SEC Issues Report on Mark to Market Accounting

The Securities and Exchange Commission recommended against suspending fair-value accounting rules, instead suggesting improvements to deal with illiquid markets and reducing the number of models used to measure impaired assets.

In a 211-page report to U.S. lawmakers, as expected, the agency's staff Tuesday definitely recommended that fair-value and mark-to-market not be eliminated or suspended. "The abrupt elimination of fair value and market-to-market requirements would erode investor confidence," the report said.

The banking lobby has argued that financial institutions have been forced to write off as losses still-valuable assets because the market for them had dried up, creating a spiral of write-downs and asset sales.

The report said that staff found no evidence to suggest that the accounting rules had played a significant role in the collapse of U.S. financial institutions. "While the application of fair value varies among these banks...in each case studied it does not appear that the application of fair value can be considered to have been a proximate cause of the failure," the report said.

Additionally, the SEC suggests that the Financial Accounting Standards Board narrow the number of accounting models firms can use to assess the impairment for financial instruments.

Michael R. Crittenden at the Wall Street Journal

See:
SEC press release

Full Report: Report and Recommendations Pursuant to
Section 133 of the Emergency Economic Stabilization
Act of 2008: Study on Mark-To-Market Accounting

Merry Christmas from FASB, IASB

The IASB and the FASB have jointly proposed requiring companies to provide additional disclosures on all their investments in debt instruments, other than those classified in the fair value through profit or loss category. The FASB released FSP FAS 107-a and the IASB issued proposed amendments to IFRS 7, "Financial Instruments: Disclosures."

The joint releases require an entity to state in tabular form the fair value, amortized cost and amount at which the investments are actually carried in the financial statements. The amendments would also require a company to disclose the effect on profit or loss and equity if all the debt instruments had been accounted for at fair value or at amortized cost.

"We continue to act swiftly in dealing with accounting issues that have arisen as a result of the crisis," said IASB Chairman Sir David Tweedie (pictured) in a statement. "Enhanced disclosures for investments in debt instruments will provide greater transparency and help to regain investors' confidence in the financial markets."

Earlier, the IASB and the FASB also published for public comment proposals for clarifying the accounting treatment for embedded derivatives. The IASB said it was responding to requests asking for the IASB and FASB to clarify the requirements in IAS 39, "Financial Instruments: Recognition and Measurement and IFRIC 9 Reassessment of Embedded Derivatives."

The IASB came under pressure in October to amend IAS 39 to allow banks to reclassify some of their assets. Participants in a recent roundtable, however, asked the IASB to prevent any diversity in practice developing as a result of the amendments. The new proposals would require all embedded derivatives to be assessed and, if necessary, separately accounted for in financial statements.

"In October 2008, in response to exceptional circumstances, the IASB amended accounting standards relating to the reclassification of financial instruments," said Tweedie. "Issuing that amendment without normal due process always carried the risk of unintended consequences, and these proposals seek to clarify the application of that amendment to embedded derivatives."

The releases are set out here:
FASB

http://www.fasb.org/fasb_staff_positions/prop_fsp_eitf99-20-a.pdf

http://www.fasb.org/fasb_staff_positions/prop_fsp_fas107-a.pdf

IASB
http://www.iasb.org/NR/rdonlyres/43D44A92-5BB8-411B-8684-81E38C0CE9F0/0/ED_AmdmentsIFRS7DebtInstruments0812.pdf
http://www.iasb.org/NR/rdonlyres/7421736D-6390-4F7B-9F0A-BE4B21CBCABD/0/ED_IFRIC9andIAS391208.pdf

Cox: Independence of Accounting Standard Setters is Key

Excerpts from Speech by SEC Chairman Christopher Cox: Remarks Before the AICPA National Conference on Current SEC and PCAOB Developments

If we learned one painful lesson from the events of the 1930s, and from the more recent scandals of the S&L crisis in the 1980s and Enron, WorldCom and the rest in the 1990s and the first part of this decade, it is how vitally important it is to protect the independence of accounting standard-setters and ensure that their work remains free of distortions from self-serving influences.

That priority must also be reflected in any regulatory reform undertaken by the next Congress and the new administration. Accounting standards-setting should remain an independent function, and regulatory oversight of the independent private-sector standard setter should not become entangled with the competing priorities of evaluating and addressing systemic risk. Accounting standards should not be viewed as a fiscal policy tool to stimulate or moderate economic growth, but rather as a means of producing neutral and objective measurements of the financial performance of public companies.

Accounting standards aren't just another financial rudder to be pulled when the economic ship drifts in the wrong direction. Instead they are the rivets in the hull, and you risk the integrity of the entire economy by removing them.

There are those who say that independent standard setting is important, and who will agree that private sector standard setting is preferable to ensure that the process is not detached from reality — but who nonetheless say that while these things are true in ordinary times, these are not ordinary times. Therefore, they argue for setting aside the normal approach to standard setting, which identifies issues for consideration, gives the public exposure documents, includes outreach efforts, and then solicits comments on the exposure documents, and finally considers all of the resulting comments in finalizing and issuing new accounting standards. All of that, they say, should be set aside and replaced with a quick fix, whether the standard setters agree or not.

