1 Fair value or an alternative measurement model ICAEW Roundtable 8 July 2008 Interventionby Fernando Restoy Commissioner Spanish CNMV Chairman CESR-Fin

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Fair value or an alternative measurement Fair value or an alternative measurement modelmodel

ICAEW Roundtable 8 July 2008ICAEW Roundtable 8 July 2008

InterventionInterventionbyby

Fernando RestoyFernando Restoy

Commissioner Spanish CNMVCommissioner Spanish CNMVChairman CESR-Fin Chairman CESR-Fin

Committee of European Securities RegulatorsCommittee of European Securities Regulators

Committee of European Securities Committee of European Securities RegulatorsRegulators

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On the On the FAIR VALUE DEBATEFAIR VALUE DEBATE

Fair value: big achievement. Provides Fair value: big achievement. Provides relevance and homogeneity to financial relevance and homogeneity to financial statementsstatements

...within a set of ...within a set of accounting accounting principles principles that can be improvedthat can be improved

– Lack of a fully coherent measurement Lack of a fully coherent measurement approachapproach For financial and non financial assetsFor financial and non financial assets For financial assets and liabilitiesFor financial assets and liabilities For difFerent types of financial assetsFor difFerent types of financial assets For financial assets held for different purposesFor financial assets held for different purposes

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– ......partly due to the lack of a partly due to the lack of a comprehensive conceptual frameworkcomprehensive conceptual framework

– ...and to the need of pragmatism...and to the need of pragmatism Technical difficulties to calculate fair value Technical difficulties to calculate fair value

(real assets, non-traded financial (real assets, non-traded financial instruments)instruments)

Avoid (apparently) counter-intuitive Avoid (apparently) counter-intuitive outcomes (financial liabilities)outcomes (financial liabilities)

Limit (excessive) volatility of income Limit (excessive) volatility of income statements (a.f.s. instruments, loans and statements (a.f.s. instruments, loans and receivables...)receivables...)

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But, has proved robust in the financial But, has proved robust in the financial turmoil turmoil

– Most effects in banks‘ trading books (no Most effects in banks‘ trading books (no reasonable alternative)reasonable alternative)

– Arguments on excessive procyclicality of Arguments on excessive procyclicality of accounting principles are misguidedaccounting principles are misguided Fair values are procyclicalFair values are procyclical But, do not lead by themselves to destabilising But, do not lead by themselves to destabilising

spiralsspirals It, something, accurate measurement contributes It, something, accurate measurement contributes

to limit excessive risk takingto limit excessive risk taking

– Check, instead the role of:Check, instead the role of: Market practices (stop-loss strategies, margin Market practices (stop-loss strategies, margin

calls)calls) Capital regulationCapital regulation

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– But avoid shortcuts: financial But avoid shortcuts: financial information is not a prudential policy information is not a prudential policy tool (do not shoot the messenger)tool (do not shoot the messenger)

Although, of course some Although, of course some improvements may be necessary. improvements may be necessary. Among othersAmong others– Additional guidance on valuation of Additional guidance on valuation of

illiquid instrumentsilliquid instruments– More comprehensive disclosures on More comprehensive disclosures on

valuation techniquesvaluation techniques

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CESR statement on fair value CESR statement on fair value measurement measurement

CESR will publish a statement regarding fair value CESR will publish a statement regarding fair value measurement within a few days. It will be open for measurement within a few days. It will be open for public consultation until 12 September 2008public consultation until 12 September 2008

CESR‘s ROLECESR‘s ROLE

Ensure sound and consistent application across Ensure sound and consistent application across jurisdictions of IFRSjurisdictions of IFRS

Ensure market participants receive comprehensive and Ensure market participants receive comprehensive and relevant information in the current difficult situationrelevant information in the current difficult situation

OBJECTIVESOBJECTIVES

Based on experience, as enforcers, provide an input Based on experience, as enforcers, provide an input that could help preparers to properly apply accounting that could help preparers to properly apply accounting principles when measuring financial instruments in principles when measuring financial instruments in illiquid marketsilliquid markets

Provide references to strengthen disclosure of Provide references to strengthen disclosure of valuation practices valuation practices

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CESR statement on fair value CESR statement on fair value measurementmeasurement

SCOPESCOPE

Remains under the domain of application Remains under the domain of application of current IFRS in line with the of current IFRS in line with the responsibilities for CESR members as responsibilities for CESR members as securities supervisors and enforcers. securities supervisors and enforcers. – The competence of setting and issuing general The competence of setting and issuing general

interpretations of existing standards lies with interpretations of existing standards lies with IASB and IFRIC.IASB and IFRIC.

