January 2010: Do banks need special accounting standards?
In a speech to the Institute of Chartered Accountants in England and Wales, Adair Turner, Chairman of the UK Financial Services Authority discussed the question: Banks are different: should accounting reflect that fact? He set out the issue as follows:
Whether that should be the case is now subject to intense debate, with two very different points of view.
- Among bank prudential regulators and central banks there is a belief that existing bank accounting standards were among the factors contributing to the crisis, inducing procyclicality in credit provision and pricing. And there is a demand that bank accounting standards must reflect the concerns of prudential regulators. There is a belief that banks are different, and that accounting standards need to recognise this.
- Among many securities analysts and investors, however, and among some accounting standards setters, there is a belief that accounts are for investors and not for regulators, that they must tell the ‘truth’ as it exists at one particular point in time, and that any influence of prudential regulators on bank accounting standards could be a Trojan horse for a wider politicisation.
This tension exists even within the regulatory community. Around the table of the international Financial Stability Board, the prudential regulators and central banks are the most convinced that banks are different and that the accounting standards setters must listen to us. The pure securities regulators, conversely, tend to be more sympathetic to the 'accounts are for investors' philosophy. And indeed the tension exists within the accounting standards-setting bodies, complicating any progress towards the convergence of international accounting standards. The International Accounting Standards Board (IASB), under David Tweedie's leadership, has been sympathetic to the idea that it must be involved in close dialogue with the prudential regulators. The Financial Accounting Standards Board (FASB) has been more wedded to the 'accounts are for investors only' philosophy, and to the philosophy that banks, in their accounting, should be treated no differently from anybody else.
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January 2010: Joint Forum review of financial regulation
The Joint Forum of financial supervisors has published Review of the Differentiated Nature and Scope of Financial Regulation: Key Issues and Recommendations. This report analyses key issues arising from the differentiated nature of financial regulation in the international banking, insurance, and securities sectors. It also addresses gaps arising from the scope of financial regulation as it relates to different financial activities, with a particular focus on certain unregulated or lightly regulated entities or activities. The Joint Forum prepared this report at the request of the G-20 to help identify potential areas where systemic risks may not be fully captured in the current regulatory framework and to make recommendations on needed improvements to strengthen regulation of the financial system.
Annex 2 of the report (Fundamental Analysis of the Objectives of Financial Regulation) states:
The objective of customer or stakeholder protection is not equivalent to the objective to reduce systemic risks. On the one hand, protecting customers may help to reduce systemic risk by for instance preserving market liquidity, while on the other this might increase systemic risks by undermining market discipline. To have financial supervisors put more emphasis on the objective of systemic risk reduction, the G-20 recommends in its 2009 report on Sound Regulation and Strengthening Transparency that 'as a supplement to their core mandate, the mandates of all national financial regulators, central banks, and oversight authorities, and of all international financial bodies and standard setters (IASB, BCBS, IAIS and IOSCO) should take account of financial system stability'.
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The Joint Forum is a consortium of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors that addresses issues common to the banking, securities, and insurance sectors, including the supervision of financial conglomerates. Click to Download the Joint Forum Report and Recommendations (PDF 986k).
January 2010: Financial Stability Board welcomes IASB progress
The Financial Stability Board (FSB) met in Basel on 9 January 2010 to take forward its regulatory policy reform agenda and reaffirm the timelines for policy development and implementation in 2010. The meeting also agreed on a framework for strengthening adherence to international standards, and reviewed current conditions and adjustment in the financial system. Regarding IFRSs, the Report of the Meeting (PDF 42k) states:
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Strengthening accounting standards. As requested by the G20 Leaders, the FSB continues to monitor progress in implementing G20 and FSB recommendations for improved, converged accounting standards. FSB members welcomed the IASB's plan to continue its enhanced technical dialogue with prudential authorities and market regulators on financial institution reporting issues, and to conclude its full review of the financial instruments standard by the end of this year.
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January 2010: FCAG letter to G-20
On 4 January 2010, the Financial Crisis Advisory Group (FCAG), an independent advisory body to the IASB and FASB, sent a Letter to G-20 Participants (PDF 26k) updating them on the progress of the IASB and the FASB toward a single set of global financial reporting standards. An excerpt:
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Although conditions may have improved somewhat in various markets around the globe, the FCAG believes it remains critically important to achieve a single set of high quality, globally converged financial reporting standards that provide consistent, unbiased, transparent and relevant information across geographical boundaries. We are encouraged by the Boards' progress to date in developing such standards....
The next several months are likely to see a number of key developments, including:
- the US Securities and Exchange Commission's response to the comments it has received regarding its proposed roadmap for the potential use of International Financial Reporting Standards (IFRS) by domestic US reporting companies;
- the European Union's endorsement decision regarding the completed first part of the IASB's financial instruments project, IFRS 9 Financial Instruments: Classification and Measurement;
- the constituent feedback on the IASB's proposed standard from the second part of its financial instruments project, Financial Instruments: Amortized Cost and Impairment, and the issuance of its proposal on hedge accounting, the third and final part of its financial instruments project; and
- the issuance by the FASB of its comprehensive financial instruments proposals on classification and measurement, impairment, and hedge accounting.
In light of all of this, the FCAG expects to meet again in the fourth quarter of 2010 to review the Boards' further progress and any relevant external developments.
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December 2009: Meeting of Financial Crisis Advisory Group
The Financial Crisis Advisory Group (FCAG) was established by the IASB and US FASB in response to the recent global financial crisis. Its purpose is to advise both Boards about the role of accounting during the crisis and potential changes. In July 2009, the FCAG published a Comprehensive Report (PDF 377k) with its recommendations related to accounting standard-setting activities and other changes to the international regulatory environment. The FCAG held its sixth meeting in London on 15 December 2009 to review progress made on its recommendations. Presented below are the preliminary and unofficial notes taken by a Deloitte observer at the meeting.
IASB-FASB Financial Crisis Advisory Group Meeting
15 December 2009 |
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The Financial Crisis Advisory Group was established by the IASB and FASB in response to the recent global financial crisis. Its purpose is to advise both Boards about the role of accounting during the crisis and potential changes.
Both co-chairs of FCAG reminded participants in their introductory remarks about the recent developments that gained so much attention, particularly the publication of IFRS 9, failure to endorse IFRS 9 by the European Union through the fast-track procedure, as well as the Joint statement of the IASB and the FASB reaffirming their commitment to convergence. Both co-chairs were highly appreciative of the IASB and the FASB as well as the opportunity for convergence that was created. Nonetheless, both noted that they saw 'dark clouds' both in the U.S. as well as in Europe regarding external pressure on the Boards and their independence.
The IASB Chairman summarised the developments in the IASB crisis-related agenda in 2009, including the publication of IFRS 9, an exposure draft on the expected cash flow model, various outreach activities, and the creation of the Expert Advisory Panel on Impairment. He explained that as soon as the FASB publishes its complete financial instruments proposal (expected in Q1 2010) the IASB would expose the document for comments. Based on the comments, the Boards will strive for a converged solution. Sir David also noted that the Boards would, to the extent possible, try to remove differences in the Fair Value Measurement, Consolidation, and Derecognition Standards. He also noted the decision of the EU to 'delay' endorsement of IFRS 9 and expressed his belief that IFRS 9 would be endorsed in Europe in 2010 as part of the normal endorsement process.
The FASB Chairman reinforced the message that convergence is a priority, explaining that the Boards have introduced monthly joint meetings (they plan to have six face to face meetings in 2010, five of them in London and the remaining by videoconference). In his words, the Boards try to avoid leapfrogging and to align their timelines for projects. To reinforce this message the Boards will issue public quarterly progress reports.
Nonetheless, the FASB Chairman also reiterated that the feedback they received from the U.S. constituents was more positive about a comprehensive project (rather than a phase approach) and about a fair value model. Therefore, the FASB will try to have a converged solution, or a solution that would ensure broad comparability of the financial statements if full convergence on the specific issue of fair value and amortised cost proved impossible (as many think that a fully converged solution would have to lead to identical equity). He stressed that the Boards were very close in the dividing line between what goes into earnings and 'the other category' but some differences remain. He underlined that the main aim of Boards was at least to have a fully converged income statement but that the Boards appreciated that both amortised cost and fair value was important information. On impairment, he cited reluctance amongst U.S. regulators about the viability of through-the-cycle-provisioning. He noted that both Boards aimed at a forward-looking model. While the FASB is concerned about the rigour and auditability of the expected-loss model, FASB has pledged full participation in the Expert Advisory Panel.
On independence of the standard setter, the FASB Chairman noted that an amendment authorising a Systemic Risk Council to override a Standard without a due process was defeated in the U.S. House of Representatives. The FCAG Co-chair noted that the Council was one of the 'dark clouds' he mentioned earlier.
Many members noted that the timing of the comprehensive financial instruments review was crucial as there was a 'window of opportunity for convergence' created by the delay of endorsement of IFRS 9 in the EU. The FASB chairman noted that the comprehensive project should be published for comments in February or March 2010 to allow the Boards time for discussions on convergence.
Many members discussed the EU decision not to endorse IFRS 9 speedily. One FCAG member was particularly concerned about the impact of that decision on the rest of the world and whether IFRS 9 was implemented as written. Some members saw the EU failure to endorse IFRS 9 in the fast track procedure as a positive development as it took pressure from the IASB that should not be there in the first place and re-instated a due process in the EU endorsement mechanism. Other members were more sceptical and saw a hidden agenda of interference that may endanger the independence of the Board. In response, the IASB Chairman noted that the actions of Europe raised concerns in other countries. He mentioned that a newly formed group of Asian standard setters might help to counteract the pressure from the U.S. and Europe. He noted that the IASB is a global standard setter that is not bound by agenda solely in Europe.
The FASB chairman noted in response to a question that the biggest risk to convergence was 'that the Boards come to different answers' and reiterated that the IFRS solution on financial instruments was not popular in the U.S. He also stated that the amortised cost model omitted very important information from the balance sheet.
On the issue of an extended role for banking regulators, most members agreed that a common solution should be found in a way that facilitates common inputs but that differences would still exist as the purpose of financial reporting and prudential regulation is different.
The Basel Committee representative clarified that the EU did not delay the endorsement of IFRS 9 but that it just decided not to accelerate it – which, in her opinion, was a fundamental difference. She also noted that the European Commission had not asked for IFRS 9 and the decision not to invoke fast-track needed to be read in that context. IASB Chairman responded that the complete overhaul of IAS 39 was required to ensure a level playing field, short of adopting the U.S. Standards. The Basel Committee representative acknowledged progress of IFRS 9 but cited some arguments raising concerns (for example, the treatment of uncertainty, no recycling for equity instruments at fair value through other comprehensive income, increased usage of fair value in particular as fair value for loans has no economic substance in continental Europe as there is no active secondary market). She also pledged the willingness of the Basel Committee to participate on the EAP discussion but raised concerns about how operational the proposed expected-loss model would be for the banking industry.
The CESR representative praised the IASB for IFRS 9 and noted that in CESR's opinion IFRS 9 was an improvement to IAS 39. On endorsement, he noted that the endorsement process was a normal part of the 'politics of the EU' and should be not taken as 'the end of the world'.
Concluding remarks
On balance, FCAG members reached a consensus that the Boards were responsive to FCAG's recommendations and appreciated the work done by the Boards. As the next step, the FCAG members would like to discuss and address the progress of convergence. Consequently, the FCAG decided to have an additional meeting in October 2010 in New York to assess the progress on convergence and the financial instruments project. At that meeting the FCAG will prepare a letter to G20 (meeting scheduled for November 2010) on the progress to achieve a global set of high-quality accounting standards.
This summary is based on notes taken by observers at the FCAG meeting and should not be regarded as an official or final summary.
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November 2009: Financial reporting lessons from the financial crisis
US SEC Commissioner Kathleen L Casey spoke about Lessons from the Financial Crisis for Financial Reporting, Standard Setting and Rule Making (PDF 45k) at Financial Executives International's 28th Annual Current Financial Reporting Issues Conference in New York on 17 November 2009. Commissioner Casey identified three key lessons from the crisis:
- First, financial stability depends upon market confidence; and investor confidence, in turn, depends upon the transparency of financial statements.
- Second, financial reporting and accounting standard setting must remain focused on the needs of investors. While there are many other important stakeholders that rely on financial statement reporting, investors' interests must remain paramount.
- Third, financial reporting must remain relevant and informative to investors, and should not impose unnecessary or costly burdens that do not add to investor understanding.
Here is an excerpt relating to IFRSs in the United States:
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As the number of US investors with holdings of securities of non-US companies continues to increase, the Commission and the FASB would be remiss and would fail the needs of investors if we did not continue to support the development of a single set of high quality global accounting standards. The desirability of convergence on certain key accounting standards – particularly those related to financial instruments and other areas relevant to the credit crisis – has been highlighted in a number of forums, including the March 2009 communique of the G-20 finance ministers, the Department of Treasury's June 2009 Regulatory Reform report and the July 2009 Report of the Financial Crisis Advisory Group. The Commission strongly supports the continued convergence efforts of FASB and IASB. The existing convergence targets of these two standard setters pursuant to their 2006 MoU, as updated in September 2008, set the goal of completing several major joint projects by 2011. And less than two weeks ago, the FASB and IASB issued a joint statement reaffirming their commitment to achieving convergence of IFRS and US GAAP, and announcing plans to intensify their efforts to complete the major joint projects described in the MoU.
Going forward, it is crucial that the United States continue to play a leadership role in the support and development of a single set of high quality global accounting standards. It is also my hope and expectation that the Commission will soon articulate the next steps to be taken with respect to the use of IFRS by US issuers – further signaling our commitment to this important goal.
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November 2009: G20 finance ministers progress report
The Finance Ministers and Central Bank Governors of the G20 nations met on 7 November 2009 at St Andrews, Scotland to assess the progress that has been made toward meeting the commitments that the G20 heads of state made at their summit meetings over the past twelve months in London, Washington, and Pittsburgh. Following the meeting the Finance Ministers published a:
Below is an excerpt from the progress report dealing with progress in accounting standards.
| No. | SUMMIT COMMITMENT | PROGRESS AND NEXT STEPS |
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| ACCOUNTING STANDARDS |
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| 83
| We have agreed that the accounting standard setters should improve standards for the valuation of financial instruments based on their liquidity and investor's holding horizons, while reaffirming the framework of fair value accounting.
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To date, the International Accounting Standards Board (IASB) published in May an exposure draft (proposed accounting standard) on fair value measurement that directly incorporates the staff guidance issued in April by the US Financial Accounting Standards Board (FASB) to better identify inactive markets and determine whether transactions are orderly. Comments were due by end-September, with the final standard expected in 2010. Also, in June the IASB published a discussion document on the effects of fair value gains arising from deterioration in a company's own credit risk, with comments due by the beginning of September. Based on its review of comments the IASB will decide how to address this issue in its standard or guidance on fair value measurement. See also Action 85. |
| 84
| Accounting standard setters should take action to reduce the complexity of accounting standards for financial instruments by the end of 2009.
| The IASB plans to address the G20 Leaders' call for reduced complexity of accounting standards for financial instruments through the development of three new standards, based on exposure drafts issued in 2009. An exposure draft (ED) was issued in July 2009, which proposes to reduce the number of categories of financial assets and liabilities to two (fair value and amortised cost). A number of changes have been made by the IASB in recent Board meetings to the approach set forth in its July 2009 ED on classification and measurement of financial instruments. This final standard should be published by the IASB in November and will be available for use for 2009 annual reports. Proposals on the remaining portions of IAS 39 – covering an expected loss approach to provisioning (see action 85) and hedge accounting – are to be issued by the end of 2009.
The FASB continues to move toward its goal of issuing one ED in the first half of 2010 that incorporates a single, comprehensive model for accounting for financial instruments. The FASB published its tentative approach to inform and solicit comments from its constituents. Unlike the IASB, the FASB is preliminarily moving toward an approach that is based on fair value measurement for all financial instruments, which will include balance sheet categories for (i) financial instruments for which changes in fair value are recognised in net income and (ii) financial instruments (including loans) for which fair value changes are recognised in 'other comprehensive income'. On provisioning, see action 85.
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| 85
| Accounting standard setters should take action to strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information by the end of 2009.
See also action 52.
| The IASB plans to issue for public comment an exposure draft on expected loss provisioning in the first half of November 2009. The comment period will last for eight months. The IASB published initial proposals on its website in June to seek input regarding the feasibility of this expected loss approach.
At its 21 October 2009 Board meeting the FASB preliminarily decided to focus on a credit impairment approach that would require, at the end of each period, an impairment loss measured as the present value of management's current estimate of cash flows that are not expected to be collected. The FASB plans to issue an
exposure draft in the first half of 2010.
The IASB plans to continue discussions with the FASB to seek convergence in this area and will establish a new joint IASB-FASB expert advisory panel to assist the Boards in addressing a number of practical issues associated with their respective credit impairment (provisioning) approaches.
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| 86
| Accounting standard setters should take action to improve accounting standards for provisioning, off-balance sheet exposures and valuation uncertainty by the end of 2009.
| The IASB is working to enhance the accounting and disclosure standards for off-balance sheet entities. The IASB plans to finalise the consolidation standard by the end of 2009 and the derecognition standard in the second half of 2010.
In June 2009, the FASB published its final standards, Financial Accounting Statements No. 166, Accounting for Transfers of Financial Assets, and No. 167, Amendments to FASB Interpretation No. 46(R), which change the way entities account for securitisations and special-purpose entities. The new standards will impact financial institution balance sheets beginning in 2010.
The IASB is giving further consideration to a possible approach to address significant valuation uncertainty through clarifying its existing guidance on valuation adjustments as part of its plan to finalise its exposure draft on fair value measurement.
On provisioning, see Action 87.
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| 87
| Accounting standard setters should take action to achieve clarity and consistency in the application of valuation and provisioning standards internationally, working with supervisors by the end of 2009.
| The IASB published in May 2009 an exposure draft (proposed accounting standard) on fair value measurement that largely incorporates the staff guidance issued in April by the FASB to better identify inactive markets and determine whether transactions are orderly.
In July 2009 the BCBS proposed to the IASB high-level principles for replacement of IAS 39.
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| 88
| We call on our international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process; and complete their convergence project by June 2011.
| The IASB and FASB held a joint meeting in October at which the Boards tentatively agreed on core principles for converging their approaches to accounting for financial instruments. The IASB and FASB have agreed to meet monthly, starting in January 2010, to achieve the goal of converging IFRSs and US GAAP to the greatest extent possible by June 2011.
In addition, nearly all FSB jurisdictions have programmes underway to converge with or adopt the standards of the International Accounting Standards Board by 2012.
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| 89
| The IASB's institutional framework should further enhance the involvement of various stakeholders.
| The IASB is working together with supervisors in key areas, including provisioning and valuation, and has had a number of meetings with the BCBS on these issues. In addition, supported by the FSB, the IASB held a meeting with senior officials and technical experts of prudential authorities, market regulators and their international organisations to discuss financial institution reporting issues on 27 August 2009. This meeting included senior
representatives from a number of emerging market economies that are FSB members. The IASB plans for the next enhanced dialogue meeting to take place in the first quarter of 2010, and the FSB Secretariat will assist the IASB in setting up this meeting.
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| 90
| Regulators and accounting standard setters should enhance the required disclosure in relation to complex
financial products by firms to market participants. (By end 2009).
| National authorities have taken, and are continuing to take, steps to encourage firms to provide disclosures consistent with international best practice by the Senior Supervisors Group and the FSB, as appropriate. Firms have continued to enhance their risk disclosures in their published annual reports.
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October 2009: Regulators' report on special purpose entities
The Joint Forum has released its Report on Special Purpose Entities. This paper serves two broad objectives. First, it provides background on the variety of special purpose entities (SPEs) found across the financial sectors, the motivations of market participants to make use of these structures, and risk management issues that arise from their use. Second, it suggests policy implications and issues for consideration by market participants and the supervisory community. Regarding accounting, here are three comments made in the report:
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The ability to achieve off-balance sheet accounting treatment is affected by the accounting regime to which the originating or sponsoring entity is subject. Generally speaking, off-balance sheet treatment is easier to achieve under US GAAP than under IFRS. However, the US FASB new accounting rules related to SPEs that are effective in 2010 will significantly reduce the ability of institutions to use SPEs to achieve off-balance sheet treatment. As a result, US accounting changes will significantly alter the motivations for originators in using SPEs. These accounting changes will also affect leverage and risk-based capital ratios, and could have an important effect on the management of regulatory capital adequacy requirements by firms.
European financial firms generally have less ability to remove assets from their balance sheets by using SPEs. However, this is offset by the fact that risk-based capital requirements are not as closely tied to accounting in Europe. In contrast, while US firms currently can more easily remove assets from their balance sheets, the US implementation of Basel I required more capital for certain exposures than in Europe.
Some examples (but not an exclusive list) of the ways SPEs can potentially confuse or obfuscate the financial position of a company are:
- Return on equity and return on assets can be exaggerated if revenue flows are received from SPEs but the assets in those vehicles are not recognised on the balance sheet;
- Sector exposure may be obscured, either deliberately or not, by recognising some SPEs on balance sheet and not others;
- Leverage ratios may be obscured.