This view gives short shrift not only to the principle of independence, but also to the credibility of the standard-setting process and investor confidence in it.

The truth is that the value of independent standard setting is greatest when the going gets tough. The more serious the stresses on the market, the more important it is to maintain investor confidence.

None of this is to say that standard-setters can or should turn a blind eye to the events in the world around us; or ignore the valid criticism and input of leaders in business, politics, and academia; or endlessly debate and deliberate instead of act when action is required. To the contrary, that is what the transparent process is for. It is meant to achieve results, and to keep standards current.

Standards must keep pace with the real world to stay relevant, and they must be refined over time to better address weaknesses, as we have recently seen with the problems in valuing assets in illiquid markets. I believe it is critical that FASB complete its analysis of the SEC's request for expeditious improvement in the impairment model in FAS 115, made formally last October, in accordance with its established independent standard-setting process.

As we have learned, illiquid markets bring new challenges to the measurement of fair value that could not have been fully appreciated in past years. These challenges have brought into focus the need for further work on improving the tools that companies have at their disposal to achieve transparent, decision-useful financial reporting.
The entire speech can be found here.

Trouble in IFRS Paradise

Survey of says finance executives have in Europe about cost and effectiveness of IFRS

Convergence of accounting standards may be on its way, but finance executives in the U.S. don’t seem overly thrilled by the prospect. What’s more, these skeptics may be on to something—if the views of their counterparts in Europe are any indication.

Indeed, a survey of 749 finance managers in the U.S. and Europe uncovered a number of misgivings about the melding of the standards put forward by the Financial Accounting Standards Board with the rules set forth by the International Accounting Standards Board. Admittedly, over half of the U.S.-based CFOs, controllers and chief accounting officers who were surveyed—and 76% of those in Europe—said that accounting rules should be developed on the international level.

But many respondents in the U.S. seemed vexed about the actual switchover, which is aimed at developing one set of global accounting rules.

For starters, finance managers in the U.S. were extremely concerned about fair-value accounting. Over 60% of those who responded to the survey, which was conducted by Duke and Oxford Universities, think IASB is moving toward fair-value accounting. But nearly the same percentage said the adoption of fair-value accounting is a bad idea.

In addition, the respondents see big hurdles to convergence. When asked whether international accounting standards and GAAP are largely identical, about 40% of U.S. respondents said no. That raises questions about whether harmonization of accounting standards is even possible. About 43% of the finance managers surveyed in the U.S. said regulators are unlikely to achieve a set of unified global accounting rules and practices because legal environments and business cultures differ too much across countries and regions.

That’s hardly an encouraging result for IASB. It’s probably not good news for the Securities and Exchange Commission, either, which has firmly placed its weight behind convergence. Under the road map the SEC issued in November, all U.S. public filers would be required to report their results using the IASB’s rules by 2014. At least 110 public companies in the U.S. will be eligible to report using IFRS as early as next year.

Those managers contemplating early filing may first want to consider what their counterparts in Europe say about IFRS. The Duke/Oxford survey revealed that, while U.S. finance executives have worries about convergence, they tend to have a much higher opinion of the effectiveness of IASB standards than managers who actually use the rules.

Case in point: Only 4% of the U.S. respondents said that IFRS does not improve the transparency and usefulness of accounts to shareholders, investors and creditors. But in the U.K., which switched to international reporting standards three years ago, fully 53% of respondents said IFRS was not effective in improving financial transparency.

Likewise, only 6% of the surveyed finance mangers in the U.S. said IFRS would not improve public confidence in the markets. But nearly half of the U.K. respondents said international accounting standards were not effective in boosting public confidence in the markets.

What’s more, fully 60% of the respondents in Europe said the cost of convergence outweighed the benefits. That figure jibed exactly with the responses from U.S. finance chiefs: six out of 10 said the cost of switching to international accounting rules offset the benefits.

According to a recent study conducted by the SEC, the cost of convergence with IFRS will likely cost U.S. filers about $32 million each over a three-year period.

Despite concerns about costs, the move to harmonized accounting standards appears to be a done deal. Mike Lloyd, a partner at Deloitte who is in charge of the global treasury and capital markets team in London, said he is more confident now than he was a few years ago that the U.S. will adopt IFRS and that there will be a single set of international accounting standards.

But Mr. Lloyd, speaking today at a conference on treasury trends, added that one thing that could possibly derail convergence is if the European Union pressures IASB to change standards and ends up creating its own set of accounting rules. “But otherwise, it’s highly likely we’ll move to international standards,” he said.
By John Goff at Financial Week

SEC Road Map for Transition to IFRS

In mid-November, the SEC its long-awaited road map for the transition by U.S. public companies to the use of International Financial Reporting Standards (IFRS). The Commission set a longer-than-expected 90-day comment period for the proposal. The proposal sets out target dates that plot the required use of IFRS by certain U.S. issuers beginning in 2014. SEC also put forward two other proposals under which U.S. issuers that elect to use IFRS would disclose U.S. GAAP information.

The proposal provides that SEC will decide in 2011 if U.S. should pass laws that issuers must use IFRS beginning in 2014. Also provided are provisions for early adoption beginning in 2010 for certain issuers.

