The five operational issues private debt audits must address

Audits are a fact of life when it comes to funds or special purpose vehicles (SPVs) investing in private debt, but it doesn’t necessarily follow they have to be a painful experience. Frustrations can be common when it comes to going through the audit process, but the good news is they can be mitigated. Smart planning and using experienced auditors with sector expertise can go a long way. 

Not only that, but practical, expert auditors can be a benefit rather than a hindrance. They’ll ask concise, relevant questions, rather than wasting your time with uninformed  and at time irrelevant queries. And in firms like ours, with dedicated audit and support teams  for private credit structures, we can avoid audit bottlenecks and crises. 

More importantly, by bringing deep insight about the nuances of private debt and the audit process itself, a good auditor can add significant value.

At Grant Thornton, we’ve identified five core operational issues that must be addressed during the audit of entities investing in private debt. Problems on any of these fronts can cause frustration for stakeholders and service providers involved such as loan servicers, corporate service providers, fund administrators and others. 

Read on to discover our approach for each issue along with how to prepare so your next audit goes smoothly.

Valuations

As with all audits, it’s vital to plan well, particularly around the valuation of private credit investments. At Grant Thornton, we ask relevant questions and communicate what we need in plenty of time to assist our work around the value debt assets and help us to understand any nuance complexities involved.

Ultimately, the value of the assets in any investment vehicle is a key area of focus for both auditors and stakeholders. Key considerations for private credit asset valuations involve ensuring financial assets held are correctly valued in line with the relevant accounting framework regardless if they are valued at fair value or amortised cost. 

Auditors must identify, assess and challenge the key inputs used as part of the valuation process, with particular focus on those that require significant judgment or estimates. Those can include discount rates, expected default rates, recovery rates and so on. 

While evaluating the controls in the valuation process, as auditors we must also determine if any potential management bias or other overriding factor could undermine those controls and render them ineffective. Valuation methodologies can differ, so as auditors, we also see it as vital to review the methodologies being used and, if applicable, the suitability of any third-party valuation expert being used. 

Valuations: how to prepare

To facilitate effective valuation work, make sure you get organised in advance with:

• a clearly defined and documented investment valuation methodology,
• preparing detailed documentation around the rationale for key inputs and any significant judgements and/or estimates in the valuation along with a relevant sensitivity analysis,
• having independent valuation reports available (if applicable), and
• having an IFRS 9-compliant ECL provisioning model available (if applicable) – this should be supported by forecasts, information on historical performance, detailed documentation and support for any key inputs, judgements and/or estimates and so on. 

Loan origination and credit risk

On this front, auditors must evaluate controls around loan underwriting, impairment reviews, credit risk control, regulatory compliance around loan originations and more.

Evaluating your credit risk framework

Auditors may need to assess your credit risk framework (if loans are originated by the entity) and ensure it’s in line with relevant credit risk policies. This framework would include your:

• loan monitoring process,
• risk framework, 
• credit rating/scoring process, and 
• collateral valuations process (including information about its frequency and so on). 

Auditors may also seek to understand and evaluate client criteria for identifying and accounting for non-performing loans and impairment provisions. Likewise, we need to ensure the client is fully compliant with the relevant accounting framework.

Loan origination/credit risk: how to prepare

Before the audit, plan ahead by collating the right documentation. This would include:

• evidence that you’re carrying out continuous reviews of loan performance, compliance with covenants and so on
• clear evidence of your criteria for impairment indicators or triggers and any action you would or do take if there are signs an asset is impaired, and
• evidence you’re monitoring credit risk policies and sticking to them. 

Investor reporting

While investor reporting doesn’t necessarily have a huge impact on the audit process, it’s a key stakeholder consideration, with the relevant data inevitably intertwined to a degree. Investors must be confident the information they receive is valid and accurate. 

First and foremost, entities must comply with the relevant timelines for investor reporting. For example, audited financial statements must be provided within a certain period after the financial year end..

Investor reporting: how to prepare

When it comes to getting ready for the audit on this front, you’ll need to pull together evidence of your organisation’s compliance with all pre-agreed investor reporting obligations. You’ll also have to be ready to offer full transparency on all expenses and fees, including detailed calculations supported by relevant agreements.

Compliance and regulatory requirements

A core element of any audit is testing internal policies and controls and ensuring full compliance with all regulatory requirements. In the case of private debt, these can come from:

• the Central Bank of Ireland,
• the Alternative Investment Fund Managers Directive (AIFMD),
• the US Securities and Exchange Commission (SEC),
• the US Foreign Account Tax Compliance Act (FATCA),
• listing requirements of applicable stock exchanges, and,
• Companies Registration Office, among others.

It’s also vital for clients to ensure they are compliant with the requirements of key investor/fund documents (such as offering documents).

Compliance and regulatory requirements: how to prepare

Ahead of any audit, gather all evidence of up-to-date regulatory filings, along with evidence the company has held regular board meetings. This should include detailed minutes.

Make sure all investor anti-money laundering (AML) and know your customer (KYC) documentation is properly maintained and ensure relevant teams are up to speed on agreed/potential future regulatory changes.

Data quality and controls

Bad data can derail the success of any project. Auditors of private credit entities will ensure their clients’ IT systems meet the requirements of all relevant auditing standards. They must also assess the effectiveness of controls around data inputs, reconciliations and so on.

Furthermore, they may reperform any key manual calculations such as testing the accuracy and completeness of relevant loan data, interest rates, maturity dates, covenants and more.

Data quality and controls: how to prepare

Before the auditors are in house, make sure you have the right processes in place year-round to underpin:

• full audit trails and documentation of any changes to IT systems or underlying data (loan data, valuation models and so on)
• robust data protection measures around confidential investor and/or borrower information
• sufficient segregation of duties around IT access and security
• reconciliations and data integrity checks across key source documents.

Expertise and support for private debt audits

Grant Thornton has dedicated teams performing the audits of private credit structures all year round. They have strong expertise in private credit audits and detailed knowledge of regulatory requirements. The audit team also works with our dedicated qualitative analytics team, which helps with valuations, and any other expert support teams deemed necessary. 

Our partner-led approach includes early engagement so we can identify known and potential issues and get ahead of them. We can also draw on the global Grant Thornton network as needed.

Talk to us today about achieving clarity, accuracy and compliance in your audits.

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