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An appendix to the report examines, in detail, the current accounting treatment of SPEs under IFRSs and under US GAAP.
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The Joint Forum is a consortium of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors that addresses issues common to the banking, securities, and insurance sectors, including the supervision of financial conglomerates.
September 2009: FSB seeks simplified global financial instruments accounting
The Financial Stability Board (FSB) has urged the IASB and FASB to simplify, improve, and converge their accounting standards for financial instruments "in a manner that does not expand the use of fair value in relation to the lending activities (involving loans and investments in debt instruments) of financial intermediaries". The FSB was established to
coordinate the policies by which countries regulate and supervise financial institutions. Click for FSB Statement (PDF 56k). Here is an excerpt:
At present, the IASB and the US Financial Accounting Standards Board (FASB) are considering a variety of approaches which could possibly lead to divergences
between IASB and FASB standards with respect to:
- improving and simplifying financial instruments accounting, where FASB is considering an approach that is based on fair value measurement for most financial instruments, which would be proposed by early 2010, while the IASB has proposed a mixed model of historical cost and fair value, to be available for use in 2009 year-end financial statements;
- provisioning and impairment, where the IASB plans to propose a standard using an expected loss or expected cash flow approach to loan loss provisioning in October 2009, which would generally recognise credit losses earlier and mitigate procyclicality,1 whereas the FASB continues to consider changes to impairment recognition, including an approach based on fair value with plans to issue its proposal by early 2010;
- off-balance sheet standards, where the IASB's proposal on derecognition, which is now subject to consultation, would require repurchase agreements to be treated as sales and forward contracts in certain situations (thus leading to off-balance sheet treatment), instead of as financing transactions on the balance sheet as under current IASB and FASB standards.
Moreover, continuing differences in accounting requirements of the IASB and FASB for netting/offsetting of assets and liabilities also result in significant differences in banks' total assets, posing problems for framing an international leverage ratio.
Therefore, additional work in the areas above is urgently needed in order to meet the important objectives of convergence, transparency and the mitigation of procyclicality, as standard setters continue their efforts to improve the quality of their standards and reduce the complexity of their standards on financial instruments.
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September 2009: G20 call for global standards by 2011
Following their meeting in Pittsburgh, Pennsylvania USA on 24-25 September 2009, the leaders of the G20 nations issued a Final Statement (PDF 102k) identifying a range of additional steps that should be taken to strengthen international financial regulatory system to avoid a future global financial crisis. One of their stated goals is complete convergence of accounting standards across the G20 member nations by June 2011:
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We call on our international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process, and complete their convergence project by June 2011. The International Accounting Standards Board's (IASB) institutional framework should further enhance the involvement of various stakeholders.
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September 2009: IASCF Trustees' letter to G20 leaders
On 16 September 2009, the Trustees of the IASC Foundation wrote to the leaders of the G20 countries in connection with their meeting on 24-25 September in Pittsburgh, Pennsylvania USA. The purpose of the letter is to inform the leaders of G20 countries of the progress that the IASC Foundation and the IASB have made in response to the G20's recommendations on accounting standards agreed at the Leaders Summits in Washington in November 2008 and in London in April 2009. An appendix to the letter includes a detailed report of specific steps the IASC Foundation and IASB have taken in response to the financial crisis.
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September 2009: US Fed Governor comments on bank accounting
US Federal Reserve Board Governor Elizabeth Duke, in a speech on bank accounting standards at the AICPA National Conference on Banks and Savings Institutions in Washington, argued that "it is crucial that an accounting regime directly link reported financial condition and performance with the business model and economic purpose of the firm. It is difficult for me to comprehend the value of an accounting regime that doesn't make that link. Click to Download Governor Duke's Remarks (PDF 67k). Here is an excerpt regarding fair value and loan reserve accounting:
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In terms of relevance, the measurement principle should reflect the manner in which entities actually use financial instruments. In this regard, the business model and risk-management approach taken by the reporting entity – as well as the way in which the value of the instrument itself is likely to be realized – should be factored into the measurement determination.
If the business model is predicated on the trading of financial instruments for the realization of value, or other strategies that essentially focus on short-term price movements, then fair value has relevance. In the trading business model, reporting fair value focuses risk management on short-term price movements and in most cases incentivizes management to define the
organization's risk appetite and to mitigate risk through hedging or other means. Fair value also incentivizes the entity to raise and maintain capital at a level sufficient to cover the price volatility of its assets. For example, if the business model is an originate-to-distribute model, then fair value has relevance.
In contrast, if the business model is predicated on the realization of value through the return of principal and yield over the life of the financial instrument, then fair value is less relevant.
Consider, for example, a bank that finances the operations of a commercial enterprise. The realization of value will come from the repayment of cash flows. Risk management is based on an assessment of the borrower's creditworthiness and the entity's ability to fund the loan to maturity. In this case, the accounting should incentivize the entity to maintain sufficient funding to hold the instrument to maturity and to hold a sufficient amount of capital to cover potential credit losses through the credit cycle, preferably in a designated reserve. Indeed, the use of fair value could create disincentives for lending to smaller businesses whose credit characteristics are not easily evaluated by the marketplace.
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August 2009: Basel Committee proposes principles for revising IAS 39
The Basel Committee on Banking Supervision has published a set of high level guiding principles to assist the IASB in addressing issues related to provisioning, fair value measurement, and related disclosures. In releasing the principles the Basel Committee said that "the principles will help it produce standards that improve the decision usefulness and relevance of financial reporting for key stakeholders, including prudential regulators. Moreover, the principles would ensure that accounting reforms address broader concerns about procyclicality and systemic risk." Click to Download the Basel Committee's Principles (PDF 20k). Here is an excerpt:
The new standard should:
- (a) reflect the need for earlier recognition of loan losses to ensure robust provisions;
- (b) recognise that fair value is not effective when markets became dislocated or are illiquid;
- (c) permit reclassifications from the fair value to the amortised cost category; this should be allowed in rare circumstances following the occurrence of events having clearly led to a change in the business model;
- (d) promote a level playing field across jurisdictions.
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The IASB has posted on its website an updated summary of the IASB Response to G20 Recommendations.
July 2009: FCAG recommendations on standard-setting
The Financial Crisis Advisory Group (FCAG) – a high level group of recognised leaders with broad experience in international financial markets formed jointly by the IASB and the US FASB – has published its recommendations related to accounting standard-setting activities, and other changes to the international regulatory environment following the global financial crisis. The report of the FCAG articulates four main principles and contains a series of recommendations to improve the functioning and effectiveness of global standard-setting. The chief areas addressed in the report are:
- Effective financial reporting
- Limitations of financial reporting
- Convergence of accounting standards
- Standard-setters' independence and accountability
The principles and a summary of the recommendations are set out in an appendix to the Press Release (PDF 30k). The FCAG will reconvene in December to review the progress made on its recommendations.
Click to download:
July 2009: ED on financial instruments classification and measurement
On 14 July 2009, the IASB published an exposure draft (ED) on Financial Instruments: Classification and Measurement as the first part of its three-phase project to replace IAS 39 Financial Instruments: Recognition and Measurement. The Board decided to address classification and measurement of financial assets and financial liabilities first because they form the foundation of a standard on reporting financial instruments. Moreover, many of the concerns about IAS 39 that have been expressed during the financial crisis relate to its classification and measurement requirements. The IASB plans to finalise the classification and measurement proposals in time for non-mandatory application in 2009 year-end financial statements. The other two phases of the IAS 39 project are addressing Impairment and Provisioning and Hedge Accounting. Additionally, the Board's project on Derecognition of Financial Instrument will also result in amendments to IAS 39. The IASB plans to complete the replacement of IAS 39 during 2010, although mandatory application will not be before January 2012. Comments on the ED on Classification and Measurement are due by 14 September 2009. Click for IASB Press Release (PDF 102k). Here is an overview of the ED:
| Overview of Exposure Draft on Classification and Measurement of Financial Instruments |
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- Primary classification and measurement categories for financial instruments
A financial asset or financial liability would be measured at amortised cost if two conditions are met:
- The instrument has basic loan features. A debt instrument has basic loan features if the return to the holder is a fixed amount, fixed over the life, variable over the life due to changes in a single referenced quoted or observable interest rate, or a combination of a fixed and variable return (such as LIBOR plus a fixed spread).
- The instrument is managed on a contractual yield basis. While this condition is similar to the 'held to maturity' condition in the existing IAS 39, there are no 'tainting provisions' comparable to those in IAS 39 that would prohibit an entity from measuring a financial asset at amortised cost if it has recently sold other financial assets measured at amortised cost before maturity. However, special disclosures would be required for derecognition of a financial asset or financial liability measured at amortised cost.
A financial asset or financial liability that does not meet both conditions would be measured at fair value. This would include all investments in equity instruments (and derivatives on those equity instruments) – including those that do not have a quoted market price in an active market. That is, there would be no 'measurement reliability' exception for equity instruments such as now exists in IAS 39.
- Existing IAS 39 classifications of 'held to maturity' and 'available for sale'
These classifications would be eliminated. Note, however, that the ED proposes an accounting policy choice to measure some investments in equity instruments at fair value through other comprehensive income (see below).
- Some investments in equity instruments could be measured at fair value through other comprehensive income
The ED proposes to permit an entity, on initial recognition of investments in equity instruments that are not held for trading but are held for purposes other than realising direct investment gains, to make an irrevocable election to present changes in the fair value of those investments in other comprehensive income. Dividends on such investments would also be presented in other comprehensive income. There would be no transfers from other comprehensive income to profit or loss ('recycling') and hence no impairment requirements.
- Embedded derivatives
The ED proposes that a hybrid contract with a host that is within the scope of the proposed IFRS (that is, it is a financial host) must be classified in its entirety in accordance with the proposed classification approach. This would eliminate the existing IAS 39 requirements to account separately for an embedded derivative and the host contract.
- Investments in contractually subordinated interests (tranches)
The ED proposes to apply the classification criteria to such investments by requiring that any tranche that provides credit protection to other tranches on the basis of any possible outcome (rather than a probability-weighted outcome) must be measured at fair value because provision of such credit protection is a form of leverage and not a basic loan feature.
- Fair value option retained
The ED would retain IAS 39's 'fair value option' by which an entity may elect at initial recognition to measure any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch').
- Classification is determined at initial recognition
The ED would prohibit subsequent reclassification of financial assets and financial liabilities between the amortised cost and fair value categories.
- Effective date
The current plan (subject ot review) is that the new requirements would not be mandatorily effective before January 2012, but early application would be permitted.
- Transition
Generally retrospective, with some exceptions.
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June 2009: IASB Chairman statement to ECOFIN
IASB Chairman Sir David Tweedie met on 9 June 2009 with the Economic and Financial Affairs Council (ECOFIN) of the European Union to discuss how the IASB is responding to issues arising from the financial crisis. He noted that the IASB has focussed its response on three areas identified by the Financial Stability Forum and four issues raised by the European Commission. The Financial Stability Forum's areas are:
- the application of fair value in illiquid markets.
- accounting for off-balance sheet items.
- disclosures related to risk.
The four issues raised by the European Commission in the fourth quarter of last year were:
- the need for guidance about fair value measurement in illiquid markets – guidance has been issued.
- the desire for clarification regarding whether credit derivative obligations (CDOs) include embedded derivatives to ensure consistency between IFRSs and US GAAP – FASB is working on a clarification that will be in place for 2009 financial reports.
- the existing impairment rules related to available-for-sale instruments – IASB will issue an exposure draft in July 2009, two-month comment period, final revisions to IAS 39 in place and available for 2009 financial reports.
- the possibility of reclassification out of the fair value option into other categories – IASB will issue an exposure draft in July 2009, two-month comment period, final revisions to IAS 39 in place and available for 2009 financial reports.
The Chairman also noted that the Board is working on other issues relating to the financial crisis, including hedge accounting and provisioning.
Click to download
June 2009: IASCF Monitoring Board statement to G20
The Monitoring Board for the International Accounting Standards Committee Foundation
has issued a Statement Regarding Due Process toward Addressing Calls from G-20 Leaders (PDF 45k). An excerpt:
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We believe that standard setters will be best able to produce high quality standards if they are able to exercise independent judgment relying on their skills, experience and due process, and taking into account the urgency of certain issues and the views of all stakeholders. Therefore, with respect to the steps taken by the IASB, we reiterate that the IASB's due process and transparency in financial reporting are critical to our continued support, as the authorities charged in our jurisdictions with determining accounting standards for use in our capital markets, for IFRS in its role as a global accounting standard.
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May 2009: Plan for US capital markets reform
The Committee on Capital Markets Regulation has published The Global Financial Crisis: A Plan for Regulatory Reform. The Committee is an independent and nonpartisan research organisation dedicated to improving the regulation of US capital markets. The Committee comprises 25 leaders from the investor community, business, finance, law, accounting, and academia. Two IASC Foundation Trustees (Samuel A DiPiazza, Jr and Robert R Glauber) serve on the Committee. The 25 members also include William C Freda, Vice Chairman and US Managing Partner of Deloitte, and William G Parrett, former Global CEO of Deloitte. The report is the result of a year-long examination into the global financial crisis and the key deficiencies in the regulatory system. Critical topics addressed include capital requirements, resolution procedures, the regulation of hedge fund and private equity, the securitisation process, credit default swaps and other derivatives, disclosure and accounting standards, credit rating agency practices, and the overall US regulatory architecture. The report makes 57 practical and specific recommendations for regulatory reform, several of which refer to the IASB and the FASB. Chapter 4 Enhancing Accounting Standards examines two accounting issues raised by the financial crisis: the use of fair value accounting and the requirements for consolidation. Click to download:
Presented below are summaries of the four accounting-related recommendations.
Recommendation 43. Study How FVA Can Be Improved.
The Committee believes 'fair value' accounting is a problematic standard in inactive or distressed markets because it conflates the concepts of market value and credit model value and may confuse investors. We do not believe the problem has been solved by FASB's latest guidance. We recommend continuing to study how 'fair value' accounting can be improved. We further recommend that this be done on a joint basis by FASB and IASB, so the two major accounting standard setters are consistent in their approach.
Recommendation 44. Supplement FVA with Dual Presentation of Market and Credit Values.
To supplement fair value reporting, the Committee proposes that FASB require an additional dual presentation of the balance sheet for Level 2 and Level 3 assets using credit value and market value independently of each other. Accompanying this dual presentation, firms should also disclose their underlying valuation methodologies. In the case of credit value, this includes sharing modeling techniques, estimates, assumptions, and risk factors. In the case of market value, the disclosures should reveal what market prices were actually relied on.
Recommendation 45. Allow The Fed to Use a Non-GAAP Methodology.
As for regulatory accounting, the Committee believes the Fed should not be limited to following US GAAP and should instead be free to choose another method (credit value, market value, or some combination of both) it deems appropriate.
Recommendation 46. Implement FIN46R.
As for consolidation, we agree with the FIN 46R approach because it focuses on the issue of control. [FIN 46R is FASB's revised standard on consolidation of special purpose vehicles.]
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May 2009: IASB-FASB Financial Crisis Advisory Group Meeting 22 May 2009
The Financial Crisis Advisory Group (FCAG) was established by the IASB and US FASB in response to the recent global financial crisis. Its purpose is to advise both Boards about the role of accounting during the crisis and potential changes. The FCAG held its fifth meeting in London on 22 May 2009. Presented below are the preliminary and unofficial notes taken by a Deloitte observer at the meeting.
IASB-FASB Financial Crisis Advisory Group Meeting
22 May 2009 |
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The Financial Crisis Advisory Group held a short public session prior to entering a closed administrative session during which it would draft its Report to the Chairmen of the International Accounting Standards Board and the US Financial Accounting Standards Board.
Recent developments: IASB decision to split the Comprehensive Financial Instruments Project into three sections
Sir David Tweedie explained that, as a result of the FASB's April 2009 amendment of FAS 115 and FAS 124, with respect to 'other than temporary' impairment of financial instruments, the IASB had come under intense pressure to modify IFRS to follow suit: the problem was that IFRSs do not have the concept of an 'other than temporary impairment' nor is the IFRS impairment model compatible with that in US GAAP generally. To accommodate the requests to follow the FASB FSPs would be too difficult for the IASB to do and would distract its efforts to meet the undertaking made to the G20 to present proposals for a comprehensive replacement of IAS 39 later in 2009.
The IASB had considered various alternatives, but had decided that the best chance that it has to meet both the simplification and timeliness objectives is to split the comprehensive replacement of IAS 39 project in to three:
- Classification and measurement – Exposure draft in July 2009, two to two-and-a-half months for comment;
- There would be two categories that would drive measurement: fair value and amortised cost (with a likely fair value option for the latter category).
- The IASB will explore two ways of making this categorisation: (i) any financial instrument that is traded would be at fair value, with all others at amortised cost; or (ii) debt instruments at amortised cost (with fair value option) and equity instruments at fair value.
- Financial statement presentation issues (the split between gains and losses reported in net profit and loss and those reported in Other Comprehensive Income) were to be resolved, but it was highly likely that there would be no recycling between OCI and Profit or Loss.
- Impairment – request for views (given the classification model developed) to be issued at the same time as the above ED
- Hedging – to follow, once classification is finalised
The entire package is to be delivered by mid-2010. In response to a question, Sir David noted that the current pressure is on Available for Sale financial instruments and the impairment rules in IAS 39; the IASB hopes that by 'fixing' classification, that pressure would be relieved. Aligning US GAAP and IFRS was not possible, since the two models have fundamentally different starting points.
Sir David also noted that, given the time scales involved, any involvement of the Financial Instruments Working Group would probably have to be through email comments rather than a physical meeting.
Robert Herz, FASB Chairman, noted that there was a desire at the FASB to arrive at a good common answer with the IASB and that the FASB would use its best efforts to achieve that. However, he cautioned that some of his Board had very different views from their IASB colleagues, especially with respect to the potential 'widening' of the amortised cost category. He noted that, in his jurisdiction, the 'appetite for convergence at the price of improvements' was not there. He also noted the recent developments in the US - especially the 'stress test' developed by the US Federal Reserve and banking regulators, which he noted had a greater degree of transparency and accommodated future changes in accounting standards. He saw these developments as helpful and commended the Fed for their very constructive assistance as the tests were being developed.
A member noted that it was especially worrying that the IASB and the FASB seemed to be in different positions on the categorisation of financial instruments and thought that this was a dangerous place to be. Several other members echoed these concerns, expressing the hope that the Boards would be able to agree on what financial items qualified for measurement at amortised cost.
An FCAG Co-Chairman noted that he was becoming increasingly concerned with the political environment and in particular the continual pressure on standard-setters from bankers (preparers and preparer associations) and finance ministers. The focus of these efforts is a relaxation of financial reporting standards that would permit financial institutions to boost their balance sheets: The result is that investors are getting lopsided financial reports, know they are getting lopsided reports and thus continue not to trust the information they are receiving. This is delaying any potential financial recovery.
The other Co-Chairman noted that the pressure on the IASB at the moment threatened the considerable progress of the past 15-20 years, in particular the removal of the reconciliation requirements for SEC registrants using pure IFRS. 'Scapegoating' the financial reporting standard-setters was unjustified and unhelpful, but to lose IFRS at this stage would be tragic and the long-term costs of such an event would be significant. Other FCAG members supported these comments.
A member noted that much of the current stress has been created between two jurisdictions: the US and EU; however, the financial crisis is a global one and IFRS is used in many jurisdictions. Having the IASB being constantly asked to accommodate the EU was risking having it diverted into non-productive areas wasting time and resources. The FCAG's report must, therefore, express strong support in favour of a global investor-focused set of financial reporting standards.
A member noted that piecemeal changes to financial reporting standards risked undermining confidence in the market. He noted that there was a great deal of cynicism among investors (especially in the US, the market with which he was most familiar). If investors lose trust with financial reporting standards any real recovery in the financial markets would be difficult to achieve. The IASB and FASB should not accept a solution that could be seen as ridiculous. (He suggested that changing financial reporting standards to avoid portraying reality was rather like trying to avoid the consequences of climate change by asking the scientists to recalibrate their thermometers.)
A bank regulator was concerned about the confrontational tone of some of the comments. What was needed was a cooperative attitude, understanding and respecting each others' views, in order to reach a solution. It was clear that financial reporting standards were not the cause of the crisis-that was accepted-but it was also true that they were linked to the crisis and had a role in the solution. Thus it was important to engage the bank regulators in a constructive manner.
It was noted that a recent Working Paper (No 16, Findings on the interaction of market and credit risk) contained very little criticism of financial reporting standards and was far more critical of banking regulation.
Another banking regulator noted that the Financial Stability Board and the Basel Committee had made strong statements in favour of independent, private-sector financial reporting standards, in particular those of the IASB and FASB, and that the two groups had worked and continue to work to preserve the independence of the Boards. He noted the constructive cooperation between the Basel Committee and the IASB's Expert Advisory Panel that led to the very useful guidance issued in October 2008, and on the work currently under way on pro-cyclicality. He noted that the FCAG's report should note that financial reporting standard-setting is at its best when it demonstrates its independence by following due process and responding to reasonable (and reasoned) input.