Critical points of the proposals:

• Improvements in accounting standards
• The accountability and funding of the International Accounting Standards Committee Foundation
• Improvement in the ability to use interactive data for IFRS reporting
• Education and training in the U.S. relating to IFRS
• Limited early use of IFRS, beginning with filings in 2010, where this would enhance comparability for U.S. investors. Eligibility would be based on both the prevalence of the use of IFRS and the significance of the issuer in a given industry. The SEC estimates that a minimum of 110 companies could be eligible.
• The anticipated timing of future rulemaking by the Commission
• Implementation of the mandatory use of IFRS, including considerations relating to whether any mandatory use of IFRS should be staged or sequenced among groups of companies based on their market capitalization.
  

Under a staged transition, IFRS filings would begin for large accelerated filers for fiscal years ending on or after Dec. 15, 2014. Remaining accelerated filers would begin IFRS filings for years ending on or after Dec. 15, 2015. Non-accelerated filers, including smaller reporting companies, would begin IFRS filings for years ending on or after Dec. 15, 2016.

The Commission believes a staged rollout would help mitigate the costs of the shift to issuers and the resource demands on auditors, consultants and others. The Commission acknowledges in the document that a staged rollout would lead to a lack of comparability of financial information and would temporarily create a dual system of reporting that would require investors to be familiar with U.S. GAAP and IFRS.

The road map spells out two alternative proposals under which U.S. issuers that elect to use IFRS would disclose U.S. GAAP information.

You can read the roadmap here:

www.sec.gov/rules/proposed/2008/33-8982.pdf

Former Fed Chairman May Bring IFRS to Fore in Obama's Presidency

2009 may see the accounting profession facing a US political regime with a clear mandate to reform and regulate. Predicting accurately the form this will take is more difficult. This is partly due to senator Obama’s meagre voting record – of his three years in the Senate, more than one has been spent campaigning for president. His platform too, gives little indication of his attitudes to accounting issues, or indeed to wider corporate governance, less some populist efforts to curb CEO pay.

The difficulty inherent in predicting an Obama administration’s behaviour can be illustrated by taking the example of US GAAP convergence with International Financial Reporting Standards (IFRS). Senator Obama has appointed Paul Volcker, former Federal Reserve chairman as one of his top economic advisers, and it is expected that he will play a role in any administration.

Volcker is a man who has unequivocally expressed an ‘interest in encouraging international convergence to a single set of global accounting standards’. One would imagine that this would be a clear indication that convergence, or outright adoption of IFRS, would continue unimpeded under president Obama.

Other indicators, however, point elsewhere. Most expect Obama to make good on promises to move toward a more protectionist position, rejecting what could be seen as international interference. This, allied to the dangers of IFRS being seen as de-regulatory, could slow the process.

Some dismiss charges of a protectionist mindset in the Obama camp, and it is true that some of the more strident ‘USA first’ language has been toned down since the need to appeal to the democratic base in the primaries ended. The broader point remains, however. The potential for a democratic controlled congress pressuring a democratic president to dispense with free-trade orthodoxy has implications for the profession that go further than IFRS, extending to the US-UK tax treaty, the debate surrounding auditor consolidation, and, indeed, on efforts to manage the extra-territoriality ramifications of Sarbanes Oxley.

For accountants seeking a ray of sunshine in all this, it is possible that a democratic administration may shy away from the prevailing republican notion that the Wall Street meltdown would not have been nearly so bad were it not for the influence of mark-to-market accounting.

Unfortunately, even that possibility is likely to fall foul of the likelihood that president Obama and his top-dollar advisers will find their room to manoeuvre significantly limited by the reality of economic circumstance.
By Simon Keymer at Accountancy Age

CFOs: Get Rid of Mark to Market

Fair share of CFOs want end to fair-value accounting, short-selling

CFOs are not only bracing for more regulation, they apparently welcome it.

According to the most recent survey of chief financial officers conducted by Financial Executives International, an overwhelming 80% of finance chiefs felt increased regulation and oversight are needed in the financial sector to correct the current market crisis.

Not surprisingly, over a third of the CFOs surveyed want permanent restrictions placed on short-selling of all companies. Respondents also cried out for increased regulation of hedge funds and credit default swaps, as well as a reinstitution of mortgage lending standards.

What’s more, a fair percentage of finance chiefs (46%) want regulators or standards-setters to ditch mark-to-market accounting (except for publicly traded companies with no liquidity issues)

The survey also revealed that liquidity concerns still dog finance departments. Close to 70% of the nearly 300 CFOs interviewed said they anticipate access to credit will continue to tighten over the next six months. Those finance chiefs said the lack of credit will cause them to take precautionary measures and make cutbacks.

Overall, the mood of finance chiefs continues to get gloomier. FEI’s CFO optimism index on the U.S. economy fell more than seven percentage points, its largest quarterly decline since the survey began.

“Our survey shows a continued, increasing loss of confidence by these CFOs, and for the first time in several years, they are actually reporting year-over-year reductions in capital investments, technology spending and hiring,” said John Elliott, dean of the Zicklin School of Business at Baruch College, which produces the survey with FEI. Although allocations to those areas had been trending downward, “[CFOs] had continued to report planned increases in these categories through the first half of 2008,” he said.

