates and credit quality, as much as possible.
All the data and methodologies used to establish the fair value of the ABTNs as at December 31, 2012, were reviewed by an independent external firm.