Unfair pressure on fair value
3 Nov 08
The row over fair value accounting has presented international financial reporting with its toughest test yet
by Robert Outram
The world’s financial system is in turmoil. National GDP is being hocked to bail out struggling banks and the UK is officially on the verge of recession.
At such a time, the argument over fair value accounting might look like a debate of interest only to the most technically-minded of number-crunchers. In fact, it’s become a highly political issue.
Many of the banks particularly dislike fair value accounting for financial instruments, partly because it can be very complex to account for, but mainly because they would prefer to smooth profits and losses over time.
As well as the banks, some accounting academics and, more importantly, political leaders in countries like the US and France have been highly critical of fair value accounting. The US Emergency Economic Stabilization Act – the “Paulson bail-out” for the US banks passed by Congress last month – includes a clause reaffirming the right of the US authorities to suspend fair value. The US financial regulator, the Securities and Exchange Commission, is also required to conduct a study on the effect of mark-to-market accounting standards on the banking sector, and to submit a report to Congress within 90 days of the Act’s passage.
Also last month, “clarifications” were issued, first by the US Financial Accounting Standards Board, and then by the International Accounting Standards Board, to confirm that under “rare” circumstances certain financial assets held for trading could be reclassified as “held to maturity”, effectively taking them from the mark-to-market regime back to historic cost. The UK’s Accounting Standards Board followed suit.
It is a long way from being a complete cave-in, but it could be the thin end of the wedge. It shows the pressure the standard setters are now under, and it also demonstrates that if one cracks, they will all crack. Companies reporting under international or UK standards would be furious if competitors following US GAAP (generally accepted accounting practice) gained an unfair advantage.
ICAS is among the voices now rallying to the support of the fair value concept. Its chief executive, Anton Colella, has written to Prime Minister Gordon Brown and other political figures to stress that suspending fair value accounting would be against the public interest.
Colella says: “While fair value accounting has been blamed by many as one of the causes of the current financial crisis, we would argue that accounting is merely a language which reports the underlying economics in a transparent and neutral way… fair value measurement still provides the most relevant information to investors. To use any other measurement basis would simply mask the real, current values of financial instruments, and past experience has shown that the absence of this information has in fact contributed to prolonged market turmoil.”
ICAS is not alone. For example, representatives of the CFA (Chartered Financial Analyst) Institute, the Consumer Federation of America the Council of Institutional Investors and the Centre for Audit Quality have written jointly to SEC chairman Christopher Cox to express “grave concern” over calls to scrap fair value. They added: “We believe such urgings are decidedly not in the public interest."
The question is not just whether marking to market is the right way to account for banks’ assets. The bigger issue is how financial standard setters should operate. Should they stick to their principles, even if they are unpopular, or should they be subject to political pressure? There is much at stake.