Looking ahead, most CFOs predicted the Fed funds rate will rise to 1.62% by April 2009 and move up to 2% by next October. The Fed funds rate stood at 2% when the survey was conducted, but the Fed has since cut it to 1%.

When asked to predict the Libor/Treasury spread a year from now, 58% said that it would narrow.

“On average, CFOs responses to the third-quarter survey agreed with many of the recent economic actions taken by the government,” said Cheryl de Mesa Graziano, vice president of research and operations at FEI.
By Matthew Scott at Financial Week

Spreadsheet Mania and Mark to Market

Can Companies Excel at Fair Value?
Finance departments are using spreadsheets to tackle FAS 157, an approach few regard as optimum.
When FAS 157 took effect last November, many finance departments and business units faced a new accounting requirement but lacked any new technology with which to address it. To determine the fair value of a wide range of balance-sheet items, they turned to that old standby, the spreadsheet, to piece together models that they hoped would make sense to shareholders and auditors.

A year later, not much has changed. Spreadsheets are often still the starting point when trying to figure out what a portfolio of credit default swaps or a series of collateralized debt obligations would fetch on the market. That's a worrisome thought for auditors and CFOs — especially because many users construct spreadsheets so poorly that the results may be impossible to verify.

FAS 157 builds on an older rule, FAS 133, which forced companies to divulge the fair value of derivative instruments. But FAS 157 goes a major step further, telling companies how to value the assets and liabilities on their balance sheets that they mark to market. It has affected financial companies in a big way. "If the subprime crisis hadn't happened, FAS 157 would have been a 'Who cares?' kind of thing," says Jiro Okochi, CEO of Reval, a New York–based vendor that recently added a 157 module to its software for managing derivatives. "Auditors wouldn't have paid much attention."

They do now. But while FAS 157 introduced a much stronger emphasis on the methodology behind fair-value calculations, that has not inspired software that can automate that process. "I haven't seen a single solution in the marketplace that would address all the issues," says Peter Marshall, a principal in Ernst & Young's treasury advisory practice. "People are using existing systems and doing manual workarounds."

Information Vs. Data
Most people, anyway. Wesley Walton, vice president of finance at CBC Federal Credit Union, has managed to tap newer technology, in this case an analytics function contained in software from Brick & Associates that allows Walton to perform fair-value calculations. But a credit union with just $300 million in assets and one primary software vendor has an easier time of it than larger companies.

Indeed, big companies face the irony of having too much software. A large bank will typically use different applications to handle accounting for bond transfers, commercial-lending decisions, and foreign-exchange transactions, to cite just three of many activities potentially affected by FAS 157. Therefore, multiple vendors must modify their systems to handle the dictates of FAS 157.

It also isn't clear that FAS 157 can even be captured in computer code. The rule is partly intended to force companies to articulate how they arrive at valuations for illiquid securities — the so-called Level 2 assets, where there may be some observable inputs in the market; and Level 3 assets, where there is nothing comparable in the market and valuations are determined by models. Explaining valuation methods amounts to disclosure notes in financial statements, a form of information that doesn't fit neatly into the fields of a database.

Still, a database, with its central controls and its knack for forcing information into a consistent format, is ultimately where all valuation information needs to end up, according to those who understand the pressures CFOs face in tracking and accounting for hard-to-value securities. The database can be the same one a company uses for other purposes — an Oracle database with programs written in Java, for example, or a SQL Server database with programs written for Microsoft's .NET framework. "Those are all off-the-shelf," says Duff & Phelps valuation expert Joseph Pimbley. "It's not a case of a specialized firm inventing something new."

Piece by Piece
In theory, the financial assets on a company's balance sheet are ready-made for tabulation, sorting, and what-if analyses — work that software does well. So the earliest attempts to address FAS 157 have come as enhancements to asset/liability management (ALM) systems, the software used at banks and corporate treasuries.

"Many companies came out fairly promptly with a patch or upgrade" addressing FAS 157, says Denise Valentine, an analyst who covers asset-management systems for the Aite Group in Boston. British Columbia–based analytics provider FinCad and Reval are among the software firms that have added FAS 157 functionality to products that are live with clients. Bank of New York offers its clients a FAS 157 reporting package as part of its Workbench online portal of software tools.

The difficulty of addressing FAS 157 comprehensively hasn't stopped software companies from tackling individual pieces. Reval was among the first to make it easy to see which financial instruments have moved from Level 3 to Level 2. That's useful, because those assets could get a company, and its auditor, into trouble if their value later evaporated and the company had to justify their recategorization.

SAP is trying to sell banks on the idea of using its accounting for financial instruments (AFI) product to comply with fair-value requirements. Introduced three years ago for European banks, AFI functions as a financial-products subledger layer between the general-ledger and operational systems, taking data from such systems and putting it into a format that lets users value most financial instruments, while allowing some work to be done in decentralized systems.

Using AFI "doesn't have to be a big-bang major paradigm shift," says Mike Russo, a former bank CFO and regulator who is now an industry principal in SAP's financial-services group. "It basically allows you to have a single point of control."

And a single point of control is vital, says Duff & Phelps's Pimbley, especially in an era when CFOs have to aggregate the fair values of many different things and, per the demands of Sarbanes-Oxley, attest to their accuracy. This is one reason that although Pimbley endorses the use of spreadsheets for initial model development in pricing hard-to-value securities, he shudders at the idea of spreadsheets as the sole fair-value calculator.