Closing comments
At the invitation of the Co-Chairmen, FASB Chairman Herz stated that the IASB and the FASB 'would move heaven and earth' to achieve a common solution, but the concern of some FASB members is that 'broadening' the amortised cost bucket was not in the best interests of investors. Sir David agreed, saying that a common answer was vital. IASB members also were concerned about limiting the number of items that could be included in the amortised cost category.
Next steps
The FCAG will now draft its report. The Co-Chairmen noted that it would probably be necessary to meet in July 2009. This meeting would take place in New York.
This summary is based on notes taken by observers at the FCAG meeting and should not be regarded as an official or final summary.
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May 2009: UK Parliament Committee defends 'mark-to-market'
A report from the United Kingdom House of Commons Treasury Committee has concluded that bad decisions at banks – not accounting rules – caused the global financial crisis. The report, titled Banking Crisis: Reforming Corporate Governance and Pay in the City, makes the following points, among others:
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Fair value accounting
Fair value accounting has led to banks publishing some very dispiriting financial results, but this is because the news itself has been bad, not the way in which it has been presented. The uncomfortable truth for banks is that market participants had overinflated asset prices which have subsequently corrected dramatically. Fair value accounting has actually exposed this correction, and done so more quickly than an alternative method would have done. Important features of accounting frameworks are that they encourage transparency and consistency across firms and asset classes. But it is a bridge too far to expect them to also lead to intelligent decision-making. We do not consider fair value accounting to be a suitable scapegoat for the hubris, poor risk controls and bad decisions of the banking sector.
EU modifications of IFRSs
We regret the power of the European Commission to pick and choose which international accounting standards should be implemented in the EU and call on the Treasury to consider the impact of the Commission's powers on the objective of establishing a single global set of accounting standards.
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April 2009: Financial Stability Forum recommendations
The Declaration on Strengthening the Financial System (PDF 137k) issued by the leaders of the Group of 20 (G20) following their meeting in London on 2 April 2009 calls for the Financial Stability Forum (FSF) to be expanded, given a broadened mandate to promote financial stability, and re-established with a stronger institutional basis and enhanced capacity as the Financial Stability Board (FSB). The FSF has now done that – click for Press Release (PDF 20k). The FSB membership will include all G20 countries as well as Spain and the European Commission. The FSB is chaired by Mario Draghi, Governor of the Bank of Italy. Its Secretariat is based at the Bank for International Settlements in Basel, Switzerland.
Obligations of Financial Stability Board members:
As obligations of membership, member countries and territories commit to pursue the maintenance of financial stability, maintain the openness and transparency of the financial sector, implement international financial standards (including the 12 Key International Standards and Codes), and agree to undergo periodic peer reviews, using among other evidence IMF/World Bank public Financial Sector Assessment Program reports. The FSB will elaborate and report on these commitments and the evaluation process. The 12 key International Standards and Codes include International Financial Reporting Standards and International Standards on Auditing.
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Concurrently, the FSF issued an updated set of recommendations and principles to strengthen financial systems. The Press Release (PDF 64k) includes an overview of the recommendations and principles plus links to download the four individual reports that comprise the recommendations and principles:
The recommendations note the following IASB actions to date:
- Consistent guidance has been issued by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) for fair valuation when markets are illiquid, and for the transfer of assets between valuation categories in rare circumstances. The IASB has also proposed revised standards for the consolidation and disclosure of off-balance sheet entities and related exposures. The IASB finalised in March 2009 an amendment to IFRS 7 setting forth enhancements to required risk and valuation disclosures for financial activities, including for complex financial instruments.
Regarding financial reporting and pro-cyclicality, the recommendations state:
- The Basel Committee on Banking Supervision should assess how to address the impact of differences between International Financial Reporting standards (IFRS) and US Generally Accepted Accounting Principles (GAAP), the appropriate treatment of off-balance sheet exposures and guarantees, and the treatment of highly liquid government securities.
- The FASB and IASB should issue a statement that reiterates for relevant regulators, financial institutions and their auditors that existing standards require the use of judgement to determine an incurred loss for provisioning of loan losses.
- The FASB and IASB should reconsider the incurred loss model by analysing alternative approaches for recognising and measuring loan losses that incorporate a broader range of available credit information. The FSF recommends that the FASB and IASB establish a resource group to provide input on technical issues and complete this project on an expedited basis.
- Accounting standard setters and prudential supervisors should examine the use of valuation reserves or adjustments for fair valued financial instruments when data or modelling needed to support their valuation is weak.
- Accounting standard setters and prudential supervisors should examine possible changes to relevant standards to dampen adverse dynamics potentially
associated with fair value accounting. Possible ways to reduce this potential impact include the following:
- Enhancing the accounting model so that the use of fair value accounting is carefully examined for financial instruments of credit intermediaries.
- Transfers between financial asset categories.
- Simplifying hedge accounting requirements.
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April 2009: G20 Declaration and IASB response
The Declaration on Strengthening the Financial System (PDF 137k) issued by the leaders of the Group of 20 (G20) following their meeting in London on 2 April 2009 calls on the accounting standard setters to improve standards for determining the fair values of financial instruments in illiquid markets and to take other actions regarding complexity of financial reporting, provisioning, and off balance sheet financing, among other matters:
Accounting standards
We have agreed that the accounting standard setters should improve standards for the valuation of financial instruments based on their liquidity and investors' holding
horizons, while reaffirming the framework of fair value accounting.
We also welcome the FSF recommendations on procyclicality that address accounting issues. We have agreed that accounting standard setters should take action by the end of 2009 to:
- reduce the complexity of accounting standards for financial instruments;
- strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information;
- improve accounting standards for provisioning, off-balance sheet exposures and valuation uncertainty;
- achieve clarity and consistency in the application of valuation standards internationally, working with supervisors;
- make significant progress towards a single set of high quality global accounting standards; and
- within the framework of the independent accounting standard setting process, improve involvement of stakeholders, including prudential regulators and emerging markets, through the IASB's constitutional review.
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The IASB has responded to the G20 leaders' recommendations and, at the same time, to Recent Decisions taken by the US Financial Accounting Standards Board (FASB). Here are excerpts:
- The IASB's response to the G20: 'The IASB is committed to taking action on each of the items recommended by the G20 by the end of 2009, the target date suggested by the G20, in order to ensure globally consistent and appropriate responses to the crisis.'
- The IASB's response to the FASB actions: 'Initial reports regarding new or additional divergences between IFRSs and US GAAP being created by these FSPs appear to be overstated. A preliminary review of the FASB's decisions by IASB staff indicates that FASB's objectives and approach on the application of fair value when a market is not active appear to be broadly similar to those in IFRSs.'
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April 2009: Three FASB Staff Positions on fair value in distressed markets
On 2 April 2009, the US Financial Accounting Standards Board approved three FASB Staff Positions to clarify fair value accounting for financial instruments, particularly in distressed markets. The Board had received 600 comment letters on three proposed Staff Positions. The letters presented mixed messages from investors, individuals, preparers, regulatory bodies, business associations, and auditors regarding the proposed FSPs. An extensive discussion took place before consensuses were reached by FASB to draft and issue final standards:
- FSP FAS 157-e Determining Whether a Market Is Not Active and a Transaction Is Not Distressed. In discussing this proposal, the FASB indicated that proposed FSP FAS 157-e was not intended to change the objective of a fair value measurement even when there has been a significant decrease in market activity for the asset being measured. The objective is to determine fair value (an 'exit price') in the current inactive market and not the value in a hypothetical active market or a midpoint between the two. A significant change from the proposed FSP FAS 157-e relates to the removal of the presumption that all transactions in an inactive market are distressed unless proven otherwise.
- FSP FAS 115-a, FAS 124-a, and EITF 99-20-b Recognition and Presentation of Other-Than-Temporary Impairments (OTTI). FASB agreed that the scope of the new OTTI model should be limited to debt securities. The existing OTTI models for equity securities would continue. The new OTTI model for debt securities would shift the focus from an entity's intent to hold until recovery to its intent to sell.
- An entity would write underwater debt securities that it currently intends to sell down to fair value through earnings.
- For those not intended for sale (available-for-sale or held-to-maturity), if it is probable that the entity will not collect all amounts contractually due, the entity will bifurcate the OTTI. The impairment due to credit, measured as the difference between amortized cost and the present value of expected cash flows discounted at the security's effective rate, would be recognised in earnings. The remaining amount of the impairment (noncredit portion) would be recognized in other comprehensive income.
- FSP FAS 107-b and APB 28-a Interim Disclosures about Fair Value of Financial Instruments. Public entities must disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments in inteirm and annual financial statements and explain any changes.
The final FSPs are expected to be issued late next week, effective for interim and annual periods ending after 15 June 15 2009. Early adoption would be permitted with restrictions.
Deloitte (United States) has published a 'Breaking News' Heads Up Newsletter (PDF 150k). The IASB has invited comments on the proposed versions of the first two of the above FSPs (see the IAS Plus News Story of 21 March 2009.
March 2009: FCAG letter to the G20
The Financial Crisis Advisory Group (FCAG) has issued a letter for distribution to the members of the G-20 meeting in London tomorrow. The FCAG was established by the IASB and the US FASB to advise the two boards about standard-setting implications of the global financial crisis and potential changes to the global regulatory environment. The letter explains the mission of the FCAG and its progress to date. The letter notes that the FCAG expects to issue its report in July 2009.
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March 2009: Third meeting of Financial Crisis Advisory Group
The Financial Crisis Advisory Group (FCAG) was established by the IASB and US FASB in response to the recent global financial crisis. Its purpose is to advise both Boards about the role of accounting during the crisis and potential changes. The FCAG held its third meeting in New York on 5 March 2009. Presented below are the preliminary and unofficial notes taken by a Deloitte observer at the meeting.
IASB-FASB Financial Crisis Advisory Group Meeting
5 March 2009 |
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The Chairman of the FCAG, Harvey J. Goldschmid, kicked off the meeting by informing the panelists and observers that FCAG is looking for feedback from the community on certain questions/topics to discuss during its next meeting in London, scheduled for 20 April 2009. FCAG expects to post these questions/topics on its website www.fasb.org/fcag/index.shtml on Monday. The members of the FCAG discussed various topics, including issues that could not be discussed due to time constraint, during its previous meeting in February 2009. Noted below are highlights of the issues discussed.
Dynamic Provisioning
Chairman Goldschmid noted that this is probably the most important issue the group will discuss today. The discussion on this topic was centered on the discussion paper prepared by the FCAG. Highlights of this discussion paper were attached as Appendix A to the meeting handouts, which can be obtained from the FCAG's website www.fasb.org/fcag/fcag_mtg_handouts.shtml.
Certain members noted that the concept of dynamic provisioning has similar connotations as the incurred loss model, and the concept is based on actual losses statistically estimated over time. In addition, certain members also pointed out that the concept of dynamic provisioning is a regulatory rather than an accounting issue, and changing the accounting to meet regulatory requirements could have an adverse impact, leading to more cyclicality.
Members also pointed out that the current incurred loss model is broken since it does not recognise losses at the 'right time' and whether a new model, such as the current value model, would be a better depiction of economic reality.
Many panelists agreed with the general concept of dynamic provisioning. Mr. Leisenring stated that any discussion of dynamic provisioning should start with defining the term. Mr. Herz indicated that standard-setter concerns include insuring that there is objective methodology in determining reserves under dynamic provisioning. The group agreed that the FASB, IASB, and the Basel Committee of Banking Supervisors will create a working group to study the various issues/questions raised on dynamic provisioning, including looking at the appropriate provisioning method (that is, incurred loss, expected loss, dynamic provisioning, or fair value). In addition, it was also noted that this new working group would provide recommendations on the appropriate model by the end of this year.
Improvement and Simplification of Accounting and Reporting of Financial Instruments
Mr. Herz provided an update on Financial Instruments: Improvements to Recognition and Measurement, a joint project of the IASB and FASB. Mr. Herz noted that the Boards were looking for input from this group to help determine the objective of this joint project. Mr. Herz and fellow Board member, Ms. Seidman also pointed out that the Boards don't have the luxury of three to five years, which is a typical timeframe for major projects.
Members generally agreed with Mr. Herz's view regarding the timing of the proposed project and noted that the key to this joint project is to converge and simplify the accounting models for financial instruments.
The group discussed that moving to a full fair value model would pose significant challenges, and consistent with recommendations of the SEC MTM Report (released on 30 December 2008 in response to a congressionally mandated study), any move to a full fair value model should not be done without addressing exiting practice issues. Members discussed the benefits and potential downfall of having two models (for example, fair value and expected loss). The group generally agreed that given the nature and complex nature of financial instruments, achieving simplification would not be without its challenges. Therefore, the group agreed that consistency and convergence should be the focus. Further, the panelists agreed that this topic/issue be added to the list of items the new working group (being formed by the IASB, FASB and Basel Committee) would address.
Recognition of Gains/Losses Related to Entity's Own Indebtedness in Fair Value Measurement of Liabilities
The panel discussed the pros and cons of recording gains (or losses) in fair value measurements of liabilities due to a change in entities own indebtedness. The general consensus of the group was that gains (or losses) may be recognised in the fair value measurement of liabilities, if (a) the change in indebtedness was for a specific issuer, (b) such gains (or losses) were realisable, and (c) appropriately disclosed. The panelist discussed that for gains (or losses) to be realizable, the standard setters would have to establish certain criteria that should be met (for example, an entity has adequate cash to buy back debt and the counterparty is willing to sell it back, etc.).
Additional Guidance on Fair Value Measurements
The co-chairs of the FCAG highlighted the additional short-term projects undertaken by the FASB to address the application and disclosure guidance of FASB Statement No. 157. These projects include (a) application guidance on determining when a market for an asset or a liability is active or inactive; determining when a transaction is distressed; and applying fair value to interests in alternative investments, such as hedge funds and private equity funds, and (b) improving disclosures about fair value measurements, which will consider requiring additional disclosures on such matters as sensitivities of measurements to key inputs and transfers of items between the fair value measurement levels.
The panelists also discussed the need for regulatory action in building sound markets and noted that some of the problems we are facing today are due to opaque markets for unregulated financial instruments.
Off-Balance Sheet Items
The members discussed the FASB and IASB consolidation and derecognition project. The panelists stated that the complex structures created in the market place which were accounted for off-balance sheet were the key cause of the financial crisis. They encouraged the Boards to reach a common ground, which may include enhanced disclosures. The panel decided to discuss this topic in further detail during the April 20 meeting.
Governance and Due Process
The panelists agreed that the independence of the standard setters is vital to ensuring an unbiased and transparent standard setting process. The members agreed that even during emergency standard setting, consultation with constituents should be essential. However, they applauded the efforts taken by the FAF and IASCF and the establishment of the Monitoring Board.
This summary is based on notes taken by observers at the FCAG meeting and should not be regarded as an official or final summary.
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March 2009: IASB-FASB credit crisis update
The International Accounting Standards Board and the US Financial Accounting Standards Board have announced further steps in response to the global financial crisis following their joint board meeting held in London on 23 and 24 March 2009. Building on work underway, the two boards have agreed to work jointly and expeditiously towards common standards that deal with off-balance sheet activity and the accounting for financial instruments. They will also work towards analysing loan loss accounting within the financial instruments project.
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March 2009: Two FASB proposals would ease mark-to-market
At its meeting on 16 March 2009, the US Financial Accounting Standards Board agreed to propose two modifications to the US mark-to-market requirements for financial instruments:
- Determining when a market for an asset or a liability is not active and determining when a transaction is not distressed. The Board decided to provide additional guidance to help an entity determine whether a market for an asset is not active and when a price for a transaction is not distressed. The Board Meeting Handout (PDF 108k) describes the proposed model the Board agreed to. The model would require 'significant judgement'.
- Other-than-temporary impairments. The Board discussed proposed changes to the guidance for other-than-temporary impairments. Currently, an entity is required to assess whether it has the intent and ability to hold a debt instrument to recovery in determining whether an impairment is other than temporary. The proposed FSP would change that guidance as follows:
- If the entity intends to sell the instrument or it is more likely than not that it will be required to sell the instrument before recovering its cost basis, the entire impairment loss would be recognised in profit or loss as an other-than-temporary impairment.
- If the entity does not intend to sell the security and it is not likely that the entity will be required to sell the instrument before recovering its cost basis, only the portion of the impairment loss representing credit losses would be recognised in profit or loss. The balance of the impairment loss would be recognised as a charge to other comprehensive income. For most debt instruments, an entity would determine the impairment charge representing credit losses by using its best estimate of the impairment amount arising from an increase in the credit risk associated with the specific instrument. The impairment recognised in other comprehensive income would be amortised over the remaining life of a debt instrument prospectively. That amortisation would be recognised in other comprehensive income with an offset to the asset and would not affect profit or loss.
For both topics, the changes will be exposed as proposed FASB Staff Positions, comment deadline 1 April 2009, and would be effective for interim and annual periods ending after 15 March 2009. The proposed FSPs would be applied prospectively. The Board expects to discuss the comments it receives at its meeting on 2 April 2009.
March 2009: Financial Crisis Advisory Group seeks input
The Financial Crisis Advisory Group (FCAG) is seeking written input from constituents in the form of responses to seven questions, to assist the FCAG in discussing accounting and reporting matters related to the global financial crisis and making recommendations thereon to the IASB and the US FASB. The two boards established the FCAG to advise them about the role of accounting during the crisis and potential changes. The questions and procedures for submitting views may be found on IASB's Website and FASB's Website. Comment deadline is Thursday 2 April 2009. The FCAG has already met three times, and notes taken by Deloitte observers at those meetings may be found elsewhere on this page.
February 2009: EU supervision report criticises IASB
The 'High-level Group on Financial Supervision in the EU' has published its Report that makes 18 detailed recommendations to strengthen supervision of the EU's financial institutions and markets. The report addresses:
- how to organise the supervision of financial institutions and markets in the EU
- how to strengthen European cooperation on financial stability oversight, early warning, and crisis mechanisms; and
- how EU supervisors should cooperate globally.
Throughout the Report, accounting is cited as one of the causes of the current global financial crisis. The Report urges that the IASB or supervisers set limits on mark-to-market accounting:
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To ensure convergence of accounting practices and a level playing-field at the global level, it should be the role of the International Accounting Standard Board (IASB) to foster the emergence of a consensus as to where and how the mark-to-market principle should apply – and where it should not. The IASB must, to this end, open itself up more to the views of the regulatory, supervisory and business communities. This should be coupled with developing a far more responsive, open, accountable and balanced governance structure. If such a consensus does not emerge, it should be the role of the international community to set limits to the application of the mark-to-market principle.
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The following is Recommendation #4 of the Report:
Recommendation 4: With respect to accounting rules the Group considers that a wider reflection on the mark-to-market principle is needed and in particular recommends that:
- expeditious solutions should be found to the remaining accounting issues concerning complex products;
- accounting standards should not bias business models, promote pro-cyclical behaviour or discourage long-term investment;
- the IASB and other accounting standard setters should clarify and agree on a common, transparent methodology for the valuation of assets in illiquid markets where mark-to-market cannot be applied;
- the IASB further opens its standard-setting process to the regulatory, supervisory and business communities;
- the oversight and governance structure of the IASB be strengthened.
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February 2009: Accounting implications of the credit crisis
At a conference in Dubai on 15 February 2009, Syed Asad Ali Shah, President of the Institute of Chartered Accountants of Pakistan and a partner in Deloitte (Pakistan), made a presentation on Global Financial Crisis – Accounting and Audit Considerations. Mr Shah discusses the origin of the crisis, current state, complex financial instruments, impact on the global economy, changes in standards, dealing with the crisis, and accounting and audit considerations.
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February 2009: Second meeting of the Financial Crisis Advisory Group
The Financial Crisis Advisory Group (FCAG) was established by the IASB and US FASB in response to the recent global financial crisis. Its purpose is to advise both boards about the role of accounting during the crisis and potential changes. The FCAG held its second meeting in New York on 13 February 2009. Presented below are the preliminary and unofficial notes taken by a Deloitte observer at the meeting.
IASB-FASB Financial Crisis Advisory Group Meeting
13 February 2009
The members of the FCAG discussed various issues ranging from the focus and purpose of the financial statements to fair value measurements. Noted below are highlights of the issues discussed:
Aim of financial statements
The FCAG members generally agreed that the financial statements are primarily directed toward investors, which includes a broad range of stakeholders, including lenders, investors, and creditors. The members also agreed that the joint project on financial statement presentation and XBRL will significantly improve and enhance how the users view the financial statements.
Financial statements vs. financial stability
The members generally agreed that financial statements must serve the purpose of helping users in making informed decisions by providing transparent information. Further, most agreed that accounting should not be used to counteract pro-cyclicality and should be neutral. In addition, the members generally agreed that it is the job of the prudential regulators to ensure financial stability and incorporating financial stability in the financial statements would jeopardize its transparency.
Dynamic provisioning for regulatory capital allocation
Various views were raised and discussed regarding the application of 'dynamic provisioning'. Some members voiced concerns that allowing entities to create reserves (without having appropriate guidelines or regulation) may lead to earnings management, while others suggested that prudential regulators should establish a minimum requirement for capital adequacy that should drive the reserve requirement.
