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CESR draft statement on fair value in illiquid markets

  • European Union (old) Image

14 Jul 2008

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. Click for:

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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