And yet, he says, with "no game-changer out there," companies will continue to rely on spreadsheets for this delicate work. Let's hope proper controls become part of the equation.
Robert Hertzberg at CFO.com

Time to Put the Brakes on the International Accounting Convergence Movement?

Jack Ciesielski is publisher of the Analyst’s Accounting Observer. His material is always worth reading and the following is an article he wrote for the Financial Times

It’s time to put the brakes on convergence
Just two months ago, there was a growing certainty that the US was on the path to adopting international accounting rules and dropping US GAAP. A roadmap for how this would happen was promised.

Now, it looks less likely – and that’s good. The events of October contain many lessons, and one of them is that it’s time to put the brakes on the international accounting convergence movement.

Accounting got caught up in the crisis as a result of fair value rules, where assets are marked to their current market price. Banks around the world have been loath to take responsibility for their own abdication of reasonable lending standards. Instead, they found the perfect villain in fair value reporting – something upon which they could blame all the pain of the credit crisis, and expect little resistance. Accountants rarely marshal much public support. Positioning accounting as a source of pain for Everyman could only help the bankers’ cause.

Politicians listened – this “solution” costs nothing, after all – and some have echoed the bankers’ refrain.

Now the SEC is holding two roundtables to debate the effects and usefulness of fair value accounting. But the International Accounting Standards Board has gone one better and hastily changed its fair value rules, and this is where the push to converge accounting rules falls down.

Uniting all countries under a single set of global accounting rules has long been the goal of the IASB, which sets the rules for 100-plus countries. US GAAP is now the only other significant set of rules.

But the IASB has now shown it is not ready to be the premier accounting standard setter in the world.

The IASB amended its rules slightly to align them with US practice by allowing an exception to fair value reporting. It did so because of political pressure. The threat it faced was that if it had not, the European Union, which follows the IASB’s rules, would have acted itself. This would have likely resulted in worse accounting rules and would almost certainly have finished the IASB’s dream of the US switching to IFRS, since the US has made it clear it will not tolerate other countries carving out chunks of the rules where they choose.

But I believe the IASB has ended that dream of US convergence itself by bowing to political pressure. The amendment was done without due process: no comments or discussion were sought from investors. Incredibly, that suspension of due process bore the blessing of the trustees who oversee the IASB.

Seeking convergence on a tiny part of the rules in this regard may seem trivial, but it is a giant step backwards. It shows that when the going got tough, the IASB waived the interests of those – the users of accounts – whom it’s supposed to serve.

Instead of converging to what is best in US standards, the IASB is adopting some of the worst features. The IASB is defining convergence downward: it is adopting an exception built into the US standard, something for which the US system is often criticised – and it is an exception bound to lead to less transparent reporting to investors. This is not what convergence is supposed to bring about.

It was the Securities and Exchange Commission that promised the roadmap on convergence. Two months later, we still have not seen it.

If it does appear, US investors should still be wary.

Instead of a rush-job convergence during the worst financial crisis since the Depression, maybe what is needed is a few more years of friendly competition between standard-setters.

The US should renew its reconciliation requirement for the registrants using IFRS, so that convergence efforts can be effectively monitored. When those reconciliations show that accounting standards are producing truly similar results consistently, then the real roadmap to convergence should be styled – one that includes protection from political pressure and the effective worldwide enforcement of accounting standards.
Jack Ciesielski is publisher of the Analyst’s Accounting Observer. This article is from the Financial Times

IASB Follows FASB; Releases Educational Material on Mark to Market: Comment

The IASB released its educational material on the application of fair value on Friday. Similar to the FASB’s release, they do not advocate a change in existing mark to market rules. Rather, they provide guidance and examples on application of existing rules. You can read the IASB's guidance here. The following article compares talks about the implications of this on the future of fair value accounting.

Undaunted: Global Fair-Value Guidance Evolves
In the face of harsh critics, the IASB releases a how-to document on fair-value accounting that tackles some thorny issues.

No accounting rules were changed, and the guidance to clarify the rules stayed the same as well — except perhaps for the addition of some new examples. Yet in some ways, the 84-page document released today by the International Accounting Standards Board speaks volumes about the future direction of fair-value accounting.

Undeterred by charges that fair-value accounting is the demon at the heart of the credit crisis, the IASB pulled together all its recent guidance on the subject into one document to answer the question of how to account for financial instruments in illiquid markets using the so-called mark-to-market methodology. The new document does not change any of the IASB's existing fair-value rules, or its proposed amendments to IFRS 7 — the fair-value disclosure rule due out in 2009. Rather, it reiterates all the principles in IAS 39, the IASB's fair-value measurement rule, and then addresses thorny practice issues, such as using transaction prices, management's estimates, and pricing service data as inputs to recalculate fair value.

The principles outlined in the guidance formalize many of the recent pronouncements made by the IASB on fair-value accounting and released piecemeal over the past few weeks. Overall, the IASB guidance is consistent with a body of guidance released by the U.S. Financial Accounting Standards Board on October 10. The U.S. guidance also provided illustrative examples, something both boards said constituents were clamoring for.