The Chairman of the IASB voiced concern that dynamic provisioning will distort the income statement and suggested that regulators and standard setters work together to figure out how best to display the impact of dynamic provisioning on the balance sheet, that is, through equity with no impact on the income statement. Certain members also supported this view recommending that accounting should not be changed to meet regulatory capital requirements. Certain members also recommended that regulators prohibit entities from distributing such capital reserves (recorded in equity) through dividends or stock buyback to maintain the adequacy of such reserves.
Although there was much discussion on this topic, the chairman of the FCAG recommended that this issue be discussed in greater detail during the March 5 meeting, prior to which a concept paper on dynamic provisioning will be distributed to the members. The concept papers will discuss the two models (that is, change in provision through income or equity) and may broaden the concept of dynamic provisioning to not just loans, but to other financial instruments.
Fair Value Measurements
The chairman of the FCAG highlighted that the SEC's study on mark-to-market accounting highlighted that fair value was used to measure a minority of assets and liabilities at the financial institutions studied and was not to be blamed for the failure of the financial institutions. In fact members pointed out that credit losses (as highlighted in the study) were the primary driver of bank failures.
Certain FCAG members highlighted that the real issue is how to apply fair value in distressed markets. These members also identified that recording gains on liabilities (due to credit downgrade) does not provide useful representation of bank's performance and results in misrepresentation of true losses, which are suppressed by such gains. Members also noted that Statement 157 provides flexibility in measuring fair value, which requires the use significant judgment, but due to litigation risk and risk of being second guessed, results in incorrect application of fair value.
Further, members agreed that fair value provides transparency; however, the Boards (the IASB and FASB) should continue to explore methods to improve fair value before broadening its application to other financial assets and liabilities.
In addition, the members agreed that the mixed attribute model should be reviewed and the Boards should consider simplifying the impairment guidance.
This summary is based on notes taken by observers at the FCAG meeting and should not be regarded as an official or final summary.
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January 2009: Financial Crisis Advisory Group meeting
The Financial Crisis Advisory Group (FCAG) was established by the IASB and US FASB in response to the recent global financial crisis. Its purpose is to advise both boards about the role of accounting during the crisis and potential changes. The FCAG held its first meeting yesterday. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the meeting.
IASB-FASB Financial Crisis Advisory Group Meeting
20 January 2009
The chairman reminded participants in his introductory remarks about the reasons why fair value gained so much attention recently, particularly where it was applied to instruments in 'frozen' markets. He continued to explain that the fair value concept was applied more broadly after the 'savings-and-loan crisis' in the US and that it was still a 'work in progress'. He said that that the two main questions asked were:
- Where did financial reporting help to identify issues?
- Where did financial reporting not help?
The chairmen of the US FASB and IASB gave a brief update on the actions taken by both boards. They reported that there were pressures to do more fundamental changes to financial reporting and that regulatory reforms could potentially affect financial reporting. They identified five major issues that emerged during the crisis:
- Fair value
- Off-balance sheet activities (consolidation)
- Securitisations (derecognition)
- Impairment
- Risk reporting (users didn't see the risks in entities)
Both chairmen emphasised that the actions taken and planned focussed on those issues.
Staff from both boards gave a detailed update on the ongoing responses so far. It was highlighted that several proposed amendments to IFRS and US GAAP had been published and will be redeliberated as soon as possible. Further, the IASB expects to issue proposals on derecognition and fair value measurement in Q1/2009. Both boards will continue to accelerate work on a comprehensive review of financial instruments accounting.
The acting chief accountant of the SEC presented a summary of the recently published SEC report on the impact of fair value accounting on the financial crisis in the US. He noted that the majority of assets were not measured at fair value in the financial statements of financial institutions in the US and that only a fraction of those was measured with changes in fair value going through profit or loss. The report concluded that fair value did not play a meaningful role in the crisis. The SEC report noted that fair value was considered by investors as useful and that many alternatives presented lacked this degree of usefulness. Further, the report highlights that the FASB process was appropriate. The acting chief accountant noted that the report contained several recommendations, including the proposal not to suspend fair value accounting (see our news of 30 December 2008).
FCAG members then expressed their views. The main themes of participants' views are summarised below.
Did fair value accelerate or worsen the financial crisis?
Many participants expressed the view that fair value played 'some' role during the financial crisis, particularly with regard to the effect of procyclicality. This was seen as having been increased by the use of financial reporting numbers for regulatory purposes. However, the majority was of the view that it did not play a major role and none of the participants proposed to abandon it – it was the business risks financial institutions have taken on and did not appropriately manage.
It was highlighted that entities would need more guidance on how to determine fair value under specific circumstances, particularly in inactive market. The work of the IASB's Expert Advisory Panel and its final document was referred to as a step in the right direction. Other FCAG members were concerned that it was the valuation process itself was not transparent and this was also an issue to be tackled.
Many FCAG members highlighted that off-balance sheet activities and hence consolidation rules allowed the development of a shadow accounting system where risks were not presented in any financial statement. It was noted that management must explain in its financial reports why entities are consolidated or not.
One member noted that the incentives systems for executives aggravated the situation and that those systems were not reported appropriately in any company reports. Some commented that accounting would not avoid future crises.
Due process in standard-setting
Many emphasised the importance of adhering to due process, possibly accelerated in difficult times, even under pressure. One member noted that the period of September/October 2008 marked a low in international financial reporting standard-setting. Shortcuts to due process could undermine investors' confidence in financial reporting. In this regard it was noted that standards must be enforceable: if standards were not applied appropriately the best accounting framework would not help. Some members emphasised the need for a single global set of standards.
Investors' confidence
A further main theme was that investors' confidence in financial reporting is key to improving the market situation – investors were interested in financial reporting that depicts economic reality. Standard-setters were urged to bear that in mind when pursuing further steps. This was linked to reducing complexity in financial reporting and avoiding information overload. One of the IASB members present said that there was a lot of cynicism in the market about financial reporting and any next steps must not further this cynicism, but instead restore credibility of financial reporting. This member noted that many of the requests by politicians to changes in accounting would provide tools for earnings management and, hence, would undermine investors' confidence.
Impairment
Many FCAG members were concerned over the complex rules on impairment and the differences between IFRSs and US GAAP. Some of the participants expressed concerns over the missing possibility to establish provisions in good times that could be used in bad times, that is provide for expected losses, not only incurred losses as under current impairment models in IFRS and US GAAP. Others responded this is a regulatory issue and could be resolved by appropriate reserve allocation to restrict the profits that could be distributed.
Objectives of financial reporting
It was noted that before concluding on any issues, the purpose of financial reporting must be clear. It was highlighted that the current frameworks would not identify regulators as primary users of financial statements and hence, financial stability was not an objective of financial reporting.
This summary is based on notes taken by observers at the FCAG meeting and should not be regarded as an official or final summary.
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January 2009: G30 recommendations on fair value accounting
On 15 January 2009, The Group of Thirty released a report Financial Reform: A Framework for Financial Stability. The report addresses flaws in the global financial system and provides 18 specific recommendations to: improve supervisory systems; enhance the role of the central banks; improve governance practices and risk management; address pro-cyclicality; enhance accounting practices; strengthen the financial infrastructure; and increase coordination internationally. The project was led by Paul Volcker, Chairman, and Tommaso Padoa-Schioppa and Arminio Fraga Neto, Vice Chairmen. Mr Volcker and Mr Padoa-Schioppa are both former Chairmen of the IASC Foundation, under which the IASB operates. The Group of Thirty is a private, nonprofit, international body that aims to 'deepen understanding of international economic and financial issues, to explore the international repercussions of decisions taken in the public and private sectors, and to examine the choices available to market practitioners and policymakers'.
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Core recommendations in the Group of Thirty report: Financial Reform: A Framework for Financial Stability
Core Recommendation I
Gaps and weaknesses in the coverage of prudential regulation and supervision must be eliminated. All systemically significant financial institutions, regardless of type, must be subject to an appropriate degree of prudential oversight.
Core Recommendation II
The quality and effectiveness of prudential regulation and supervision must be improved. This will require better-resourced prudential regulators and central banks operating within structures that afford much higher levels of national and international policy coordination.
Core Recommendation III
Institutional policies and standards must be strengthened, with particular emphasis on standards for governance, risk management, capital, and liquidity. Regulatory policies and accounting standards must also guard against procyclical effects
and be consistent with maintaining prudent business practices.
Core Recommendation IV
Financial markets and products must be made more transparent, with better aligned risk and prudential incentives. The infrastructure supporting such markets must be made much more robust and resistant to potential failures of even large financial institutions.
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One of the specific recommendations under Core Recommendation III relates to 'Fair Value Accounting':
Fair Value Accounting – Recommendation 12:
- a. Fair value accounting principles and standards should be reevaluated with a view to developing more realistic guidelines for dealing with less liquid instruments and distressed markets.
- b. The tension between the business purpose served by regulated financial institutions that intermediate credit and liquidity risk and the interests of investors and creditors should be resolved by development of principles-based standards that better reflect the business model of these institutions, apply appropriate rigor to valuation and evaluation
of intent, and require improved disclosure and transparency. These standards should also be reviewed by, and coordinated with, prudential regulators to ensure application in a fashion consistent with safe and sound operation of such institutions.
- c. Accounting principles should also be made more flexible in regard to the prudential need for regulated institutions to maintain adequate credit loss reserves sufficient to cover expected losses across their portfolios over the life of assets in those portfolios. There should be full transparency of the manner in which reserves are determined and allocated.
- d. As emphasized in the third report of the CRMPG, under any and all standards of accounting and under any and all market conditions, individual financial institutions must ensure that wholly adequate resources, insulated by fail-safe independent decision-making authority, are at the center of the valuation and price verification process.
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January 2009: Accounting considerations in 'turbulent times'
Deloitte's IFRS Global Office has published Turbulent Times: Key Accounting Considerations in Today's Volatile Markets (PDF 172k). This accounting alert highlights the accounting issues and literature most likely to be relevant when assessing the accounting implications of today's financial environment. It focuses on the following:
- determining fair values in inactive markets,
- revised projections of economic outlook indicating impairment and lack of recoverability for many assets,
- reduced availability of credit and increasing cost of finance,
- increased levels of bankruptcy,
- the impacts on hedge accounting, and
- critical enhanced disclosure requirements.
The accounting considerations described apply to all entities – they are not unique to financial institutions. The alert does not introduce new accounting guidance. Rather, it highlights the provisions of current IFRSs that are most likely to be relevant when assessing the accounting in markets characterised by volatility, a credit crunch, and recession.
December 2008: Members of IASB-FASB financial crisis advisory group
On 30 December 2008, the IASB and the FASB announced the membership of the Financial Crisis Advisory Group (FCAG). The FCAG is the high-level advisory group set up by the boards to consider financial reporting issues arising from the global financial crisis. The boards had previously announced that the FCAG will be jointly chaired by Harvey Goldschmid, former US SEC Commissioner, and Hans Hoogervorst, Chairman, AFM (the Netherlands Authority for the Financial Markets). Membership of the FCAG is as follows:
- John Bogle, Founder, Vanguard, United States
- Jerry Corrigan, Goldman Sachs and former President of the New York Federal Reserve Bank, United States
- Fermin del Valle, former President, IFAC, Argentina
- Jane Diplock, Chairman, IOSCO Executive Committee, New Zealand
- Raudline Etienne, Chief Investment Officer, New York State Common Retirement Fund
- Stephen Haddrill, Director General, Association of British Insurers, UK
- Toru Hashimoto, former Chairman, Deutsche Securities Limited, Japan
- Nobuo Inaba, former Executive Director, Bank of Japan, Japan
- Gene Ludwig, former Controller of the Currency, United States
- Yezdi Malegam, Board Member, National Reserve Bank of India, India
- Klaus-Peter Muller, Chairman of the Supervisory Board, Commerzbank, Germany
- Don Nicolaisen, former Chief Accountant, US Securities and Exchange Commission, United States
- Wiseman Nkuhlu, Chairman of the Audit Committee, AngloGold Ashanti; former Economic Advisor to the President of the Republic of South Africa
- Tommaso Padoa-Schioppa, former Finance Minister, Italy
- Lucas Papademos, Vice-President, European Central Bank
- Michel Prada, former Chairman, Autorite des marches financiers, France
There will also be observers from the Basel Committee, CESR, IAIS, Japan Financial Services Agency, US SEC, and the advisory councils of IASB and FASB. The FCAG will hold its first meeting in London on 20 January 2009 (there's more information about the meeting on IASB Website).
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December 2008: IASB ED on consolidation
On 18 December 2008, the IASB issued an exposure draft (ED) of proposed amendments to IAS 27 Consolidated and Separate Financial Statements. The objective is to strengthen and improve the requirements for identifying which entities a company controls and, therefore, must include in its consolidated financial statements. The proposals form part of the IASB's comprehensive review of off balance sheet activities and address an area cited in a Declaration of the G20 Leaders at their 15 November meeting. The proposals also respond to the recommendations contained in a Report by the Financial Stability Forum published in April 2008. Further proposals on off balance sheet items, covering the derecognition of assets and liabilities, are due to be published in the first quarter of 2009, consistent with the G20 target date of 31 March 2009. The new standard would replace IAS 27 Consolidated and Separate Financial Statements and Interpretation SIC-12 Consolidation - Special Purpose Entities. The proposal ED 10 Consolidated Financial Statements, may be downloaded without charge from the IASB's Website. The comment letter deadline is 20 March 2009. The proposed effective date is 1 July 2009. Click for Press Release (PDF 48k).
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Proposed Definition of Control of an Entity
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The consolidation ED proposes a new, principle-based, definition of control of an entity that would apply to a wide range of situations and be more difficult to evade by special structuring. The proposals also include enhanced disclosure requirements
that would enable an investor to assess the extent to which a reporting entity has been involved in setting up special structures and the risks to which these special structures expose the entity. The proposed definition:
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A reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity to generate returns for the reporting entity.
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Under IAS 27, the definition is 'power to govern the financial and operating policies'. 'Power to direct the activities' is broader than 'power to govern the financial and operating policies' and, therefore, would broaden the scope of consolidation. The ED also clarifies that a reporting entity can have power even if it has not exercised its voting rights or options to acquire voting rights, or is not actively directing the activities of another entity. The ED proposes guidance on how to
assess power and returns when:
- a reporting entity has less than a majority of the voting rights
- assessing control of a structured entity (called special purpose entity in SIC 12)
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December 2008: Notes from the financial crisis roundtable in Tokyo
In response to the challenges caused by the current market conditions the IASB and the FASB decided to hold a series of roundtables to gather views from constituents on the most urgent accounting issues and how to approach them. The first roundtable was held in London on 14 November 2008 (click for Deloitte Notes). The second was held at the FASB's office in Norwalk, CT USA, on 25 November 2008 (click for Deloitte Notes). Presented below are the preliminary and unofficial notes taken by Deloitte observers at the 3 December 2008 roundtable held in Tokyo.
Notes from the IASB-FASB Global Financial Crisis Roundtable
ASBJ Offices, Tokyo – 3 December 2008
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The IASB and FASB concluded their joint roundtables on financial reporting issues arising from the global financial crisis with two roundtables held in the offices of the Accounting Standards Board of Japan (ASBJ) on the afternoon of 3 December 2008. The objective of the roundtables was for the Boards to hear input from a wide range of stakeholders on accounting issues that may require urgent attention to help enhance investor confidence in financial markets.
The Tokyo roundtable was divided into two 2-hour sessions. IASB Board Member John Smith chaired both sessions. As in other sessions it was noted that all next steps, in response to calls from constituents, will be considered jointly by IASB and FASB and following their due process. Therefore, no decisions were taken at these roundtable meetings.
The chairman of the ASBJ, Mr Ikuo Nishikawa, welcomed participants and observers to both sessions, while at the second session Dr Takafumi Sato, Commissioner of the Japanese Financial Services Agency, made some introductory comments that included strong support for global high quality accounting standards and the harmonisation between the IASB/FASB. He did not support the recent calls to reduce standards, indicating an expectation that accounting standards would result in fair and accurate reporting of financial position by issuers and a prompt recognition of losses. He expressed a strong view that due process must be followed, and he concluded that standard setters were best placed to create solutions. These sentiments were echoed by many of the participants.
Mr Smith indicted the objective of the roundtable was hear from participants about those issues that had arisen from the global financial crisis, to identify whether the issues were convergence issues, whether any 'fixes' were urgent or whether they could be dealt with as part of a longer term project. He noted that issues raised by participants in their written submissions were very similar to those raised at the roundtables in the US and UK, that he had received a clear message that due process must be followed and, accordingly, it was most unlikely any changes to IFRS would occur prior to 31 December 2008.
Topic 1 – Impairment Issues
Key discussion points around the triggers (what and when) and measurement of impairment included:
- The difficulty in identifying when 'significant or prolonged' had occurred, with some suggesting the test should be 'and' rather than 'or', that the temporary test in FASB should be introduced, and that entities should disclose their accounting policy for assessing significant and prolonged.
- Suggestions that the trigger for AFS debt instruments should be credit related, not just market, with credit related loss taken to P&L and remaining loss left in OCI.
- The difficulty in identifying trigger point for reversal of impairment losses generally , with suggestions that AFS equity reversal of impairments loss in P&L should be permitted with, perhaps, a trigger test similar to that required for impairment with some noting that the inability to reverse impairment losses caused reluctance to, or delay in, the recognition of impairment.
IASB Chairman Sir David Tweedie floated the idea of removing the recycling option (treat all AFS securities as trading) as this would overcome many of the impairment difficulties with all movements being recorded in P&L. This proposal did not receive much support although an IOSCO .member noted that IOSCO members were divided on the issue
There was no apparent appetite by participants for a quick fix in this area before 31 December 2008, with general agreement that any review should be comprehensive and longer term, although there was some support for a review of the impairment and measurement of AFS securities in the short term, with a shorter than normal due process.
Topic 2 – FV Measurement
Most participants felt the guidance issued by the expert advisory panel measuring fair value in an illiquid market was useful, with some suggesting a need for greater guidance around the use of discount rates. Others noted the difficulties auditors face in obtaining sufficient appropriate evidence to support valuations in illiquid or inactive markets.
Some participants commented on user misunderstanding about what was meant by fair value, and suggested the IASB develop ways to educate users about FV and why FV is used for financial reporting.
In terms of disclosure, some suggested a need for more guidance on what and when to disclose information, with mixed views on whether the IASB or industry groups were the best suited to produce illustrative disclosures. Some participants expressed concern with the ever increasing disclosure requirements which tends to reduce understandability of financial statements.
Topic 3 – Other Issues
CDOs. Not a great deal of support for anything to be done in relation to CDOs.
Hedging. Strong support for a total review and rethink on hedging accounting requirements, with a desire for simplification of the rules. Agreed any review would need to be comprehensive, it needed to have high priority, and probably could not be done in the short term and may need to be incorporated into any review of classification (see below).
Simplification of Classification. There was a fair degree of support for permitting redesignation out of the FV option, for example when there is a change in conditions for original designation. However, there was no agreement about the criteria to be applied to permit such reclassification. General agreement that this area need to be reviewed and was a long term project.
Pro-cyclicality. Mr Smith noted that accounting standards should show information to the market, good or bad. The was general agreement with that view, however the IASB was encouraged to review their approach in relation to provisioning which is based on an as incurred model, while many regulators require the application of an expected loss model for prudential purposes. The IASB indicated that it would appreciate gaining a better understanding of the expected loss model, referred to by some as dynamic provisioning.
Future Issues. Participants encouraged the IASB to give appropriate consideration to the following topics: hyper-inflation, foreign exchange translation, and definition of an active market.
This summary is based on notes taken by observers at the Roundtable and should not be regarded as an official or final summary.
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December 2008: Notes from the financial crisis roundtable in United States
In response to the challenges caused by the current market conditions the IASB and the FASB have decided to hold a series of roundtables to gather views from constituents on the most urgent accounting issues and how to approach them. The first roundtable was held in London on 14 November 2008 (click for Deloitte Notes). The second was held at the FASB's office in Norwalk, CT USA, on 25 November 2008. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the 25 November roundtable.
Notes from the IASB-FASB Global Financial Crisis Roundtable
FASB Offices, Norwalk, CT 25 November 2008
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On 25 November 2008, the IASB and the FASB held a public roundtable at the FASB offices in Norwalk, CT on the subject of reporting issues arising from the global financial crisis. The objective of the roundtable was for the Boards to hear input from a wide range of stakeholders on accounting issues that may require urgent attention to help enhance investor confidence in financial markets.
The main topics discussed were (1) impairment of financial assets, (2) fair value option, (3) fair value measurements, and (4) disclosures. The following are some of the highlights from the roundtable.
Impairment of Financial Assets
Much of the roundtable discussion focused on issues with the current impairment models related to debt securities. Several issues identified include:
- The purpose of 'impairment' in financial reporting is not well understood. There is no unified definition and there are multiple models depending on the type of financial asset.
- Triggering events are not well understood. Some believe that management intent should play a significant role in whether a triggering event has occurred. Others indicate that management intent changes and is subjective; as such, management intent should not be a factor when determining whether an asset is impaired.
