Accounting paper confirms efforts to calm fair value option fears
LONDON, February 11 - Global accounting rule-makers have revised their latest proposals on the so-called fair value option to try to meet banking supervisor fears that the option could be abused by weak banks.
As expected, the International Accounting Standards Board (IASB), the London-based accounting standards setter, is suggesting that firms taking the option state clearly why they are using it and how it fits into their asset management liability strategies.
The proposal is contained in a redrafted version of a December paper on the topic that will be discussed next week by the IASB at its regular three-day monthly meeting. Accounting industry sources expect the Board, which comprises 14 leading international accounting experts, to give the go-ahead for a public meeting on March 16 on an issue that's pitted the interests of the supervisors against those of both financial and non-financial firms and their accountants and auditors.
Europe's top financial regulator, internal markets commissioner Charlie McCreevy, has called for urgent action to resolve the question, which has dragged on for many months.
The fair value option is part of the now notorious IAS 39 rule for valuing financial assets and liabilities, such as bonds, shares, derivative contracts, loans and receivables, in the new International Financial Reporting Standards (IFRS) that came into effect in many countries on January 1.
Under IAS 39 some items have to be measured at fair value, that is at current market prices, and others at amortised cost. But the rule provides firms with an option - the fair value option - under which they can choose to measure any item at fair value. The aim is to avoid the accounting distortions and mismatches that might arise if economically matched assets and liabilities were measured on different bases - some at fair value and others at cost.
But bank regulators, in particular the European Central Bank and the Basel Committee on Banking Supervision, are worried that troubled banks might use the fair value option to under-value the liabilities in their accounts, possibly threatening financial stability.
The IASB's December paper sought to develop a "principles-based" approach to the problem that would require firms to observe the spirit of the option, namely that it should only be used to avoid accounting mismatching of assets and liabilities.
The December paper was developed after an April exposure draft last year, which proposed a set of "rules-based" restrictions on the option's use, received an overwhelming thumbs down from all interested parties save the bank regulators. Opponents of the exposure draft could not see why their freedom to use the option should be hampered by what they regarded as banking supervisor quibbles.
Banking supervisors, including those with the Basel Committee, felt the December paper could be a step forward, but remained worried that that the new approach still lacked a context of sound risk-management policies.
The revised version, with its requirement that firms make clear how the use of the option aligns with their asset-liability management, is intended to meet these concerns. Banking regulators were not available for immediate comment on the paper.
Insurance companies were notably vocal in their opposition to the December paper, saying that its terms would block their ability to use the option for entirely appropriate purposes. They want the option to be left as it is and argue that banking regulators fears should be addressed through general accounting standards.
The IASB's latest draft rewords a key condition for using the option - that it would eliminate a mismatch that would otherwise arise from measuring items on different bases. In the new wording the principal is basically unchanged, but it makes clear that the condition applies to measurement mismatches and mismatches in the recognition of gains and losses.
Insurance industry sources were also not available for immediate comment.
Meanwhile, there was some consolation for the often seemingly beleaguered IASB this week in a message of support from stock exchange regulators.
The International Organisation of Securities Commissions (IOSCO), the Madrid-based body that brings together the world's securities markets regulators, reaffirmed its support for the development and use of IFRS as a set of high quality standards in cross-border offerings and listings.
Commissioner McCreevy, on the other hand, reiterated earlier this month his desire to see greater `democratic governance' and political accountability of the IASB.
(The IASB's redraft of its December paper on the fair value option is available as part of the Observer Notes for next week's February 15-17 Board meeting - see www.iasb.org)
David Keefe (dkeefe@globalriskregulator.com)