To arrive at this point, both the IASB and FASB sidestepped usual vetting periods to rush out recent fair-value guidance in response to the worsening credit crisis. Indeed, on October 9 the IASB got the go-ahead from its trustees to "accelerate" its response to the crisis, which included embracing a new clarification of FAS 157, the U.S. fair-value measurement standard.

A week earlier, FASB had reduced its public comment period for the FAS 157 guidance to just seven days, hoping to quell the controversial issue of how to measure the value of a financial asset under the rule when no market exists for the asset. FASB usually allows between one and four months — and sometimes more — to collect and digest public opinions about new guidance. But bankers, who are one of the most outspoken critics of fair-value accounting because the methodology forces their companies to write down assets to current value, needed a quick response.

For its part, the IASB's new package of information discusses all the key controversies, covering, among other topics, characteristics of an inactive market — which include a significant decline in volume and level of trading activity or significant price variations among market participants. The IASB also underscores the relevance of judgment in uncertain markets, but it makes clear that all judgment calls have to be weighed with other risk factors. Indeed, the document states that "regardless of the valuation technique used, an entity must include appropriate risk adjustments that market participants would make, such as for credit and liquidity."

Likewise, judgment must be used to determine whether a transaction is "forced," which could mean a deal is settled at a fire-sale price, and therefore the value may have to be adjusted upward. The guidance also devotes 13 pages to evaluating available market information, including transaction prices, indices, and changes in the company's own credit.

The guidance was prepared by an IASB expert advisory panel, which was set up in May 2008. The panel was put together in response to a recommendation by the Financial Stability Forum to enhance guidance of valuing financial instruments in illiquid markets, and to strengthen related valuation disclosures. The Forum comprises 26 finance and economic organizations from around the world, including central banks and national treasury departments.

Together, the IASB and FASB will move beyond the Forum's advisory group by creating a new group of advisers to deal with financial-reporting issues that emerge from the credit crunch. The boards are currently working to identify external chairs and members of the group and expect to hold three roundtables, one each in Asia, Europe, and North America.
Marie Leone at CFO.com

Fair Value, Mark to Market Not Going Anywhere Soon

Fair-value Accounting: Here to stay
While changes are needed, a proponent concedes, mark-to-market accounting does a fair job of assessing a company's financial health.
Fair value accounting is still fair game for attack, but there may be more common ground than imagined between critics and proponents of the rules governing how financial firms value the securities they hold.

The Securities and Exchange Commission at a Wednesday roundtable heard comments on fair value, or mark-to-market bookkeeping, which requires firms to value securities in their portfolio at, well, market prices.
Such accounting arcana has turned into a political football in recent months as firms were forced to write down the value of debt for which few buyers existed - like mortgage-backed securities in a deflating real estate bubble. SEC chief Christopher Cox said Wednesday that the fair-value standards need "further work." He wasn't alone. Though fans maintain the fair-value approach results in greater transparency for investors, critics such as former Federal Deposit Insurance Corp. chief William Isaac argue that it does no such thing.

Worse, they say, it's intensifying the financial-sector meltdown by forcing banks to write down the value of debt securities even if the loan payment streams behind them are flowing satisfactorily. "Mark-to-market accounting has been extremely and needlessly destructive of bank capital in the past year, and is a major cause of the current credit crisis and economic downturn," Isaac said in prepared remarks. "The rules have destroyed hundreds of billions of dollars of capital in our financial system, causing lending capacity to be diminished by ten times that amount." (Banks typically lend out around ten times their capital.)

Caught in the middle is the Financial Accounting Standards Board, the private-sector group that sets U.S. accounting rules along with the SEC.

Not so opposite
Despite the lively debate, one expert says there is more common ground than might be initially apparent - which, in his view, means the mark-to-market rules are likely here to stay. "Those who looked like polar opposites were actually much closer than they appeared," says David Larsen, a managing director at financial advisory firm Duff & Phelps and a member of the FASB committee that advises the board on fair-value accounting issues. "The task now is to harmonize the conflicting views."

Isaac's broadsides aside, Larsen says he believes many comments made at Wednesday's meeting show that critics of the mark-to-market regime often misunderstand the current rules and how they should be applied. Proponents and critics of the rules, he says, often agree on some principles but don't know it because they're "speaking different languages."

That observation, he says, gives the FASB and the SEC latitude to possibly issue further guidance and make minor changes to the rules, without throwing them out - a move that he said would reduce whatever insight investors have into often opaque financial firms.

One aspect of the fair-value approach that may need adjusting, Larsen says, revolves around how to hold accountants, auditors and financial executives accountable for the judgments they make in assessing the value of an infrequently traded security. He says that one common misperception centers on what happens when a recent trade has been at a fire-sale price. He takes the example of Merrill Lynch's (MER, Fortune 500) agreement in July to sell a $30.6 billion portfolio of troubled debt to Lone Star funds for 22 cents on the dollar.

Fair value rules don't force holders of similar securities to use 22 cents as their mark, Larsen says. But he says some comments made by opponents of the fair value rules suggest they believe otherwise - and he fears that accountants and auditors who recall Arthur Andersen's prosecution for its mishandling of Enron's books may see things the same way.