- Once impairment is deemed appropriate, the use of multiple impairment models for recognition in the financial statements creates complexity and makes it difficult for users to understand the financial statements. For example, loans receivable are carried at amortised cost less impairment for credit loss, but securitised loans, which may have the same economic characteristics as loans receivable, are written down to fair value.
Roundtable participants shared several views on how some of these issues could be address. Some Users of the financial statements were proponents of full fair value with changes in fair value reflected in the income statement. They indicated that this would take away issues related to triggering events and multiple impairment models. Others (some preparers and auditors) suggested a model that was proposed by the AICPA Center for Audit Quality (CAQ) in their Comment Letter to the SEC on Fair Value (PDF 119k). Under that model the debt security would be carried at fair value on the balance sheet with credit losses recognised currently in income and other changes in the fair value recognised in other comprehensive income. The credit loss would be calculated on the basis of changes in expected cash flows in a manner similar to the Statement 114 model. Under that proposal other comprehensive income would be displayed on the income statement so the components of change in fair value are in the same statement. These proponents indicated that it would give users of the financial statement information regarding expected cash flows of the debt security as well as other changes in fair value.
These two suggestions sparked debate about what is appropriate to be recorded in earnings. While the debate was interesting, it did not solve the issue of what is causing the lack of confidence in financial institutions. Some indicated that the lack of confidence was of result of investors not trusting what companies have reported in their balance sheet. They indicated the real issue is lack of transparency necessary for investors to make investment decisions. Several analysts suggested that additional disclosure of what the entity is holding and how management estimated the fair value are necessary. One suggestion was a table, by class of investment, which would include: cost, current fair value, implied value or other measure that the company feels is appropriate, a description of how fair value is calculated including significant inputs, a description of how implied value was calculated, and why the company believes the other measurement is appropriate. Members of the both Boards indicated that it would probably be easier to get a short term project completed that deals with disclosure than one that tries to address the multiple issues related to impairment.
Fair Value Option
Participants were asked whether they believed that the fair value option should continue to be irrevocable. Most agreed that the option should be irrevocable. They indicated that they liken it to an anti-abuse provision which keeps people from applying it to an instrument when it is beneficial and reversing the application when fair value is detrimental. Some indicated that the reason the option was initially elected may no longer be valid as a result of changes in the business. For example, if the option was selected to alleviate an accounting mismatch that no longer exists, then some believe the election should be revocable.
Fair Value Measurements
Several participants indicated that the measurement guidance in the whitepaper issued by IASBs Expert Panel was very useful and that it would be good for the Boards to codify the information into authoritative guidance. One participant asked for guidance on measuring alternative investments, such as investments in closed end hedge funds. The participant indicated that the FASB staff and FASB's Valuation Resource Group had previously discussed the difficulties in measuring these investments and whether net asset value was the appropriate measurement under Statement 157. Others indicated any short term guidance should solely focus on helping the capital markets recover and transparency.
Disclosures
Several participants commented on the disclosure suggestion noted above. They indicated that disclosure would be a good start but they would also like to see forward looking information, sensitivity to changes in inputs, and uncertainties in the estimate.
Others stated that the level 3 rollforward provides a significant amount of good information, and they would like to see that information for all levels within the hierarchy.
This summary is based on notes taken by observers at the Roundtable and should not be regarded as an official or final summary.
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November 2008: Basel Committee proposes fair value guidance
The Basel Committee on Banking Supervision has invited comment on proposed Supervisory Guidance for Assessing Banks' Financial Instrument Fair Value Practices. The comment deadline is 6 February 2009. The guidance is intended to help supervisors assess the rigour of banks' valuation processes and to promote improvements in risk management and control
practices. The guidance supports one of the key recommendations for enhancing transparency and valuation set out in the April 2008 Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience.
The main principles in the proposed Basel Committee guidance are:
- strong valuation governance processes;
- use of reliable inputs and diverse information sources;
- independent verification and validation processes;
- communication of valuation uncertainty to internal and external stakeholders;
- consistency in valuation practices for risk management and reporting; and
- strong supervisory oversight around bank valuation practices.
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November 2008: Credit crunch challenges for directors
The United Kingdom Financial Reporting Council (FRC) has published two alerts to directors on the corporate reporting challenges arising from current economic conditions. Because of the global liquidity squeeze, directors and audit committees may need to spend more time planning the year-end activities, reviewing key assumptions and models used in financial reporting, and reviewing the significant accounting and disclosure judgements. In response to those challenges, the FRC has published:
The purpose of the documents is to assist directors by identifying key questions that they may wish to consider when preparing for the year-end and in meeting their responsibilities in relation to annual reports and accounts. These documents do not impose any new requirements on UK companies or their auditors. These publications are copyright by the FRC and are posted on IAS Plus with the kind permission of the FRC.
November 2008: Notes from the IASB-FASB financial crisis roundtable in London
In response to the challenges caused by the current market conditions the IASB and the FASB have decided to hold a series of roundtables to gather views from constituents on the most urgent accounting issues and how to approach them. The first roundtable was held in London on 14 November 2008. The second will be at the FASB's office in Norwalk, CT USA, on 25 November 2008. The final roundtable will be on 3 December 2008 at the offices of the Accounting Standards Board of Japan in Tokyo. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the London roundtable.
Notes from the IASB-FASB Global Financial Crisis Roundtable
London 14 November 2008
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The London roundtable was divided into two 2.5 hour sessions. IASB Board Member John Smith chaired both sessions. The 44 participants were drawn from a wide range of constituents. It was noted that all next steps, in response to calls from constituents, will be considered jointly by IASB and FASB and following due process and, therefore, no decisions were taken at these roundtable meetings.
For the roundtable in London the following topics were discussed based on submissions from participants received:
- Impairment of financial assets
- Reclassification of financial instruments designated under the fair value option
- Fair value measurement
- Disclosures
- Other issues
Impairment of financial assets
The chairman introduced the topic highlighting that the guidance for impairment both regarding triggers and measurement is different in IFRS and US GAAP.
Much of the discussion focussed on the different impairment models that exist in IFRS and US GAAP, particularly for impairment of debt instruments. Many participants believe there should be convergence. They commented most frequently on the differences between loan loss impairment for a debt instrument measured at amortised cost compared to one measured at fair value as an available-for-sale (AFS) investment. Recent market events had resulted in the latter being recognised at an amount significantly lower than if it has been measured under an amortised cost model due to the current market's assessment of credit and liquidity risk compared to an impairment that would have been recognised had the impairment been calculated using the original effective interest rate. Some participants put forward the idea that impairment of an AFS debt instrument should be recognised on the same basis as if the asset was measured at amortised cost. If that is done, differences due to liquidity risk or credit risk in excess of the incurred loss model would be recognised in other comprehensive income, rather than currently recognised in profit or loss. This led to a broader question about what impairment in income is meant to represent – loss of recoverable cash flows or loss in fair value.
Some participants raised a number of interpretative issues with the current model of impairing AFS debt instruments. Specifically, if an AFS debt instrument is impaired, are further declines in fair value considered as further impairments, or does this depend on whether further fair value declines are derived from movements in the risk-free rate as opposed to further declines in credit quality, or whether further declines in fair value are impairment losses only if there are further impairment triggers?
There was feedback from user groups as to whether impairment losses based on the incurred loss concept were useful even if the loss recognised in profit or loss is based on fair value. Some participants noted that fair value is a good predictor of real cash losses. It was also highlighted while there is a difference between impairment and fair value volatility, markets are usually better than individuals in predicting the performance of an instrument.
There was discussion of whether for equity securities an impairment loss should be allowed to be reversed through profit or loss – currently it is not. Some argued that as the trigger event is a significant or prolonged decline in fair value below cost, then should this trigger event no longer apply, the impairment should be reversed through profit or loss.
The Boards will consider whether amendments to the existing measurement guidance for impairment is needed, or alternatively whether further disclosure in the short term could be introduced to align the different impairment approaches. The chairman noted that the challenges resulting from the current guidance are rooted in the fact that there are different measurement classification categories within IFRS and US GAAP. Aligning the classification categories would address many of these issues.
Many of the participants agreed with this conclusion.
Reclassification of financial instruments designated under the fair value option
The roundtable then discussed the use of the fair value option and possible reclassifications out of this designation. Some participants sympathised with revising the conditions for invoking the fair value option to achieve convergence with US GAAP (that is, so the fair value option under IFRS is unrestricted) and widening the fair value option for certain arrangements over non-financial items not currently in IAS 39. Others proposed allowing reclassification out of the fair value option in case where conditions for invoking the fair value option are no longer met. Participants holding this view felt this was appropriate in the case of an accounting mismatch that existed when the fair value option was invoked which no longer applied, for example:
- where financial assets were matching insurance liabilities and the continuation of the fair value option created more of an accounting mismatch, or
- when the fair value option was used instead of fair value hedge accounting and the mismatch failed due to changes in fair value of the assets due to credit and prepayment risk, or
- when the entity ceased to manage the financial instruments on a fair value basis due to difficulties in establishing fair value in the current markets.
Concern was raised that to allow an entity to reclassify in such circumstances would require further rules as what would be a permitted reclassification.
Fair value measurement
Regarding how to determine fair value, it was noted there was a recent submission to the IFRIC on how to include liquidity spreads in valuation when the market is no longer active. While many participants agreed that determining fair value is more challenging in inactive markets, it is not appropriate to normalise values or use liquidity spreads that do not reflect a current market participant's view of spreads. It was noted the view expressed in the IFRIC submission was not in accordance with IAS 39. Others referred to the work done by the IASB Experts Advisory Panel and that this guidance should indeed be authoritative (and not voluntary as it is at the moment).
The roundtable participants discussed the procyclical effects of fair value accounting. There seemed to be agreement that it is not the purpose of financial reporting to report 'regulatory numbers' that avoid overly positive or negative market movements. It was noted that within the European Union, ECOFIN has established a working group to analyse the roots of procyclicality and that Bob Herz (FASB chairman) and Sir David Tweedie (IASB chairman) would be on a Financial Stability Forum working party looking at procyclicality.
Disclosures
The chairman introduced this topic by presenting the various projects on the boards' agendas on the topic of disclosures. User groups were concerned that the IAS 39 amendment on reclassifications of financial assets issued in October 2008 only amended IFRS 7, which only deals with disclosure in annual accounts. User groups stated that there are widely different variations in the amount of disclosure in interim financial statements for entities that reclassified financial assets in Q3 and proposed that the additional disclosures included in IFRS 7 should be required in interims.
Other issues
The roundtable discussed the issue of accounting for synthetic Collateralised Debt Obligation (CDO) structures. Many speakers highlighted that there is a divergence between IFRS and US GAAP as to whether credit-related embedded derivatives require separation or not in the instance when the instrument is not fair valued through profit or loss. It was noted that both the IASB and FASB would consider this issue.
It was noted that clarification is needed on whether embedded derivatives need to be assessed if an entity reclassified an asset out of fair value through profit or loss as a result of the IAS 39 amendment issued last month. Some IASB Board members noted that the IAS 39 amendment was not intended not to require assessment of embedded derivatives. Participants noted that IAS 39/IFRIC 9 was not as clear as it could be in this respect. Staff from the IASB indicated that this would be addressed in the future, and the chairman stated that should the IASB issue a clarification it would most likely state that assessment of embedded derivatives would be required at the date of reclassification and it would be applied retrospectively.
One participant noted that the IASB and FASB projects on derecognition and consolidation did not seem to be aligned, and a request was made that they should be.
The chairman asked participants if there were other issues the boards should address. No participant raised other issues.
This summary is based on notes taken by observers at the Roundtable and should not be regarded as an official or final summary.
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November 2008: Report of the G20 Summit
At the conclusion of the 15 November 2008 meeting of the G20 Heads of State and leaders of the World Bank, the International Monetary Fund, the United Nations, and the Financial Stability Forum, the participants published a Declaration of the Summit on Financial Markets and the World Economy (PDF 50k). The Declaration sets out both immediate actions (by 31 March 2009) and medium-term actions that should be taken to strengthen the global economy and reform the world's financial markets. The leaders agreed on a set of common principles for market reforms, including the following principle for strengthening transparency and accountability:
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We will strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions. Incentives should be aligned to avoid excessive risk-taking.
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The excerpts below are the recommendations most directly related to the IASB and IFRSs.
Strengthening Transparency and Accountability
Immediate Actions by March 31, 2009:
- The key global accounting standards bodies should work to enhance guidance for valuation of securities, also taking into account the valuation of complex, illiquid products, especially during times of stress.
- Accounting standard setters should significantly advance their work to address weaknesses in accounting and disclosure standards for off-balance sheet vehicles.
- Regulators and accounting standard setters should enhance the required disclosure of complex financial instruments by firms to market participants.
- With a view toward promoting financial stability, the governance of the international accounting standard setting body should be further enhanced, including by undertaking a review of its membership, in particular in order to ensure transparency, accountability, and an appropriate relationship between this independent body and the relevant authorities.
- Private sector bodies that have already developed best practices for private pools of capital and/or hedge funds should bring forward proposals for a set of unified best practices. Finance Ministers should assess the adequacy of these proposals, drawing upon the analysis of regulators, the expanded FSF, and other relevant bodies.
Medium-term actions:
- The key global accounting standards bodies should work intensively toward the objective of creating a single high-quality global standard.
- Regulators, supervisors, and accounting standard setters, as appropriate, should work with each other and the private sector on an ongoing basis to ensure consistent application and enforcement of high-quality accounting standards.
- Financial institutions should provide enhanced risk disclosures in their reporting and disclose all losses on an ongoing basis, consistent with international best practice, as appropriate. Regulators should work to ensure that a financial institution's financial statements include a complete, accurate, and timely picture of the firm's activities (including off-balance sheet activities) and are reported on a consistent and regular basis.
Reinforcing International Cooperation
Medium-term actions:
- Authorities, drawing especially on the work of regulators, should collect information on areas where convergence in regulatory practices such as accounting standards, auditing, and deposit insurance is making progress, is in need of accelerated progress, or where there may be potential for progress.
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November 2008: National standard setters communique to IASB and IASCF
On 14 November 2008, twenty members of the National Standard Setters Group (NSS) sent a communique to the IASB and the IASCF Trustees expressing support for the IASB's efforts to achieve true global financial reporting standards. The NSS members mention the
Request by the European Commission asking the IASB to amend or interpret IAS 39 to ensure that three specific matters are addressed in time for year-end 2008 financial reports. The NSS members state that:
- It is important that the IASB follows appropriate due process.
- While appropriate due process should allow constituents ample time to consider and comment on any changes, it may be, in these extraordinary times, that due process will need to be shortened. Should this be the case we stand ready to assist the IASB to achieve the most effective due process possible. For instance we could stimulate debate among our national constituents, hold round tables on the technical issues involved and act as focal points for comments.
- We urge those adopting international financial reporting standards to accept the decisions of the IASB if they are made with adequate due process and deliberation, taking into account the impacts on markets and the economy.
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November 2008: Co-chairs of IASB-FASB economic crisis advisory group
Hans Hoogervorst, Chairman of the Netherlands Authority for the Financial Markets (AFM, the Dutch securities regulator) and
Harvey Goldschmid, former Commissioner of the United States Securities and Exchange Commission, have agreed to co-chair the high-level advisory group formed jointly by the IASB and the FASB to consider financial reporting issues arising from the global economic crisis.
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November 2008: President Bush – accounting must show 'true value'
In a Speech on Financial Markets and the World Economy (PDF 67k) on 13 November 2008 in New York, US President George W Bush said that the purpose of the meeting of the G20 Heads of State on 15 November is to address the current crisis, and to lay the foundation for reforms that will help prevent a similar crisis in the future. President Bush said that discussions among the Heads of State and leaders of the World Bank, the International Monetary Fund, the United Nations, and the Financial Stability Forum will focus on five key objectives:
- understanding the causes of the global crisis,
- reviewing the effectiveness of our responses thus far,
- developing principles for reforming our financial and regulatory systems,
- launching a specific action plan to implement those principles, and
- reaffirming our conviction that free market principles offer the surest path to lasting prosperity.
President Bush said, 'While reforms in the financial sector are essential, the long-term solution to today's problems is sustained economic growth. And the surest path to that growth is free markets and free people.' He specifically cited the need of accounting standards for financial instruments that tell investors their 'true value':
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One vital principle of reform is that our nations must make our financial markets more transparent. For example, we should consider improving accounting rules for securities, so that investors around the world can understand the true value of the assets they purchase.
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November 2008: Press briefing on upcoming G20 summit – accounting is on the agenda
On 12 November 2008, a press briefing on the upcoming G20 Summit on Financial Markets and the World Economy, to be hosted by US President George W Bush, was conducted by Daniel Price, Assistant to the President for International Economic Affairs, and David McCormick, US Under Secretary of the Treasury:
- Mr Price provided an overview of the structure of the summit and 'what some of our objectives are and how we think it will go'.
- Secretary McCormick then reviewed 'a number of those areas where we believe there is sufficient common ground that leaders may be in a position to take some near-term decisions and some near-term actions'. Among the areas Secretary McCormick touched on were global accounting standards and financial reporting by financial institutions.
Click to download the Full Text of the Press Briefing (PDF 63k). Here is an excerpt about global accounting standards and financial reporting:
Global accounting standards
Within those four areas that Dan laid out – transparency and accountability, sound regulation, integrity in our financial markets, and international cooperation – there are a number of topics that leaders might touch on. One under the area of transparency and accountability would be global accounting standards. This has been an area that's gotten a lot of attention, and by creating a more aligned and ultimately convergence of global accounting standards, that reduces a huge burden on businesses and ensures a level playing field in terms of how we measure the performance of different businesses.
Financial reporting by financial institutions
There's been a lot of discussion up until this point about the complexity and the opaqueness of some of the products, the financial services products that have been developed. So the role of regulators in enhancing the transparency of those complex products will certainly be an area that I suspect will be touched on, and then the importance of financial reporting, and financial reporting in a way that captures all the activity under a financial institution, both on balance sheet and off balance sheet activity. These are the kinds of themes that we would expect to be touched on under the broader heading of transparency and accountability.
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November 2008: ICGN opposes political interference in accounting standards
The International Corporate Governance Network has issued a Public Statement on the Global Financial Crisis (PDF 62k). The statement, released ahead of the 15 November 2008 international summit on the crisis, calls on the leaders involved to include strengthened corporate governance as part of a package of measures aimed at restoring confidence to markets. ICGN members are largely institutional investors who collectively represent funds under management in excess of US$15 trillion. The ICGN statement expressly rejects any political interference in setting accounting standards:
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Accounting standards: There must be no political interference in setting accounting standards. The fair value approach has been blamed for encouraging pro-cyclicality. Investors generally support fair value that delivers a picture of what is actually happening. There are some challenges to address, but abandoning this approach would damage confidence in financial reporting. It is important to recognise that there is a difference between fair value used for reporting and fair value used to measure the need for regulatory capital. Accounting standards also need to be clearer about when off-balance sheet business should be reported.
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November 2008: IASB and FASB will hold financial crisis roundtables
The IASB and the US Financial Accounting Standards Board have announced that they will hold three public roundtable discussions to identify financial reporting issues highlighted by the global financial crisis. The roundtables will provide an opportunity for the two boards to hear input from a wide range of stakeholders including users and preparers of financial statements, governments, regulators, and others. The roundtables are intended to help the boards identify any accounting issues that may require the urgent and immediate attention.
Here are details of the roundtables:
| Date | Local Time | Roundtable Location |
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| 14 November 2008 | Sessions at 10:30 and 13:30 | Holborn Bars, 138-142 Holborn, London EC1N 2NQ UK |
| 25 November 2008 | Afternoon | FASB Office, 401 Merritt 7, Norwalk,
Connecticut 06856-5116 USA |
| 3 December 2008 | Afternoon | Office of the Accounting Standards Board of Japan, Fukoku Seimei Building 20F, 2-2, Uchisaiwaicho 2-chome, Chiyoda-ku, Tokyo 100-0011, Japan |
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November 2008: Newsletter on proposed improvements to IFRS 7
Deloitte's IFRS Global Office has published a special edition of our IAS Plus Newsletter explaining the IASB's Proposals to Improve Disclosures about Financial Instruments (IFRS 7) (PDF 202k). The proposals are set out in an Exposure Draft of proposed amendments to IFRS 7 Financial Instruments: Disclosures. The proposals form part of the IASB's response to the credit crisis and follow recommendations of the Financial Stability Forum, which had the support of the Group of Seven (G-7) Finance Ministers. The proposals also reflect discussions by the IASB's Expert Advisory Panel on measuring and disclosing fair values of financial instruments when markets are no longer active. The ED, titled Improving Disclosures about Financial Instruments, may be downloaded without charge from the IASB's Website. The comment letter deadline is 15 December 2008 with a proposed effective date of 1 July 2009.
October 2008: IASB publishes fair value guidance
On 31 October 2008, the IASB published educational guidance on the application of fair value measurement when markets become inactive. The guidance consists of a summary document prepared by IASB staff and the final report of the expert advisory panel established to consider the issue:
- The summary document sets out the context of the expert advisory panel report and highlights important issues associated with measuring the fair value of financial instruments when markets become inactive. It takes into consideration and is consistent with recent documents issued by the US FASB and the US SEC.
