The staff noted that FAS 157 Fair Value Measurements was issued on 15 September 2006 (see IAS Plus News Story of 19 September 2006). The IASB staff can now complete the preparation of an IASB Discussion Paper on Fair Value Measurements, which will comprise:

• FAS 157;
• excerpts of existing FVM guidance in IFRSs; and
• an Invitation to Comment that expresses the Board's preliminary views and requests constituent input on certain matters

Non-performance risk

The Board noted that IFRSs currently do not discuss non-performance risk in relation to the fair value of liabilities. IAS 39 requires the fair value of a financial liability to reflect the credit quality of the instrument. Reflecting credit quality in the fair value measurement of a financial liability effectively causes the fair value measurement to reflect the risk that the obligation will not be fulfilled. FAS 157 extends this principle to the fair value measurement of both financial and non-financial liabilities.

It was noted that non-financial liabilities include both credit risk (which related to the financial component) and non-performance risk (which related to the activity). After some discussion, the Board agreed to include a preliminary view in the invitation to comment agreeing with the concept that the fair value of a liability should reflect the non-performance risk relating to that liability (in addition to credit risk).

Issues in the Invitation to Comment

Entry and exit prices

The Board agreed that the Invitation to Comment should discuss the concepts of entry and exit prices without stating a preliminary view. The Discussion Paper will address two views without stating a preference. The discussion note that the notion of a price established between 'a willing buyer and a willing seller' matters only when one is shifting markets. In many IASB standards, 'fair value' is used to mean an exit price; in a few (such as IFRS 3, IAS 39, and IAS 41), the phrase is used to mean an entry price. Board members found using the same phrase to communicate two different measurement objectives confusing. Board members noted that they might need to reassess the measurement objective in IFRS 3, IAS 39, and IAS 41 should they adopt the approach in FAS 157 paragraph 17(d), which allows the use of a price other than the transaction price to represent fair value if the transaction occurred in a market other than the principal or most advantageous market.

The staff proposed wording 'on the fly', which they will bring back to the Board.

Principal or most advantageous market

IAS 39 requires an entity to use the most advantageous active market in measuring the fair value of a financial asset or liability when multiple markets exist, whereas IAS 41 Agriculture requires an entity to use the most relevant market. By comparison, the FAS 157 requires an entity use the principal market for the asset or liability. In the absence of a principal market for the asset or liability, the entity uses the most advantageous market. The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability. The most advantageous market is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability, considering transaction costs in the respective market(s). In either case, the principal (or most advantageous) market (and thus, market participants) should be considered from the perspective of the reporting entity, thereby allowing for differences between and among entities with different activities.

The Board reconfirmed their view taken in May 2006, namely:

A question will be asked on this topic in the Invitation to Comment.

Calling 'level 3' measurements 'fair value'

The Board noted that FAS 157 establishes a three level hierarchy for categorising and prioritising inputs for fair value measurements. Level 3 of the hierarchy is 'unobservable inputs' for the asset or liability (that is, they are not observable in a market). Unobservable inputs are used to measure fair value only to the extent that observable inputs are not available. These inputs reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). When Level 3 measures are used, FAS 157 prescribes additional disclosures.

The Board agreed that the disclosure requirements in FAS 157 highlight sufficiently the nature of the fair value measurement so that users of financial statements can develop a view of the potential uncertainty of that measurement. Therefore, it would not be necessary to include in the Discussion Paper a discussion of whether measurements comprised of significant Level 3 inputs should be labelled something other than fair value.

Block premiums and discounts

The Board agreed to address the issue of whether block premiums and discounts should be discussed in the Discussion Paper. Such premiums or discounts may arise when a larger-than-normal quantity of an asset or liability is being sold in a market. Board members noted that the requirement to use the 'Price x Quantity' formula is limited to Level 1 measures, and that this opens the treatment of block purchases and sales to abuse, since it could be argued that these should be measured using Level 2 or 3 inputs.

Board members also agreed that there is a need to distinguish illiquidity caused by the size of the block from that caused by the thinness of the market.

The staff will draft a question on this issue for inclusion in the Invitation to Comment.

Day 1 gains and losses

The Board noted that an exit price measurement objective could have significant implications on certain fair value measurements in IFRSs, particularly in IAS 39 on initial recognition. They reasoned that it is important to highlight situations where the guidance in FAS 157 differs significantly from current IFRSs. Further, convergence on the day-one gain matter is a high-profile issue to many large financial institutions and is an area where the staff expects many comments. The Invitation to Comment will contain a discussion and question on the transaction price presumption.

US GAAP-specific material contained in FAS 157

The Board agreed that, in the interests of timely publication, they would not alter FAS 157 in any way for the purposes of the Discussion Paper and Invitation to Comment, and that it would therefore have US GAAP-specific material. The Invitation to Comment would note that any Exposure Draft would be IFRS-specific.

Next steps

On a poll, 12 Board members voted to issue the Invitation to Comment and Preliminary Views, and one Board member abstained, pending resolution of the discussion of entry and exit prices.

The Discussion Paper is scheduled for publication in late 2006.