"We have people who are doing the right thing who are just afraid of making a mistake," said Larsen. He says one thing regulators might consider is some sort of safe harbor that would permit accountants to make difficult securities-valuation judgments without the risk of jail time. Those aren't the only changes that may come to the fair-value regime. The FASB is working on adding disclosure requirements, Financial Week reported, that would help investors and analysts more fully understand the types of assumptions firms made in valuing infrequently-traded securities.

Wednesday's roundtable came about as a result of the passage earlier this month of the Emergency Economic Stabilization Act, which directed the SEC to study the economic impact of fair-value accounting. The agency is due to hold another roundtable next month and to report back to Congress by Jan. 2. Larsen, for one, believes the fair value rules are here to stay, even if their form is apt to change at the margins. "My sense is that investors want and need transparency," he said. "That's out of Aladdin's lamp, and you can't push it back in."
By Colin Barr, Fortune

SEC: Back to the Drawing Board on Fair Value, Mark to Market

SEC's Cox Says Fair-Value Rule Needs `Further Work'

U.S. Securities and Exchange Commission Chairman Christopher Cox said an accounting rule blamed for pushing American International Group Inc. and other firms to the brink of collapse needs ``further work.''

``Illiquid markets are bringing new challenges to the measurement of fair value,'' Cox said today during an accounting conference at the SEC's Washington headquarters. ``These challenges have brought into focus the need for further work on improving the tools that companies have at their disposal to achieve transparent'' financial reporting, he said.

Cox's comments may provide an opening for business groups that want regulators to give financial companies more flexibility in valuing assets after more than $684 billion in losses since the start of 2007. Fair-value accounting forces firms to mark down holdings to current trading prices every quarter, which companies say makes no sense when markets are frozen.

Fair-value has been ``extremely and needlessly destructive of bank capital in the past year and is a major cause of the current credit crisis,'' said William Isaac, a former chairman of the Federal Deposit Insurance Corp. ``Assets should not be marked to unrealistic fire-sale prices,'' he said.

The rules on fair-value accounting instruct companies to measure assets and liabilities assuming ``an orderly transaction between market participants.'' A forced or distress sale isn't an orderly transaction, the rules say.

Cox didn't endorse a suspension of fair-value accounting, a move that Isaac and some members of Congress have advocated.

`Independent and Deliberative'
The SEC chairman also said the Financial Accounting Standards Board should be free from outside pressure, and should consider changes to the rule in an ``independent and deliberative manner.'' The SEC oversees Norwalk, Connecticut-based FASB, which writes U.S. accounting standards.

The American Bankers Association and the U.S. Chamber of Commerce have urged Cox to override FASB, which they say has been too rigid in interpreting accounting requirements.

The SEC is required to examine fair-value accounting under terms included in the $700 billion federal financial-rescue package enacted this month. The agency must submit a written report to Congress by Jan. 2 that evaluates how the rule can be improved and whether it has caused banks to fail.

Former executives of AIG, the insurer saved from collapse by an $85 billion Federal Reserve loan last month, told lawmakers the requirement forced the company to book unrealized losses on distressed mortgage-backed securities and credit-default swaps.

`Historic Cost'
Placing a moratorium on the fair-value rule would be a mistake, said Raymond Ball, a University of Chicago accounting professor. He cited Japan, which in the 1990s let its banks hide losses by holding assets at ``historic cost'' instead of current trading prices.

``Investors in the capital markets didn't know which were the strong banks and which were the weak banks,'' Ball said at the SEC conference. ``That inhibited the recovery of the economy.''

The accounting industry has defended the fair-value requirement, arguing in letters to the SEC and lawmakers that it gives investors transparency about the health of companies.

Isaac said accountants, who must sign off on companies' financial statements, are worried about getting sued if their clients go bankrupt. He said Congress should consider giving auditors protections from lawsuits when they base fair-value assessments on ``reasonable business judgment.''

``One important consequence of subjecting accountants to enormous potential liabilities is that the profession reacted by moving toward very rigid rules that leave little room for judgment,'' Isaac said.
By Jesse Westbrook and Ian Katz at Bloomberg

SEC Roundtable: Accountants Battle it Out

SEC Gets Conflicting Advice On Mark-to-Market Accounting

U.S. securities regulators received conflicting advice Wednesday on whether to dispense with mark-to-market accounting rules that critics say are deepening the nation's economic woes.

The issue was debated at a public forum at the Securities and Exchange Commission, which is under pressure to suspend or repeal mark-to-market accounting for certain financial instruments. Congress ordered the SEC to examine the matter and provide a written report by Jan. 2. SEC Chairman Christopher Cox said regulators will hold a second public session on the topic on Nov. 21, and seek written input from the public through Nov. 13.

Supporters and opponents of fair-value, or mark-to-market, accounting clashed at Wednesday's session on whether the approach is helping or harming investors.

Former Federal Deposit Insurance Corp. Chairman William Isaac called for fair- value accounting to be suspended or repealed immediately, saying it is " transparently wrong" and "senselessly destructive" to force companies to slash the values of loans and other financial assets to unrealistically low levels.

Yet changing the rules on fair-value accounting could increase uncertainty among investors and make markets more anxious rather than less, countered University of Chicago accounting professor Ray Ball.