- The report of the expert advisory panel identifies practices that experts use for measuring the fair value of
financial instruments when markets become inactive and practices for fair value disclosures in such situations. The report provides useful information and educational guidance about the processes used and judgements made when measuring and disclosing fair value.
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October 2008: Six US groups urge SEC to provide fair value guidance
The leaders of six US business organisations have written a joint letter to the Securities and Exchange Commission asking that "the SEC issue elaboration on the use of judgment in fair value accounting". The letter states that the lack of guidance in this area "has the potential to cloud transparency". The letter was written by leaders of the US Chamber of Commerce Center for Capital Markets Competitiveness, Financial Services Roundtable, Property Casual Insurers Association of America, American Council of Life Insurers, Mortgage Bankers Association, and American Insurance Association.
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We would respectfully request that the SEC formally elaborate on the use of judgment in the application of FAS 157. This elaboration, by the SEC should include principles-based guidance for the transparent disclosures needed by investors when judgment is exercised. The elaboration will provide the clarity needed by management to appropriately value assets in inactive markets, and give investors the transparent information needed to make informed decisions.
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October 2008: EC asks IASB to amend IAS 39
The European Commission has written to the IASB asking the IASB to amend or interpret IAS 39 to ensure that the following three specific matters are addressed in time for year-end 2008 financial reports:
- Financial assets presently classified as fair-value-through-profit-or-loss using the Fair Value Option can be classified into other categories and not measured at fair value, for the same reasons, and under the same conditions as the assets reclassified out of the held-for-trading category.
- Clarification on whether synthetic collateralised debt obligations (CDOs) include embedded credit derivatives. Currently, IAS 39 is interpreted as requiring separation and fair value measurement for such embedded credit derivatives, whereas US GAAP does not require an embedded derivative to be recognised separately.
- Adjustments to impairment rules applicable to available-for-sale (AFS) interest-bearing financial assets, so that AFS would be treated the same way as loans and receivables and held-to-maturity debt instruments, The effect of such a change would be to keep a portion of the fair value decline on AFS in equity rather than recognising it in profit or loss as IAS 39 currently requires.
An annex to the letter also asks for a fourth change – allowing reversal of impairment losses not only for debt securities but also for equity instruments. The Commission's letter also states that:
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Recent developments raise broader issues related to the role of fair value accounting for financial instruments which we intend to explore further with all stakeholders as a matter of urgency. This issue should also be comprehensively addressed in the context of ongoing IASB projects. There may be a need to adjust the timetable of ongoing projects to reflect the immediate needs of the current crisis.
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October 2008: Follow-up on implementation of FSF recommendations
On 10 October 2008, the Financial Stability Forum (FSF) published a report assessing the implementation, to date, of the recommendations in their 7 April 2008 Report on Enhancing Market and Institutional Resilience. The FSF is a global organisation of regulators and central bankers. That report analysed the causes and weaknesses that have produced the recent turmoil in financial markets worldwide and made recommendations for correcting those weaknesses, including several for the IASB. Those recommendations addressed, among other things, accounting and disclosure standards and guidance for off-balance sheet vehicles and for valuations. The new implementation report, titled
Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience: Follow-up on Implementation (PDF 161k) reviews the progress of the IASB and the FASB on off-balance sheet vehicles on pages 16-17 and on valuations on pages 17-19.
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Regarding valuations, the FSF implementation report states:
The FSF acknowledges the significant efforts of accounting standards setters, and urges them to accelerate their work to enhance and converge their guidance on the valuation of instruments in inactive markets.
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October 2008: Joint letter to US SEC supporting fair value measurements
On 15 October 2008 the Center for Audit Quality, CFA Institute, Consumer Federation of America, and the Council of Institutional Investors issued a joint letter to US SEC Chairman Christopher Cox urging the SEC not to override the fair value guidance recently issued by the Financial Accounting Standards Board, FSP FAS 157-3 Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (FSP). The letter states:
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A move by the SEC to suspend fair value accounting would be a disservice to the capital markets, would be inconsistent with the views of investors, would harm the credibility and independence of the standards setting process, and would run counter to fundamental notice and comment principles. With third quarter financial statements now in process and year-end 2008 imminent, such a change could jeopardize already-fragile investor confidence.
No one disputes that these are trying economic times. However, the current crisis of liquidity, credit, and confidence was not caused by fair value accounting; rather, sound accounting principles helped expose the problem. Fair value accounting with robust disclosures provides more accurate, timely, and comparable information to investors than amounts that would be reported under other alternative accounting approaches.
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October 2008: Credit crisis audit considerations
The US Public Company Accounting Oversight Board will meet with its Standing Advisory Group on 22-23 October 2008 in Washington. One of the issues that the advisory group will discuss is audit considerations relating to the current economic environment. The agenda paper for this topic discusses possible considerations in upcoming audits, including:
- Fair value measurements
- Other than temporary impairment
- Credit derivatives
- Going concern
- Pensions/other postretirement benefits
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- Receivables
- Inventory
- Other asset impairments
- Disclosures
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October 2008: IASB ED on financial instruments disclosures
On 15 October 208, the IASB published an exposure draft of proposed amendments to IFRS 7 Financial Instruments: Disclosures. The proposals form part of the IASB's response to the credit crisis and follow recommendations of the Financial Stability Forum, which had the support of the Group of Seven (G-7) Finance Ministers. The proposals also reflect discussions by the IASB's Expert Advisory Panel on measuring and disclosing fair values of financial instruments when markets are no longer active. The ED, titled Improving Disclosures about Financial Instruments, may be downloaded without charge from the IASB's Website. The comment letter deadline is 15 December 2008 with a proposed effective date of 1 July 2009. Click for Press Release (PDF 93k).
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The exposure draft proposes the following changes to IFRS 7:
Fair value disclosures
- Introduction of a three level hierarchy when disclosing fair values (comparable to the US SFAS 157 hierarchy)
- Reconciliations of balances for fair values measured without using observable market inputs
- Reconciliations of movements between the levels (including reasons)
Liquidity risk disclosures
- Clarification of scope of which instruments are to be included
- Disclosure of liquidity risk for derivative financial liabilities based on risk management of the entity
- Disclosure of expected remaining maturities of non-derivative financial liabilities if the entity manages risk in that way
- Enhance relationship between quantitative and qualitative disclosures of liquidity risk
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October 2008: IASB update on applying fair value in inactive markets
On 14 October 2008, the IASB published a Press Release (PDF 161k) updating its work to consider the application of fair value when markets become inactive. In the update, IASB Chairman Sir David Tweedie states:
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"This press release says two things. First, that guidance within IFRSs is already clear that distress sales should not be included in fair value measurement. Secondly, that recent guidance from the FASB is consistent with the findings of our own expert panel on illiquid markets. |
October 2008: IASB amends IAS 39 to permit some reclassifications
On 13 October 2008, the IASB issued amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures that would permit reclassification of some financial instruments out of the fair-value-through-profit-or-loss category and out of the available-for-sale category. The amendments introduce into IFRSs the same possibility of reclassifications that is already permitted under US GAAP in rare circumstances. The amendments are effective 1 July 2008.
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October 2008: AICPA staff issue technical Q&A on liquidity restrictions
The staff of the American Institute of CPAs has issued a new nonauthoritative Technical Practice Aid (TPA) addressing the potential accounting and auditing implications when a fund or its trustee imposes restrictions on a nongovernmental entity's ability to withdraw its balance in a money market fund or other short term investment vehicle. The TPA covers balance sheet classification, disclosures, debt covenants, subsequent events and going-concern considerations, among other things.
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October 2008: FASB guidance on FV of financial instruments in inactive markets
On 10 October 2008, the US Financial Accounting Standards Board issued FASB Staff Position 157-3 Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies the application of FASB Statement No. 157 Fair Value Measurements in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.
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October 2008: Deloitte Alert on default and other risks in credit market turmoil
Deloitte (United States) has published a Financial Reporting Alert on Potential Counterparty Default and Other Accounting Considerations Related to the Credit-Market Turmoil. Deloitte Financial Reporting Alert 08-14 addresses the impact that recent market events, such as the bankruptcy of Lehman Brothers Holdings Inc. and the credit-standing deterioration of other financial institutions, may have on an entity's financial statements. This alert focuses on the following:
- The impact of possible counterparty default on an entity's derivative contracts that are (1) designated as hedging instruments in cash flow or fair value hedging relationships and/or (2) accounted for under the normal purchases and normal sales exception criteria defined in Statement 133,1 as amended.
- Other accounting considerations associated with counterparty default (or potential default), highlighted in Appendix A of the Alert.
- Other accounting considerations arising from the current turmoil in the credit markets, highlighted in Appendix B of the Alert.
Although this Alert highlights a number of items preparers and auditors should consider, it is neither a comprehensive checklist nor a complete analysis. Organizations should consider their own facts and circumstances and monitor ongoing developments to determine the impact of market conditions on their financial statements. Consultation with independent accountants also may be advisable in certain circumstances.
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October 2008: IASB announces four planned 'credit crisis' steps
On 3 October 2008, the IASB announced the current status of its response to the credit crisis and the next steps it expects to take. In its announcement, the IASB indicated that it 'is closely monitoring developments in the United States and other jurisdictions to avoid unnecessary inconsistencies in accounting treatments under IFRSs and US generally accepted accounting principles (GAAP)'. The IASB's next steps will be in the following areas:
- Ensure consistency of fair value measurement guidance between IFRSs and US GAAP
- Consider the possible impact of the US Emergency Economic Stabilization Act of 2008 and other similar programmes internationally on the valuation of assets and liabilities
- Immediately consider the ability to reclassify financial instruments.
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US GAAP permits entities, in rare circumstances, to reclassify financial instruments that are in the form of securities from their trading portfolio (measured at fair value with changes through the income statement) to 'held to maturity' (measured at amortised cost and subject to testing for impairment). Also US GAAP permits some loans that are not securities to be transferred from Held for Sale (measured at lower of cost or market with changes through the income statement) to Held for Investment (measured at amortised cost and subject to testing for impairment). IAS 39 does not currently permit such transfers. The IASB intends to assess (at its October 2008 Board meeting) any inconsistencies in how IAS 39 and US GAAP practice address the issue of reclassifications and decide whether to eliminate any differences.
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- Be willing to participate in any study on the impact of accounting in the credit crisis
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October 2008: Final 'bailout bill' includes two fair value measurement sections
On 3 October 2008, by vote of 263-171, the United States House of Representatives approved the version of the so-called 'Financial Institutions Bailout Bill' previously approved by the Senate. President Bush signed it into law. The final bill included the following two sections relating to fair value measurement issues that were noted in our News Item Below:
- Sec. 132. Authority to suspend mark-to-market accounting
Restates the Securities and Exchange Commission's authority to suspend the application of Statement Number 157 of the Financial Accounting Standards Board if the SEC determines that it is in the public interest and protects investors.
- Sec. 133. Study on mark-to-market accounting
Requires the SEC, in consultation with the Federal Reserve and the Treasury, to conduct a study on mark-to-market accounting standards as provided in FAS 157, including its effects on balance sheets, impact on the quality of financial information, and other matters, and to report to Congress within 90 days on its findings.
October 2008: IASB statement on joint SEC-FASB fair value guidance
Our News Item Below reports that the US SEC's Office of the Chief Accountant and the FASB staff jointly issued a press release containing questions and answers aimed at clarifying fair value measurement practices in the current environment. They issued this guidance pending the completion by FASB of additional interpretative guidance about the requirements of FASB Statement No. 157 Fair Value Measurements in illiquid markets. The IASB has issued a Press Release (PDF 99k) stating that its staff has reviewed the SEC-FASB release and considers it consistent with IAS 39 Financial Instruments: Recognition and Measurement.
October 2008: CFAs in Europe vote against suspension of fair value standards
In an overnight poll of CFA Institute members based in the European Union (EU), 79% of the 597 respondents do not support the suspension of fair value measurements for financial instruments under IFRSs. 85% also think that a suspension of fair value standards would further decrease confidence in the European banking system. The CFA Institute polled its EU based members in advance of the summit called by EU and French President Sarkozy to establish a common European position on regulation.
Following the poll, the CFA Institute submitted a letter to President Sarkozy, who is seeking more flexibility in accounting rules. The letter affirms that any weakening of accounting rules will not improve market stability and will further undermine investor confidence. Click for CFA Institute Press Release (PDF 21k), which also includes a copy of the letter to President Sarkozy. Previously, the CFA Institute joint the Center for Audit Quality and the Council of Institutional Investors in issuing a Joint Statement (PDF 19k) "opposing suspension of mark-to-market accounting".
October 2008: FASB proposes fair value guidance in inactive markets
On 2 October 2008, the US Financial Accounting Standards Board invited comment on a proposed FASB Staff Position (FSP) that addresses concerns regarding the determination of fair value in markets that are not active. The objective of the guidance in proposed FSP FAS 157-d is to clarify how SFAS 157 applies to determining the fair value of assets and liabilities in inactive markets and to provide an example that illustrates several key principles, including the following:
FAS 157 principles that will be illustrated in the guidance:
- In some cases an entity might determine that observable inputs to a market approach valuation technique require significant adjustment and thus are ultimately considered unobservable or Level 3 inputs. The entity might then conclude that an income approach valuation technique that uses management's internal assumptions about market participants' expectations of cash flows is equally or more representative of fair value. However, regardless of the valuation technique used, entities must include appropriate adjustments that market participants would make for risks, such as nonperformance and liquidity.
- A fair value measurement represents the price at which a transaction would occur between market participants at the measurement date. As discussed in paragraph 30 of Statement 157, in situations in which there is little, if any, market activity for an asset or liability at the measurement date, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant.
- Broker quotes or pricing services may be a relevant input when measuring fair value, but not necessarily determinative if an active market does not exist for the security. In weighing a broker quote as an input to fair value, an entity should place less reliance on quotes that do not reflect the result of market transactions.
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There is more information in the Handout for Observers at the FASB Meeting (PDF 46k) beginning on page 7. The proposed FSP is not yet posted on FASB's Website. The planned one-week comment period will end on 9 October 2008, and the FASB expects to meet on 10 October 2008 to discuss comments received and vote on final guidance. The guidance would be effective on issuance. Any resulting changes in fair value measurements would be reflected in current profit or loss rather than by restating prior period financial statements.
October 2008: EC President Barroso comments on global financial crisis
At a press conference in Brussels on 1 October 2008, European Commission President Jose Manuel Barroso
commented on the global financial crisis, including accounting implications: "We must refine the rules on the evaluation of complex assets. This includes adapting our accounting rules to a new situation. In particular if other markets also apply changes, we don't want EU banks in a situation of disadvantage as compared to banks for other markets." He also seemed to support a proposal that has been sent to the European Commission by French President Nicolas Sarkozy to modify or suspend the mark-to-market accounting requirements for some financial assets of banks.
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October 2008: US FAF express concern about legislating accounting standards
Robert E Denham, chairman of the Financial Accounting Foundation (FAF) under which the FASB operates, has written to the leadership of both houses of the US Congress and to other key US government officials expressing grave concerns about the possibility of legislation that would overturn FASB Statement 157 Fair Value Measurements. The FAF urges Congress to reject proposals that would threaten the independent accounting standard setting process. Here is an excerpt from the letter:
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We are very concerned about the current efforts of some to legislate the suspension of one of the FASB's standards, Statement 157 on fair value measurements. We believe that any legislative effort to overturn a FASB standard will greatly undermine investor confidence. We believe that once Congress starts setting accounting standards through its political process, the integrity of US accounting standard setting and the credibility of US financial reporting will be greatly compromised.
If Congress sends the message that special interests, through legislation, are able to overturn expert accounting judgement arrived at through an open and thorough due process, necessary and timely improvements in financial reporting will likely become impossible and the best interests of participants in the capital markets will not be served.
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October 2008: AICPA CAQ expresses concerns about accounting provisions of 'bailout bill'
On 1 October 2008, the United States Senate passed (vote 74 to 25) a version of the so-called 'Financial Institutions Bailout Bill' (PDF 596k). The House of Representatives (which previously rejected a version of the bill) will consider a similar bill tomorrow. In our News Item Below, we identified two sections of the House's draft bill that relate to fair value measurement issues:
- Sec. 132. Authority to suspend mark-to-market accounting
- Sec. 133. Study on mark-to-market accounting
Those two sections remain in the version of the bill that the Senate voted on yesterday. On 30 September 2008, the Center for Audit Quality (CAQ) of the American Institute of CPAs (AICPA) sent a Letter to All Members of Congress (PDF 61k) stating that 'proposals advocating suspension of mark-to-market (or fair value) accounting are not in the best interest of investors or the capital markets and should be rejected'. The CAQ's letter states:
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The principles of mark-to-market accounting are rooted in the fundamental virtue of transparency and are central to informed market decisions and efficient allocation of capital. In our view, investor confidence would be undermined by efforts designed to mask the actual value of financial assets at a given point in time.
It is important to underscore that mark-to-market accounting has contributed positively to revelations about the severity of the economic crisis facing our country's credit markets and certain institutions, but it did not create the economic crisis.
Recently, some have suggested that the Securities and Exchange Commission (Commission or SEC) or the Financial Accounting Standards Board (FASB) should suspend the application of mark-to-market or fair value accounting or somehow impose a moratorium on mark-to-market requirements for certain financial institutions when preparing financial statements to be used by investors.
Although determining fair values for financial instruments in an illiquid market can be challenging, the best estimate of the prices that would be received for such instruments in orderly transactions occurring at the measurement date remains the most relevant information for investors and policymakers. To lessen the uncertainties about the value of these securities, it is critical that investors continue to have the insight provided by the application of mark-to-market accounting principles.
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Views similar to the CAQ's were expressed publicly by the CFA Institute and the Council of Institutional Investors. The three groups issued a Joint Statement (PDF 19k).
October 2008: Deloitte Alert on proposed FASB FSP on FV measurement in illiquid markets
Deloitte (United States) has published an Alert on a proposed FASB Staff Position (FSP) that would amend FASB Statement 157 Fair Value Measurements to provide guidance on measuring fair values (FV) in illiquid markets. Alert 08-12 points out that the FSP will not change the measurement principles in FAS 157 but will provide guidance for applying those principles in inactive markets by elaborating on the guidance that the SEC and FASB Issued Jointly on 30 September 2008 (see News Item Below). Examples will be added to FAS 157 on:
- How entities' internal (entity-specific) assumptions should be considered in the measurement of FV for a financial asset when relevant market data does not exist.
- How observable market information in an inactive market affects FV measurements.
- How entities should consider the use of broker quotes or pricing services when assessing the relevance of inputs available to measure FV.
FASB will expose the proposed FSP for comment by the end of this week, with comments due by 9 October 2008. FASB plans to finalise the FSP on 10 October 2008, with an immediate effective date (including for financial statements for periods ending 30 September 2008 that have not yet been issued).
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October 2008: Joint SEC-FASB guidance on fair value measurements
The SEC's Office of the Chief Accountant and the FASB staff have jointly issued a press release containing questions and answers aimed at clarifying fair value measurement practices in the current environment. They issued this guidance pending the completion by FASB of additional interpretative guidance about the requirements of FASB Statement No. 157 Fair Value Measurements in illiquid markets. FASB has announced a change to the Agenda of its 1 October 2008 Meeting to consider a draft FASB Staff Position that would provide additional measurement guidance on FAS 157.
The joint press release contains answers to the following questions:
- Can management's internal assumptions (e.g., expected cash flows) be used to measure fair value when relevant market evidence does not exist?
- How should the use of 'market' quotes (e.g., broker quotes or information from a pricing service) be considered when assessing the mix of information available to measure fair value?
- Are transactions that are determined to be disorderly representative of fair value? When is a distressed (disorderly) sale indicative of fair value?
- Can transactions in an inactive market affect fair value measurements?
- What factors should be considered in determining whether an investment is other-than-temporarily impaired?
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September 2008: Systemic banking crises: a new database
The International Monetary Fund (IMF) has published a working paper by Luc Laeven and Fabian Valencia titled Systemic Banking Crises: A New Database. This 80-page paper presents a new database on the timing of systemic banking crises and policy responses to resolve them. The database covers the universe of systemic banking crises for the period 1970-2007, with detailed data on crisis containment and resolution policies for 42 crisis episodes, and also includes data on the timing of currency crises and sovereign debt crises. The database extends and builds on the Caprio, Klingebiel, Laeven, and Noguera (2005) banking crisis database, and is the most complete and detailed database on banking crises to date. The paper represents the views of the authors and is Copyright 2008 by IMF.
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September 2008: Accounting provisions of US financial institutions 'bailout bill'
The Emergency Economic Stabilization Act of 2008 that is being considered by the United States Congress (the so-called financial institutions bailout bill) has as its objective: "To provide authority for the Federal Government to purchase
and insure certain types of troubled assets for the purposes of providing stability to and preventing disruption in the economy and financial system and protecting taxpayers, and for other purposes". Two sections of the draft bill relate to fair value measurement accounting issues:
Sec. 132. Authority to suspend mark-to-market accounting.
| "The Securities and Exchange Commission shall have the authority under the securities laws 12 (as such term is defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer (as such term is defined in section 3(a)(8) of such Act) or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors."