Focuses onFocuses on– Measurement Measurement

Active and non active markets Active and non active markets Selection of inputs to valuation techniquesSelection of inputs to valuation techniques

– Leading disclosure practicesLeading disclosure practices

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MEASUREMENTMEASUREMENT

On the identification of active and non On the identification of active and non active markets the statement stresses:active markets the statement stresses: – As judgment is required, need of a well-As judgment is required, need of a well-

documented valuation policy. Should be consistent documented valuation policy. Should be consistent across time and across financial instrumentsacross time and across financial instruments

– Even if a market is not very liquid or the number of Even if a market is not very liquid or the number of transactions is relatively low compared to other transactions is relatively low compared to other markets or to the past, the market could still be markets or to the past, the market could still be activeactive

– The size of the holdings of instruments is not a The size of the holdings of instruments is not a criterion to decide whether a market should be criterion to decide whether a market should be considered active considered active

– Different pricing sources can be available in an Different pricing sources can be available in an active market, such as prices for actual active market, such as prices for actual transactions or for binding quotes transactions or for binding quotes

– Market quotes can only be disregarded if there is Market quotes can only be disregarded if there is sufficient evidence that they do not constitute a sufficient evidence that they do not constitute a reliable reference for valuationreliable reference for valuation

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On the use of valuation techniquesOn the use of valuation techniques– Entails a significant amount of judgmentEntails a significant amount of judgment– The issuer should document the criteria, the The issuer should document the criteria, the

assumptions and the inputs to the valuation assumptions and the inputs to the valuation techniques to ensure consistency year after techniques to ensure consistency year after yearyear

– Transactions conducted in a market that is not Transactions conducted in a market that is not considered active can often provide the most considered active can often provide the most relevant information to determine fair value.relevant information to determine fair value.

– Liquidity risk and correlation risk could also be Liquidity risk and correlation risk could also be relevant in addition to the inputs to valuation relevant in addition to the inputs to valuation techniques in IAS 39.AG82 techniques in IAS 39.AG82

– The use of indexes should be approached with The use of indexes should be approached with cautioncaution

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DISCLOSUREDISCLOSURE

Good disclosure practices is a Good disclosure practices is a natural counterpart to the use of natural counterpart to the use of judgment in measurement judgment in measurement practicespractices

Issuers should consider publishing Issuers should consider publishing the most relevant criteria and the most relevant criteria and accounting policies for deciding onaccounting policies for deciding on– Active or non active markets and Active or non active markets and – Identification of a forced transaction Identification of a forced transaction – Prioritisation among several price sourcesPrioritisation among several price sources

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and provide information (by asset subclasses) and provide information (by asset subclasses) onon– References used in active marketsReferences used in active markets– Type of valuation techniques including inputs, Type of valuation techniques including inputs,

assumptions and dataassumptions and data– Any relevant change in techniques applied to Any relevant change in techniques applied to

specific instrumentsspecific instruments

The statement also provides an example on The statement also provides an example on how issuers could present a useful summary how issuers could present a useful summary of their valuation procedures in a tabular of their valuation procedures in a tabular form separating the information in the form separating the information in the following categories:following categories:– Quoted prices in active marketsQuoted prices in active markets– Valuation techniques with observable and non Valuation techniques with observable and non

observable inputsobservable inputs

Documents

1 Fair value or an alternative measurement model ICAEW Roundtable 8 July 2008 Interventionby Fernando Restoy Commissioner Spanish CNMV Chairman CESR-Fin