- What is it?
Financial institutions, regulators and finance ministers worldwide have, this year, been pressing the International Accounting Standards Board (IASB) to relax its rules on fair-value accounting. The rules force banks and others to value their assets at current market prices.
Asset holders argue that in times of illiquid and falling markets it is difficult or impossible to value assets accurately. Fair-value accounting is resulting in assets being valued at distressed sale prices, rather than at their fundamental value, creating a downward spiral.
The IASB has countered that any relaxation in the fair value rules would cloud the picture for investors and regulators and could sow the seeds of the next crisis. But last month it made a significant amendment to the rules.
- Who dreamed it up?
The IASB’s IAS 39 Financial Instruments: Recognition and Measurement is the standard which regulates how financial instruments are measured.
The Financial Stability Forum said earlier this year that there were “potential weaknesses” with fair valuation when markets are inactive. It called on the IASB to “enhance its guidance” on the matter – a euphemism for relaxing the rules.
The IASB set up an expert advisory panel on the topic. It produced a draft document in September – Measuring and Disclosing the Fair Value of Financial Instruments in Markets that are No Longer Active – but banks were disappointed by the proposals, which only offered guidance not the changes to IAS 39 that they wanted.
- What are the main provisions?
IAS 39 states that fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
- What’s in the small print?
IAS 39 separates financial assets into four classes:
- Those held for trading purposes;
- Those available for sale;
- Those held to maturity; and
- Loans and receivables.
The strictest rules apply to assets held for trading, and to impose discipline these assets cannot be reclassified.
- What does the industry say?
The British Bankers’ Association says accounting standards-setters must recognise that fair value is not always appropriate for valuing financial instruments.
It wrote to the IASB in September advocating a mixed-measurement model, which would continue to use the fair-value method for some instruments such as those held for trading purposes – and other, more relevant methods for those such as longer-term loans.
The BBA asked the IASB to make fast-track changes to IAS 39. These changes included a review of how different classes of assets are valued and, in particular, the immediate suspension of paragraph 50 of IAS 39 prohibiting reclassification from trading.
- How much will it cost?
If the rules were left unchanged, firms worldwide would continue to mark down asset values by billions of dollars more than necessary.
- What do the accounting standards-setters say?
The IASB admitted in September that the rules were problematic but it simply offered guidance. In mid-October it amended IAS 39 to allow assets held for trading to be reclassified so they could be valued differently.
But further changes may be demanded by banks. US authorities have been under similar pressure, and in September and October, announced similar relaxations of the US GAAP rules on fair-value accounting contained in FASB Statement 157, Fair Value Measurements.
- The law of unintended consequences
When IAS 39 was written, it was never imagined that it could exacerbate a financial crisis.
- Could we live without it?
Yes and we needed the amendments sooner.