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Sec. 133. Study on mark-to-market accounting.
"The Securities and Exchange Commission, in consultation with the Board [of Governors of the Federal Reserve System] and the Secretary [of the Treasury], shall conduct a study on mark-to-market accounting standards as provided in Statement Number 157 of the Financial Accounting Standards Board, as such standards are applicable to financial institutions, including depository institutions. Such a study shall consider at a minimum —
- (1) the effects of such accounting standards on a financial institution's balance sheet;
- (2) the impacts of such accounting on bank failures in 2008;
- (3) the impact of such standards on the quality of financial information available to investors;
- (4) the process used by the Financial Accounting Standards Board in developing accounting standards;
- (5) the advisability and feasibility of modifications to such standards; and
- (6) alternative accounting standards to those provided in such Statement Number 157."
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The SEC must submit the report to Congress within 90 days after enactment of the bill.
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September 2008: IOSCO Technical Committee activity
The Technical Committee (TC) of the International Organization of Securities Commissions (IOSCO) met on 16 September to discuss current market conditions and further prioritise IOSCO's work in response to the subprime crisis. The TC continues to prioritise its focus on two key areas:
- Greater international coordination for the oversight of credit rating agencies; and
- Market participants responsible for retail clients. The TC members expect investment managers to carry out appropriate due diligence procedures in order to properly understand the risks associated with any products in which they are intending to invest their clients' funds, and the TC has an active workstream on this topic. The TC expects to publish its findings and recommendations in the next months.
Other work on firm risk management, prudential supervision and valuation and accounting continues to be a priority.
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September 2008: G7 statement on global financial market turmoil
On 22 September 2008, the Group of Seven Finance Ministers and Central Bank Governors released the following statement on global financial market turmoil. Among other things, the statement urged more effective regulation. The G7 said: "We remain committed to full and rapid implementation of the Financial Stability Forum (FSF) recommendations to enhance the resilience of the global financial system for the longer term. We look forward to the FSF report this fall on progress made in strengthening prudential supervision and regulation, improving firms' risk management practices, enhancing disclosure and transparency, and strengthening accounting frameworks."
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September 2008: Heads Up on credit derivatives and financial guarantees
Deloitte & Touche LLP (United States) has published an issue of Heads Up discussing the FASB's recently issued Staff Position No. FAS 133-1 and FIN 45-4, which amend and enhance the disclosure requirements for sellers of credit derivatives and financial guarantees. The new disclosures must be provided for reporting periods (annual or interim) ending after 15 November 2008.
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September 2008: FASB chairman's views – lessons learned from the credit crisis
In a speech on 18 February 2008 to a broad group of financial executives at a forum on structured finance in New York, US Financial Accounting standards Board Chairman Robert H Herz spoke about Lessons Learned, Relearned, and Relearned Again from the Credit Crisis – Accounting and Beyond. Click to Download Mr Herz's Remarks (PDF 53k). Here are some excerpts.
So, here's my list of some of the key lessons to be learned and, in some cases relearned, as well as some important questions that I feel need to be asked:
- Remember the risks
- Liquidity matters
- The double edged sword of leverage
- 'Out of sight, out of mind'
- 'Buyer beware'
- Accounting has consequences, but, can we handle the truth?
- Mind the exceptions
- Good reporting requires both sound standards and faithful application of those standards
- Fair value – villain or savior?
- Sound markets require a proper infrastructure
- Fundamental changes may be needed in our capital markets and financial services industry
- Global problems demand global solutions
- Perverse incentives lead to perverse outcomes
- Each crisis brings many challenges, but also many opportunities for change and improvement
Regarding the use of fair value measurements for financial instruments, Mr Herz said:
To be sure, there is no question that implementing fair value in illiquid markets can be challenging and difficult and there are important questions to be asked. Does it lead, reflect, or lag reality? Are there genuine concerns over procyclicality ? These are important questions and issues; but I would ask, what is the alternative? Not to try to be truthful about the current value of your assets, to use original cost or some other smoothed value that ignores current market
conditions? Yet, in some cases, that is what some people have asked us to do – suspend the bad news for a while, until things get better. That is what Japan tried to do rather unsuccessfully for over a decade.
Investors have been clear: they want to see the current fair values of a company's financial assets. They believe it is the
appropriate method of accounting for such items, and they generally applaud the added transparency provided by the new disclosures under FAS 157 (and indeed would like some additional disclosures like ranges and sensitivities).
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September 2008: CEBS advice to EC on liquidity risk management
The Committee of European Banking Supervisors has submitted to the European Commission the second part of its advice on liquidity risk management. The advice consists of an analysis of specific issues listed by the Commission and challenges not currently addressed in the EEA and includes 30 recommendations, as follows:
- CEBS's 30 recommendations on liquidity risk management are principles-based and subject to an overarching principle of proportionality.
- The first 18 recommendations are targeted at credit institutions and investment firms established in the European Union to ensure that adequate liquidity risk management for both normal and stressed times is in place. In particular this should build on diversification of funding sources, appropriate liquidity buffers, robust stress tests and regularly tested contingency funding plans.
- CEBS's last 12 recommendations target liquidity risk supervision. Supervisors should consider whether their requirements could be supplemented or replaced by internal methodologies developed by institutions, based on a thorough prior supervisory assessment. Enhanced coordination between supervisors should be pursued, notably through active use of colleges or through delegation of tasks.
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September 2008: SEC letter on fair value measurements
On 28 March 2008, the US SEC's Division of Corporation Finance sent a letter to certain financial institutions concerning additional disclosure considerations in Management's Discussion and Analysis (MD&A) regarding fair value for their upcoming filings on Form 10-Q. While the letter was sent only to financial institutions, the SEC staff indicated that the letter 'can be applicable to any company'. Details are Below, including a link to a Deloitte Financial Reporting Alert (PDF 57k) about the letter. On 16 September 2008, the SEC issued an Addendum to the 28 March 2008 Letter (PDF 49k) identifying additional disclosure issues related to fair value measurements that companies may wish to consider in preparing their MD&A. The additional issues are the result of the SEC's reviews and the public roundtables that took place over the summer.
September 2008: Three FASB derecognition exposure drafts
As part of its response to the 'credit crunch', on 16 September 2008 the US Financial Accounting Standards Board issued three separate but related exposure drafts (EDs) for public comment. The proposed FASB Statements Accounting for Transfers of Financial Assets and Amendments to FASB Interpretation No. 46(R) address amendments to FASB Statement No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and to FASB Interpretation No. 46 (revised December 2003) Consolidation of Variable Interest Entities. Proposed FASB Staff Position FAS 140-e and FIN 46 (R)-e Disclosures about Transfers of Financial Assets and Interests in Variable Interest Entities addresses related disclosure requirements for public entities. Click for Press Release (PDF 16k). The proposals are available on FASB's Website.
September 2008: Update on EU response to financial market turmoil
Charlie McCreevy, European Commissioner for Internal Market, presented a report on Financial Turmoil: Latest Developments on Policy Response to the Committee on Economic and Monetary Affairs of the European Parliament on 10 September 2008. He commented, among other things, on activities of the IASB in this regard. Here are excerpts:
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The turmoil has exposed a chronic lack of private sector discipline and competence and some weaknesses in the global financial regulatory framework. We must strengthen market and institutional resilience. This is what the ECOFIN Roadmap of October 2007 is designed to do....
The upgrading of valuation methods, in particular with respect to the valuation of illiquid assets. Work is being led by the Basle Committee and the International Accounting Standards Board (IASB), who have established a panel on fair valuation. Advice is expected by the end of the third quarter of 2008. The IASB is also working on off-balance sheet items with the key question being: when should an entity be brought onto another entity's balance sheet? The input received in these meetings will help the IASB in shaping its forthcoming proposals on reviewing consolidation rules under IFRS. Deliverables are expected in 2009. Proper due process must be carried out. I believe we need to look hard at issues such as dynamic provisioning* – and how to account for prudential reserves built up by banks to buffer for bad times. It should not have escaped people's attention that banks in Spain were better placed to withstand the turmoil because they had not yet adopted the relevant IFRS Standard. There is a lesson there that needs to be drawn....
On accounting, SEC Chairman Cox has unveiled a roadmap where US companies would switch from US GAAP to IFRS by 2014. Unthinkable only two years ago! A dramatic signal indeed. Following the EU's lead, the US is indicating it also wants to choose global standards. One set, in sight, at last. And of course we need to strengthen the governance of the IASB. That is why we are working hard with some of our major counterparts to install new, strengthened oversight mechanisms.
*IAS Plus comment: Dynamic provisioning refers to loan loss provisions measured on the basis of expected future losses rather than incurred losses.
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September 2008: New FASB disclosures about credit derivatives and guarantees
On 12 September 2008, the US Financial Accounting Standards Board issued FASB Staff Position (FSP) No. 133-1 and FIN 45-4 Disclosures about Credit Derivatives and Certain Guarantees. The FSP is intended to improve disclosures about credit derivatives by requiring more information about the potential adverse effects of changes in credit risk on the financial position, financial performance, and cash flows of the sellers of credit derivatives. It applies to sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. The new disclosures are effective for reporting periods (annual or interim) ending after 15 November 2008.
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August 2008: 'Fair Value Update' from Deloitte United States
Since the Financial Accounting Standards Board issued SFAS 157 Fair Value Measurements and SFAS 159 The Fair Value Option for Financial Assets and Financial Liabilities, fair value measurements have gained notoriety and been the topic of many headlines in the United States due to the current credit markets turmoil. Deloitte (United States) has published a Fair Value Update Newsletter covering issues from the widespread adoption of SFAS 157 and SFAS 159. Specifically, the newsletter examines the Form 10-Q filings from 50 SEC registrants for the first quarter of 2008 and analyses their respective disclosures related to SFAS 157 and SFAS 159. The analysis includes entities from the banking, insurance, investment management, and energy industries, as well as other corporate filers.
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August 2008: CRMPG-III report on containing systemic risk
The Counterparty Risk Management Policy Group III (a group of senior officials from a number of major financial institutions) has published a report titled Containing Systemic Risk: The Road to Reform. The Report sets out an integrated framework of private initiatives that will complement official oversight to help contain systemic risk. The Policy Group focused on four key areas, which it deemed the most important and timely and were the areas in which the Policy Group believed it could make the greatest contribution. Those areas include:
- Reconsideration of the standards for consolidation under US GAAP of entities currently off-balance sheet coming on-balance sheet.
- Measures to better understand and manage high-risk financial instruments.
- Significant enhancements to risk monitoring and management.
- A series of sweeping measures to enhance the resiliency of financial markets generally and the credit markets in particular, with a special emphasis on OTC derivatives and credit default swaps.
The report also highlights important emerging issues that will require close attention in the period ahead. Accounting recommendations begin on page 18.
An excerpt from the accounting recommendations:
II-1. The Policy Group endorses, in principle, the direction of the changes to the US GAAP consolidation rules provided that the changes are (1) principles-based, (2) convergent with International Financial Reporting Standards, and (3) accompanied by suitable disclosure and transition rules regarding regulatory capital which will provide flexibility in the implementation of these rules over a reasonable period of time.
II-2. The Policy Group recommends adoption of a single, principles-based global
consolidation framework that is based on control and the ability to benefit from
that control. The analysis of whether an entity (the investor) has a controlling
interest in another entity (the investee) should be based on:
- the investor's power over the investee, including the ability to make decisions that determine the success of the investee;
- the degree of investor exposure to the risks and rewards of the investee, including through guarantees, commitments and all other explicit and implicit arrangements between the two entities; and
- the design and sponsorship of the investee, including the degree to which the activities of the investee expose the investor to commercial, legal, regulatory and reputational risks.
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July 2008: Joint Forum paper on credit risk transfer
On 31 July 2008, the Joint Forum released the final version of its paper entitled Credit Risk Transfer – Developments from 2005 to 2007. This follows the consultation process that began in April 2008. This paper was developed in response to a request from the Financial Stability Forum (FSF) in March 2007 to consider the extent to which the Joint Forum's March 2005 paper Credit Risk Transfer (CRT) required updating as a result of the continued growth and rapid innovation in the CRT markets. The Joint Forum was established in 1996 under the aegis of the Basel Committee on Banking Supervision, IOSCO, and the IAIS to deal with issues common to the banking, securities and insurance sectors, including the supervision of financial conglomerates.
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July 2008: CESR draft statement on fair value in illiquid markets
The EU Committee of European Securities Regulators has invited comment on a draft statement titled Fair Value Measurement and Related Disclosures of Financial Instruments in Illiquid Markets. The statement, when finalised, will provide guidance to preparers and auditors in the current financial market situation when preparing the next financial statements. "CESR acknowledges that the competence of setting standards, formally interpreting standards and issuing general interpretation of existing standards lies with the IASB/IFRIC. The work conducted by CESR remains under the domain of the application of current IFRS, as CESR Members' role regarding IFRS is the enforcement of financial information." CESR requests comments by 12 September 2008. CESR intends to consider the comments received and publish a final guidance statement in October 2008.
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The starting point for the measurement of financial instruments is the assessment of whether the financial instrument is traded on an active or a non active market. The measurement of financial instruments on active markets is conducted with the reference to quoted prices. If an active market does not exist, the measurement is determined by using valuation techniques that incorporate all factors that market participants would consider in setting a price, minimising entity-specific inputs.
The distinction between active and non active markets is therefore important in the application of the measurement of financial instruments.
On the identification of active and non active markets the statement stresses:
- As judgment is required, a well-documented valuation policy is needed. It should be consistent across time and across financial instruments;
- Even if the number of transactions is relatively low compared to other markets or to the past, the market could still be active;
- The size of the holdings of instruments is not a criterion to decide whether a market should be considered active;
- Different pricing sources can be available in an active market, such as prices for actual transactions or for binding quotes;
- Market quotes can only be disregarded if there is sufficient evidence that they do not constitute a reliable reference for valuation.
On the use of valuation techniques CESR highlights that:
- It entails a significant amount of judgment;
- The issuer should document the criteria, the assumptions and the inputs to the valuation techniques to ensure consistency;
- Transactions conducted in a market that is not considered active can often provide the most relevant input for valuation techniques;
- Liquidity risk and correlation risk could also be relevant in addition to the inputs to valuation techniques listed in the accounting standards;
- The use of indices (e.g. the ABX HE index) should be approached with caution.
The draft statement then proposes some disclosure guidance.
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July 2008: Commissioner McCreevy discusses the 'credit crunch'
On 3 July 2008, EU Commissioner for Internal Markets and Services Charlie McCreevy spoke about The Financial Turmoil – The Role of the EU-Commission at a meeting of the The Centre for European Policy Studies in Brussels. Among other things, he discussed the IASB's current efforts to address the valuation of illiquid financial assets. He said that the solution lies in improved valuation techniques and not in disregarding fair value changes entirely. An excerpt:
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There have been calls to temporarily disregard fair value accounting in order to neutralise possible pro-cyclical effects and avoid having to write-down assets. Intervention right now risks adding to the confusion and create even greater distrust in companies' accounts. What is needed is additional guidance on the valuation of complex and illiquid financial instruments. This has also been underscored in a report published by the Committee of European Banking Supervisors (CEBS) last month. It highlighted a number of accounting issues that may require further attention of accounting standards setters in order to improve consistency, comparability and transparency of valuation practices.
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One day later in Dublin, he presented related comments on Regulation and Supervision after the Credit Crunch.
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June 2008: EU bank regulators report on valuing instruments in illiquid markets
The Committee of European Banking Supervisors (CEBS) has published a report on issues relating to the valuation of complex and illiquid financial instruments. The report puts forward a set of issues that should be addressed by institutions and accounting and auditing standard setters in order to improve the reliability of the values ascribed to these instruments.
The analysis focuses on the following valuation related aspects:
- challenges for the valuation of complex financial instruments or instruments for which no active markets exist;
- transparency on valuation practices and methodologies as well as related uncertainty; and
- auditing of fair value estimates.
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June 2008: G8 Ministers urge swift IASB action on SPEs and valuation
The Finance Ministers of the G8 countries met on 14 June 2008 in Osaka, Japan, in preparation for the Summit of the G8 Heads of State and Government to be held 7-9 July 2008 in Hokkaido-Toyako. The Communique released by the Finance Ministers at the conclusion of the meeting addressed a wide range of issues, including the world economy, commodity prices, climate change, development, and abuses of the financial system. With regard to financial reporting, the communique said:
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We call on the IASB to accelerate its reviews of accounting issues around off-balance sheet entities and valuation in illiquid markets.
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May 2008: IOSCO publishes recommendations to address 'subprime crisis'
The International Organization of Securities Commissions (IOSCO) has published the final report of its Technical Committee's Task Force on the Subprime Crisis. The report contains an analysis of the underlying causes of the crisis, the implications for international capital markets, and recommendations that address the issues facing securities regulators. The report includes recommendations by the Technical Committee for future IOSCO work to counter these issues in three areas, including accounting. These are:
- Issuer transparency and investor due diligence
- Firm risk management and prudential supervision
- Valuation and accounting issues
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April 2008: International Banking Federation report on accounting for financial instruments
The International Banking Federation (IBFed) has published Accounting for Financial Instruments: A Conceptual Paper. IBFed is a consortium of banking associations in Australia, Canada, Europe, Japan, and the United States. The paper sets out the position of the IBFed on "the extent to which the fair value measurement meets the needs of the user community and the objectives of financial reporting". The overall conclusions:
- Fair value measurement provides an appropriate accounting base for financial instruments held for trading purposes or otherwise managed on a fair value basis. However, full fair value measurement of financial instruments would overstate the extent to which instruments are held for trading or managed on a fair value basis within the business and the extent to which deep and liquid markets exist. These are highly significant factors in determining the relevance of fair value in financial reporting.
- A mixed measurement model provides investors with better information for evaluating financial institutions. It requires fair value measurement for assets and liabilities managed on a fair value basis and recognizes that not all financial instruments – let alone non-financial assets and liabilities – are managed on a fair value basis or are even capable of reliable fair value measurement. Where an entity does not manage instruments on a fair value basis, amortised cost is the more appropriate way to estimate future cash flows. Fair value information is already disclosed in footnotes, which are an integral part of financial statements and is a more suitable format for providing the information to investors.
- Reality is more complex than can be communicated in a fair value model. Relevant performance reporting will never be achieved if the framework for financial reporting sticks rigidly to either an amortised cost model or a fair value model. A mixed measurement model represents a principles-based approach to measurement by acknowledging the fact that different entities may follow different business models. Instead of the IASB determining that one approach offers a superior model to that of others, the aim should be for the accounting standards to accommodate the various business models and circumstances in which financial instruments are used. As widely recognized at the IASB Roundtables on measurement, a mixed model is more likely to result in useful reporting.
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April 2008: Joint Forum paper on customer suitability in sale of financial produces
The Joint Forum – a consortium of the Basel Committee, IOSCO, and IAIS – has released a paper entitled Customer Suitability in the Retail Sale of Financial Products and Services:
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The customer suitability report considers how supervisors and regulated firms across the banking, securities, and insurance sectors deal with risks posed by the sale of unsuitable retail financial products. The Joint Forum reviewed both the disclosure of information to retail investors and requirements on firms to determine whether recommended investment products are suitable for such investors. The report focuses exclusively on requirements related to retail customers and products with a significant investment component. The Joint Forum evaluated investment-based or investment-linked insurance products, but not those insurance contracts that insure only against risk.
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April 2008: Joint Forum paper on management of risk concentrations
On 27 April 2008, the Joint Forum – a consortium of the Basel Committee, IOSCO, and IAIS – published a paper titled Cross-sectoral Review of Group-wide Identification and Management of Risk Concentrations:
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The Risk Concentrations paper is being released in final form and has also been included in the Joint Forum submissions to the Financial Stability Forum to contribute to its work related to the market turmoil. This paper expands on previous reports and explores the extent to which financial conglomerates active in two or more of the banking, securities, and insurance sectors currently identify, measure, and manage risk concentrations at the firm-wide level and across the major risks to which these firms are exposed. The paper also explores how current and emerging risk techniques, including stress testing and scenario analyses, are employed to identify potential concentrations. It also includes observations and lessons drawn from the market turmoil that begin in mid-2007. An annex to the paper contains a summary of current regulatory requirements relating to risk concentrations.
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April 2008: Discussion of FASB and IASB responses to credit crisis at joint meeting of the two Boards
At their Joint Meeting on 21-22 April 2008 in London, the IASB and FASB discussed the standard-setters' response to the credit crisis.
The FASB Chairman encouraged both Boards to share information on the key issues that emerged during the credit crunch and discuss on the measures to be taken. He said that the three key areas of concern from an accounting perspective are:
- Derecognition (especially in the context of securitisations)
- Consolidation
- Fair value measurement
He continued that the US Senate is interested in some of the accounting issues. He also said that some problems are more compliance issues than problems with the standards, and that the reason for the crisis is mainly that the business models employed were flawed.
