Changing Evaluated Pricing Methodologies

As a panel focusing on evaluated prices was coming to a close at a recent Financial Information Services Division meeting held in London, an end-user raised a question about vendor policies on changing pricing methodologies. And it seems the user is not alone in having concerns about how changes are communicated and processed.

In the past few years, discussions in the evaluated prices space have always seemed to return to the issue of lack of transparency, and the need for greater communication between data providers and users. The discussions about transparency have now also reached the methodology-stage, as users are looking for transparency into pricing methods used and communication when the methods change.

Staying on top of the latest academic discussions, facilitating data accuracy and boosting transparency remain key drivers behind the need for vendors to adapt, change or slightly tweak a methodology. The problem for data consumers is that they want to make sure they are informed about the decisons to make these changes, and that they are given sufficient time to inform their own customers and test the new methods.

New York-based Brian Sentance, chief executive at analytics and data management software provider Xenomorph, says the lack of communication can sometimes stem from the pricing model vendors and evaluation service providers’ belief their methodology is the value-added factor that gives them the ability to differentiate their services from the services other people offer.

“The negative side of this belief is that some of them are less transparent, or less willing to actually expose their valuation methodology to their clients because of the proprietary nature of what they are doing. As a result, some still operate a “black box” approach to sharing, or rather not sharing, what they are doing with clients,” says Sentance.

The level of communication varies from vendor to vendor. In some cases, data consumers have simply accepted they will not be informed about changes to the underlying methodologies, and this then becomes a case of trusting the vendors to choose the best approach.

A Paris-based valuations expert says that while his firm does work with four providers in the field, they have not had any discussions about changing methodologies for the past two years. “They [the vendors] do not share any information regarding a potential change to the model until it is carried out. If a change has taken place, we will receive a document stating this is the case, but there will be no actual communication between us and our providers,” he says.

Obtaining consensus on evaluated prices can be very complex, and this is why not all consumers see the need to know about the changes up front if it is not essential to the pricing process or final price. “As long as the change is only minor, receiving only minimum information from our providers regarding the change isn’t a problem, as we ourselves will be able to see there has been a change in the prices,” says the Paris-based user.

Still, some types of changes are important to communicate. The user says the company would want to be informed if a vendor were to use an approximation instead of a calculation, for example.

This is also in line with the approach some vendors take, saying it is not necessary to inform a client of minor changes to the methodology if there is going to be no major impact on the final price. But when there is a major change this change will have to be communicated well in advance.

Paris-based Phillipe Rozental, head of asset servicing at Société Générale, says while changing methodologies isn’t high up their list of concerns at the moment, he does not think providers communicate potential major changes early enough to enable the group to prepare.

Rozental explains timing has, in fact, been an issue in the past when one provider only informed them of an upcoming change one week prior to the change taking place. “In this particular case, we were informed one week ahead of time when we would really need to be told around one month in advance [to prepare for this particular type of change],” he says.

“We do expect our providers to inform us of the changes they carry out, including the minor tweaks, just like we inform our customers, but sometimes we are informed on a last-minute basis,” he adds.

The Provider View

The financial crisis has led to a growing demand for evaluated prices, and teams have had to ensure they keep up with client requirements for transparency.

London-based Ian Blance, head of evaluated pricing business development, SIX Telekurs, says communication when it comes to methodology changes should be a priority, despite the fact not all users see the smaller tweaks as critical.

“As far as there is a material impact in the way you are pricing a security, we do need to make sure those messages are fully communicated to the client,” he says, explaining typically the vendor would inform clients in a two-fold way by giving them advanced notice of usually around 60 days prior to carrying out the change, as well as informing clients about the change when it has taken place.

“A major [change] in the methodology used would inevitably have to lead to a thorough communications exercise, especially if you are completely changing the way you price a security, as in doing so there is every chance there will be some substantial changes in the final prices,” explains Blance, adding that SIX Telekurs also informs clients of the minor tweaks such as minor changes to cashflows or option pricing.

London-based Anthony Belcher, director, European fixed income, Interactive Data, says prior to carrying out any change, whether small or potentially major, it is important to discuss with clients to receive their direct feedback. The last time Interactive Data made a major methodology change in its European fixed-income evaluation services was in August 2008, when the pricing time was moved from 16:30 to 16:15pm UK time to more accurately reflect when the end-of-trading day occurred.

“Prior to sending them notices, we discussed the change with clients to know what their views were on this, as well as whether it was something they were seeing in the market-place,” he says. “In that instance, the change didn’t have a significant impact on the evaluated prices as generally most of the trading had already occurred by that point in the day, so typically neither the benchmark curves nor the credit information would change in a significant fashion between those two points in time,” adds Belcher.

While some users seem content with little or no communication with their providers regarding the methodologies used or potential minor changes, market participants agree there is no question the greater the impact on the final price, the greater the need for timely information about that change. Because of the different expectations, it is up to clients to make sure vendors know what they want from them.