Summary of Discussion at the Joint IASB-FASB meeting:
Derecognition and Consolidation
On the issue of derecognition and consolidation, the FASB Chairman explained that the relevant US GAAP guidance (SFAS 140 and FIN 46R) will be revised to abandon the exemption from consolidation for qualifying special purpose entities (QSPE) – they would be consolidated in the sponsor's financial statements. He noted that the QSPE concept worked until the credit crunch, but with hindsight they have been ticking time bombs. FASB expects to publish changes to the US GAAP guidance by the end of 2008.
On the IASB side, a derecognition team has been formed to start with a clean sheet approach, and issues have been identified. The project team recognises the time pressure and will bring the issue back to the next Joint Board meeting in October 2008.
The IASB Chairman said that all three projects mentioned above have be prioritised and accelerated. The FASB Chairman supported approaching these projects jointly as far as possible, but that there were different time constraints.
One IASB member noted that IFRS 7 could be used at a starting point for enhanced disclosures. Assessments based on the first full year of application (2007) could be used. One FASB member expressed concerns over the ability to have a converged consolidation standard but thought it should be possible to have a converged disclosures standard.
The FASB Chairman then continued to elaborate on liquidity risk. He noted that many models didn't include liquidity risk and that many FIN 46R calculations did not either. He said that qualitative evaluation of facts and circumstances has to be improved and that the evaluation of whether an entity must be consolidated must be reassessed on an ongoing basis. In response to a question about the timing for the changes to US GAAP, he answered that an exposure draft (ED) is planned before end of June with the final amendments to be released at the end of the year.
On the IASB consolidation project, the project manager reported that the project has been accelerated and that the models in IAS 27 (control model) and SIC 12 (risk and rewards model) are currently being aligned, with improved disclosure. The IASB plans to publish an ED in summer 2008 with the goal of having the single source of guidance on consolidation.
A FASB member noted that it would probably be easier to disclose risky items then to find the right model for consolidation.
Fair value measurement
On fair value measurement the FASB Chairman said that both Boards have received a request from the IIF (Institute of International Finance) to address two issues:
- Allowing management to switch from mark-to-market to mark-to-model in certain situations where market values are not representative.
- Facilitate transfers from the trading book to the bank book for financial institutions.
The IASB Chairman underlined that the Financial Stability Forum (FSF) and the Basel Committee support the IASB's and the FASB's approach to use market values, as markets would be more confused by some sort of arbitrary measurement attribute. He also noted that the fair value measurement project will have a focus on accounting responses to illiquid and contracted markets.
The FASB Chairman informed the Boards that the US Securities Exchange Commission have issued a Paper Advising Registrants to Further Explain Fair Value in their management discussion and analysis.
One IASB member noted that a move from fair value would increase uncertainty in the markets.
The FASB Chairman closed this session with an appeal to share information and align any efforts as far as possible.
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April 2008: Basel Committee announces steps to strengthen the resilience of the banking system
On 16 April 2008, the Basel Committee on Banking Supervision announced a series of steps to help make the banking system more resilient to financial shocks. These include:
- Enhancing various aspects of the Basel II Framework, including the capital treatment of complex structured credit products, liquidity facilities to support asset-backed commercial paper (ABCP) conduits, and credit exposures held in the trading book. At the same time, the Committee notes the importance of prompt implementation of the Basel II framework, as this will help address a number of the shortcomings identified by the financial market crisis.
- Strengthening global sound practice standards for liquidity risk management and supervision, which the Committee will issue for public consultation in the coming months.
- Initiating efforts to strengthen banks' risk management practices and supervision related to stress testing, off-balance sheet management, and valuation practices, among others.
- Enhancing market discipline through better disclosure and valuation practices.
These measures will be introduced in a manner that promotes long-term bank resiliency and strong supervision, while seeking to avoid potentially adverse near-term impacts as the re-pricing of risk and deleveraging process continues in financial markets. The Committee's actions also are in support of the Financial Stability Forum's Working Group on Market and Institutional Resilience, which recently released its report to the G7 Finance Ministers and Central Bank Governors.
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April 2008: European Commission consultation on bank capital requirements Directive
The European Commission has launched a public consultation on possible changes to the Capital Requirements Directive (CRD) (2006/48/EC and 2006/49/EC). The purpose of Directives 2006/48/EC and 2006/49/EC is to ensure the financial soundness of credit institutions and investment firms and thus provides the very backbone of day to day prudential supervision of these institutions; it follows that this legal framework needs to be regularly updated and refined to respond to the needs of stakeholders.
The consultation takes place in the context of on-going work related to the Capital Requirements Directive (CRD) at various supervisory and industry fora. The review of the CRD is, in part, also a response to the recent recommendations of the G-7 Financial Stability Forum.
Opinions are sought on: (a) large exposures, (b) hybrid capital instruments, (c) supervisory arrangements, (d) the waivers for banks organised in networks, and (e) adjustments to certain technical provisions.
The suggested measures concerning large exposures and hybrid capital instruments and the adjustments to the technical provisions are largely based on advice from the Committee of European Banking Supervisors (CEBS). The working document does not constitute a formal Commission proposal. Nevertheless, informal discussions have already started in the European Banking Committee. The consultation is open until 16 June 2008 on: http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm. Comments should be sent to the following email address: markt-crd2008-survey@ec.europa.eu
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April 2008: Joint Forum paper on credit risk transfer
On 1 April 2008, the Joint Forum – a consortium of the Basel Committee, IOSCO, and IAIS – published a paper on Credit Risk Transfer (CRT): Developments from 2005 to 2007. The paper updates a 2005 paper to reflect the continued growth and rapid innovation in the CRT markets. The main findings of the paper are:
- Some of the more complex CRT instruments developed since 2004 are associated with increased leverage and a high variance of loss or high vulnerability to the business cycle.
- A failure to understand some of these risks contributed to the market turmoil of 2007.
- Despite these shortcomings, the structured credit market is likely to survive, but will remain weak for a period of time.
- Supervisors remain concerned about several aspects of the CRT market: its complexity; valuation issues; liquidity, operational and reputational risks; and the broader effects of the growth of CRT. Supervisors believe that market participants must better understand the structure and risks of the CRT products in which they invest, as well as how the rating agencies assign ratings to specific instruments and what circumstances would lead them to downgrade ratings.
- With continued innovation in the CRT markets, the effort and resources that firms and regulators will need to expend to properly understand these instruments increases significantly.
- There are steps that the industry and regulatory community can take to enhance the robustness of their risk management and oversight of these products. The paper includes recommendations in this regard.
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April 2008: IIF interim report on bank market practices
In April 2008, the Institute of International Finance (a banking association) published the Interim Report of the IIF Committee on Market Best Practices. The IIF convened the committee as a result of the deterioration of the US subprime mortgage market. The committee noted:
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Rapidly developing ramifications of market stress have revealed major points of weaknesses in business practices and market dynamics, particularly but not exclusively related to the dramatic growth of complex structured products.
The areas of weakness revealed include deteriorating lending standards by certain originators of credit prior to summer 2007; a decline of underwriting standards both with respect to the packaging of structured products and leveraged loans; excessive
reliance on poorly understood, poorly performing, and less than adequate ratings of structured products; valuation difficulties as assets shifted quickly from liquid to illiquid; purchase of structured products without full appreciation of the risks; liquidity risk and reputational risk exposure of conduits and structured investment vehicles with major adverse implications for sponsoring banks; and difficulties in identifying where exposures reside in a world of widely dispersed risks.
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Paragraphs 65-78 of the report address valuation issues, particularly fair value (mark-to-market) issues. Paragraphs 90-92 address transparency and disclosure issues. The objective of the committee is to arrive at broad agreement on changes in practices necessary to address these weaknesses. The IIF expects to publish a final report in third quarter 2008.
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April 2008: 'Leading-Practice Disclosures for Selected Exposures'
On 11 April 2008, the Senior Supervisors Group of financial regulators from major countries published a set of recommendations for Leading-Practice Disclosures for Selected Exposures. The report responds to the Financial Stability Forum's request that the Senior Supervisors Group undertake a review of disclosure practices regarding exposures to certain instruments that the marketplace now considers to be high-risk or to involve more risk than previously thought, including:
- collateralised debt obligations,
- residential mortgage-backed securities,
- commercial mortgage-backed securities,
- other special purpose entities, and
- leveraged finance.
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April 2008: G-7 ministers seek 'urgent action' by the IASB
On 11 April 2008, the G-7 Finance Ministers and Central Bank Governors, at their meeting in Washington, strongly endorsed the recommendations in the FSF report highlighted in our news story immediately below. Regarding the IASB, the G-7 said:
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We have identified the following recommendations among the immediate priorities for implementation within the next 100 days:
The International Accounting Standards Board (IASB) and other relevant standard setters should initiate urgent action to improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly on valuing financial instruments in periods of stress.
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April 2008: FSF urges IASB to improve accounting for off-balance sheet entities
On 7 April 2008, the Financial Stability Forum, a global organisation of regulators and central bankers, submitted a Report on Enhancing Market and Institutional Resilience to the G7 Ministers and Central Bank Governors. The IASB participated in preparing the report. The report analyses the causes and weaknesses that have produced the recent turmoil in financial markets worldwide and makes recommendations for correcting those weaknesses. The report addresses the following areas:
- Strengthened prudential oversight of capital, liquidity and risk management
- Enhancing transparency and valuation
- Changes in the role and uses of credit ratings
- Strengthening the authorities' responsiveness to risks
- Robust arrangements for dealing with stress in the financial system
Regarding accounting and disclosure standards for off-balance sheet entities, the report concludes:
The IASB should improve the accounting and disclosure standards for off-balance sheet vehicles on an accelerated basis and work with other standard setters toward international convergence. The report notes:
Off-balance sheet treatment in financial reports can arise as a result of the standards for derecognition (e.g., removing assets from balance sheets through securitisations) and consolidation (e.g., special purpose entities). The standards of the IASB and the US Financial Accounting Standards Board (FASB) differ for both topics and with respect to the required disclosures about off-balance sheet vehicles. The IASB and FASB have projects underway to converge their standards in these areas and this work should be accelerated so that high-quality, consistent approaches can be achieved. In doing so, and consistent with their required due process, the IASB and the FASB should consider moving directly to exposure drafts on off-balance sheet issues, rather than discussion papers, to meet the urgent need for improved standards. Standards should require the risk exposures and potential losses associated with off-balance sheet entities to be clearly identified and presented in financial disclosures. The IASB and FASB should consult investors, regulators, supervisors and other stakeholders for their views during this process, and should take note of issues that have come to light during the current market turmoil and the progress reflected in 2007 annual reports and other disclosures.
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Regarding valuations, the report concludes that:
International standard setters should enhance accounting, disclosure, and audit guidance for valuations. The report states that:
- The IASB will strengthen its standards to achieve better disclosures about valuations, methodologies and the uncertainty associated with valuations.
- The IASB will examine its principles and requirements for disclosures about the valuation of financial instruments to identify areas for enhancement in light of lessons learned from the market turmoil. This effort will assess disclosures in year-end 2007 annual reports and draw on the views of investors, firms, auditors, supervisors and regulators about the quality of valuation disclosure practices.
- The IASB will enhance its guidance on valuing financial instruments when markets are no longer active. To this end, it will set up an expert advisory panel in 2008.
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April 2008: Concern about banks' disclosures in Europe
At a hearing conducted by the Economic and Monetary Affairs Committee of the European Parliament, Kerstin af Jochnick, Chair of the Committee of European Banking Supervisors (CEBS), expressed some concerns about current financial statement disclosures by European banks:
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We are concerned that the lack of disclosure on banks' business models and on their role in structured finance activities could make it difficult for market participants to properly assess the banks' risk profile. While the coming into force of the Pillar 3 requirements of the CRD [EU Capital Requirements Directive] and of new accounting disclosure requirements (IFRS 7) should contribute to the quality, granularity and comparability in the disclosure of exposures, the disclosures seem in many cases to be aimed at banks' immediate stakeholders – i.e. at their shareholders – and not so much at market participants in the wider sense. It may be necessary for banks to reconsider their disclosure policies and the principle they build on, especially in times of stress.
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March 2008: US Treasury proposal to overhaul US regulation of financial markets
On 31 March 2008, US Secretary of the Treasury Henry M Paulson Jr released a Blueprint for a Modernized Financial Regulatory Structure that proposes a series of 'short-term' and 'intermediate-term' reforms of the structure for regulating financial institutions and markets in the United States. The changes are of a magnitude not seen since the current regulatory system was set up in response to the 1929 stock market crash and subsequent Great Depression.
- The short-term recommendations focus on taking action now to improve regulatory coordination and oversight in the wake of recent events in the credit and mortgage markets.
- The intermediate recommendations focus on eliminating some of the duplication of the US regulatory system and try to modernise the regulatory structure applicable to certain sectors in the financial services industry (banking, insurance, securities, and futures) within the current framework.
The report also includes a conceptual model for an 'optimal' regulatory framework. The optimal structure envisions the Federal Reserve as the 'market stability regulator', a new 'prudential financial regulator' for banks and savings institutions, and a new business conduct and corporate finance regulator. The latter would assume the SEC's current responsibilities over corporate disclosures, corporate governance, and accounting oversight.
Among the short-term recommendations:
- President's Working Group on Financial Markets (PWG). This existing inter-agency coordinating body should be expanded, and its role as policy-maker should be enhanced.
- Mortgage origination. Create a six-member federal Mortgage Origination Commission (MOC) that would establish uniform minimum licensing qualification standards for state mortgage market participants. The MOC would also evaluate, rate, and report on the adequacy of each state's system for licensing and regulation of participants in the mortgage origination process.
- Liquidity provisioning by the Federal Reserve. First, the current temporary liquidity provisioning process during those rare circumstances when market stability is threatened should be enhanced to ensure that: the process is calibrated and transparent; appropriate conditions are attached to lending; and information flows to the Federal Reserve through on-site examination or other means as determined by the Federal Reserve are adequate. Key to this information flow is a focus on liquidity and funding issues.
Among the intermediate-term recommendations:
- Federal thrift institutions. Federally chartered savings and mortgage institutions should become national
banks. The Office of Thrift Supervision would be closed, and its operations assumed by the Office of the Comptroller of the Currency (the federal bank regulator). This transition would take place in two years.
- Federal banking supervision. There should be direct federal supervision of state-chartered banks. A number of proposals are set out in this regard.
- Payment and settlement systems oversight. There should be direct federal oversight of all systems used to transfer funds and financial instruments between financial institutions and between financial institutions and their customers.
- Insurance. A federal system for chartering, licensing, regulating, and supervising insurers should be created. Insurers, reinsurers, agents, and brokers would elect to be regulated under the federal system or to continue under the current state-based regulation. A new Office of Insurance Oversight would be established within the Treasury Department to take the lead role in federal insurance regulation.
- Futures and securities. The Commodity Futures Trading Commission (CFTC, which regulates futures and options) and the Securities and Exchange Commission (SEC, which regulates securities, mutual funds, stock markets, and broker/dealers) should be merged to provide unified oversight and regulation of the futures and securities industries.
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March 2008: SEC advises registrants to further explain fair value in MD&A
The US SEC's Division of Corporation Finance has sent a letter to certain financial institutions concerning additional disclosure considerations in Management's Discussion and Analysis (MD&A) regarding fair value for their upcoming filings on Form 10-Q. While the letter was sent only to financial institutions, we understand that the SEC staff has indicated that the letter 'can be applicable to any company.'
The letter reminds registrants that have significant amounts of financial instruments to consider the SEC's requirements for disclosures in MD&A. Regulation S-K, Item 303,1 requires registrants, among other things, to discuss in their periodic filings any known trends or any known demands, commitments, events, or uncertainties that the registrants reasonably expect to have a material impact, either favorable or unfavorable, on their results of operations, liquidity, or capital resources.
This letter is in response to the challenges, resulting from current market conditions, in determining the fair value of certain financial instruments, such as asset-backed securities, loans carried at fair value or lower of cost or market (fair value), credit default swaps, and other derivative assets and liabilities. Because of the decline in or disappearance of liquidity in some markets, judgment has become increasingly important in estimating fair values. In addition, there may be a broader range of reasonable fair value estimates for some financial instruments. As a result, judgments may materially affect a registrant's reported results of operations, liquidity, or capital resources.
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March 2008: PWG Policy Statement on Financial Market Developments
The United States President's Working Group (PWG) on Financial Markets has issued a Policy Statement on Financial Market Developments. The policy statement sets out recommendations to improve the future state of US and global financial markets. Those recommendations cover improved transparency and disclosure, better risk awareness and management, and stronger oversight. The PWG believes that, "collectively, the recommendations will mitigate systemic risk, help restore investor confidence, and facilitate economic growth".
The policy statement offers the PWG's insight on causes of recent market issues and next steps for mitigating systemic risk, restoring investor confidence, and facilitating stable economic growth. The PWG will work with foreign regulators, finance ministries, and central banks through the international Financial Stability Forum and other venues to address these challenges globally. The PWG intends to issue a progress statement in the fourth quarter of 2008 and consider whether further steps are needed to address weaknesses in financial markets, institutions and related supervisory policies.
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March 2008: Supervisory Agencies Issue Joint Report Assessing Risk Management Practices
On 6 March 2008, Senior financial supervisors from five countries issued a report that assesses a range of risk management practices among a sample of major global financial services organizations. This report Observations on Risk Management Practices during the Recent Market Turbulence summarises a joint review that supervisors initiated this past autumn. The seven supervisory agencies participating in this project are the French Banking Commission, the German Federal Financial Supervisory Authority, the Swiss Federal Banking Commission, the UK Financial Services Authority, and, in the United States, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Federal Reserve. They are referred to collectively as the 'Senior Supervisors Group'.
The report also reflects the results of a roundtable discussion that participating supervisory agencies held with industry representatives on 19 February 2008, at the Federal Reserve Bank of New York. Supervisors undertook this effort to evaluate the effectiveness of current risk management practices during this period of stress. These observations could then be used in supervising individual firms and in assessing potential future changes in supervisory requirements, guidance and expectations.
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March 2008: Deloitte Special Update – Keeping Your Cool Through a Financial Crisis
Deloitte & Touche Investment Advisors has published a Special Update: Keeping Your Cool Through a Financial Crisis. This special economic and market review is presented to provide perspective and context within which to evaluate your portfolio performance as well as a forward look at the questions, events, and circumstances that may impact performance in the quarter ahead – in light of the current pressures on the US financial system. Topics addressed:
- Our Financial System Under Pressure
- The Fed to the Rescue
- Could the Overall US Financial
- Systems Fail?
- Keeping Your Perspective
- What Are the Signs that We Are Out of the Woods?
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December 2007: 'Big 6' GPPC – Determining fair values of financial instruments under IFRSs
The six largest accounting networks under the auspices of the Global Public Policy Committee (GPPC) have jointly issued a paper entitled Determining Fair Value of Financial Instruments under IFRSs in Current Market Conditions. The objective of the paper is to enhance awareness of the requirements of IFRSs in relation to the determination of fair value of financial instruments and related disclosures. It is similar to the paper issued by the Center for Audit Quality on Measurement of Fair Value in Illiquid (or Less Liquid) Markets under US GAAP (see the item immediately below). A draft of this paper was shared with the Financial Stability Forum, some board members and staff of the IASB, Standing Committee No. 1 of IOSCO, and the Accounting Task Force of the Basel Committee on Banking Supervision. The GPPC group believes that drawing attention to the issues is helpful in advance of the 2007 year-end reporting season, particularly because this is the first time that IFRSs – and especially the literature relating to valuation of financial assets and liabilities – has been applied extensively in difficult market conditions.
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October 2007: Center for Audit Quality – Accounting issues arising from illiquid market conditions
The Center for Audit Quality (CAQ) issued three white papers addressing key accounting issues arising from the current illiquid market conditions from the perspective of existing United States GAAP. While the papers are written in a US GAAP context, the issues are likely to be of interest in an IFRS context as well. The CAQ was created by the American Institute of CPAs "to foster confidence in the audit process and to aid investors and the capital markets by advancing constructive suggestions for change rooted in the profession's core values of integrity, objectivity, honesty and trust".
Download the three CAQ white papers:
- Fair Value Measurements in Illiquid (or Less Liquid) Markets (PDF 32k). The paper discusses measurement of fair value under existing US GAAP (most of which is contained in SFAS 157 Fair Value
Measurements) in the context of illiquid (or less liquid) market conditions that currently exist in many segments of the credit markets. Although much of the discussion is in the context of assets backed by subprime mortgage loans, the GAAP principles discussed regarding the measurement of fair value are also applicable to the measurement of the fair value of other assets (such as unsecuritized assets), not just those backed by subprime mortgage loans.
- Consolidation of Commercial Paper Conduits (PDF 31k). The objective of this paper is to discuss the application of FASB Interpretation No. 46 (revised December 2003) Consolidation of Variable Interest Entities by sponsors of commercial paper conduits, particularly as impacted by market conditions that currently exist in many segments of the credit markets, including illiquid (or less liquid) conditions in the commercial paper markets.
- Accounting for Underwriting and Loan Commitments (PDF 39k). This paper discusses existing US GAAP associated with commitments to lend money or underwrite securities in the context of illiquid (or less liquid) market conditions that currently exist in many segments of the credit markets.
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