"I think it would be a terrible shame if we shot the messenger and ignored the message," said Ball.

PricewaterhouseCoopers LLP partner Vincent Colman defended the current rules and said the Norwalk, Ct.-based Financial Accounting Standards Board should be kept "free from political pressures" and undue outside influence.

Although the SEC oversees the FASB, it rarely overrules it. Isaac recommended more direct oversight, requiring U.S. accounting rules to be approved by the Federal Reserve and the Federal Deposit Insurance Corp. He endorsed a return to historical accounting, which values assets and liabilities at their original cost, terming that vastly superior to the more volatile mark-to-market approach.

Mark-to-market accounting rules require companies to adjust valuations of certain assets and liabilities they intend to trade or sell to reflect current market prices. Critics say it makes earnings too volatile and intensifies market downturns. Even supporters of the approach concede that it is much harder to apply when markets aren't functioning normally, requiring companies to estimate values using computer models, or look to distressed "fire-sale" transactions.

While it's "deeply deluded" to think some battered assets will recover anytime soon, efforts to value something that isn't trading could produce "mark to mush, " worried AFL-CIO associate general counsel Damon Silvers.

"There is a real risk that things here are not what they seem to be," said Silvers.

Mark-to-market accounting rules also are crimping mergers because companies have to adjust valuations of assets they acquire even if they don't intend to sell them, a nasty side-effect that only makes bad markets worse, warned Aubrey Patterson, chairman and chief executive of BancorpSouth Inc. (BXS), based in Tupelo, Miss.

Cleveland-based KeyCorp (KEY) abandoned some acquisitions for that reason, according to accounting policy director Chuck Maimbour. He said the bank "just couldn't make it work" and walked away from deals due to the potential hit from mark-to-market accounting rules.

PwC's Colman suggested that the current fair-value accounting rule could be tweaked to distinguish between actual credit losses and other factors, such as declines in value due to illiquid markets. The idea drew a mixed response, with some questioning whether companies could make such calls easily, or if that would make it even harder to determine the fair value of an illiquid asset.

Cindy Ma, a managing director and valuation expert with Houlihan Lokey Howard & Zukin, said she would be afraid to use that approach, fearing it would rely heavily on computer models that "can be manipulated," and create a "nightmare" for auditors who have to sign off on a company's financial reports.

Swiss Reinsurance Co. (SWCEY) Managing Director and Chief Claims Strategist Richard Murray, who chairs the U.S. Chamber of Commerce Center for Capital Markets Competitiveness, said there is no easy way to value a company, with or without mark-to-market accounting rules. He stressed the need for companies and auditors to bring judgment to bear and asked regulators to consider offering a "safe harbor" from legal liability for honest valuation mistakes.
By Judith Burns, Dow Jones Newswires

SEC Roundtable on Mark to Market Today

The SEC is having its Roundtable on mark to market accounting today.

The agenda is here.

You can listen here.

Don’t Blame Accounting

Will 'mark to market' accounting take the fall for the Wall Street mess?
Mark to market is a business rarity - an accounting term that draws reactions from people who don't know spreadsheets from bedsheets. Mark to market, which we'll call MTM, evokes images of Enron's made-up profits and the other corporate scandals that marred the first years of this decade. Not pretty.

Now MTM - which means valuing marketable securities at market prices - is a hot item again, but for the opposite reason. This time financial companies and their allies are claiming it's too strict. They argue that marking the value of complex, illiquid securities to artificially low market prices has unnecessarily crippled the U.S. and world financial systems by creating billions of illusory losses on perfectly fine (albeit illiquid) securities, such as collateralized debt obligations linked to mortgages. Markets for these things, the argument goes, are depressed way below true economic value.

Accountants argue that MTM - known formally as Financial Accounting Standard 157 - is fine, although the Financial Accounting Standards Board has agreed to tweak it some. (Don't ask me for details - the written arguments on this are so sleep-inducing they could be marketed as an Ambien alternative.)

This week, the Securities and Exchange Commission is scheduled to hold a high-profile public meeting about MTM. The SEC, which has the power to overrule FASB, is holding the meeting because Section 133 of the $700 billion bailout bill requires that it study MTM and report to Congress by late December.

The guy who got 133 into the bill, Representative Spencer Bachus (R-Alabama), the ranking minority member of the House Banking Committee, told me he wasn't trying to politicize accounting. "It just says, 'Study it,'" he told me. "It doesn't say [to do] a study to repeal it. It doesn't say [to do] a study to suspend it."

But given that it's finger-pointing time both in Washington and on Wall Street, it's not going to be easy for the SEC to leave mark to market strictly alone. In this environment what regulator dares run the risk of being held responsible for not doing something that would supposedly mitigate the world's credit crunch? Would you want to find yourself accused of failing to act if the financial world totally melted down, as it has occasionally seemed about to do?

Normal accounting is being overridden to help banks in various ways. In early October, for instance, federal financial regulators jointly ruled that the $125 billion of preferred stock the Treasury is buying from nine big banks will be treated as tier-one capital (the best kind), even though it normally wouldn't qualify.

Second, in a little-noted move, regulators allowed banks with losses on some Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) securities to treat the resulting tax savings as tier one in their regulatory statements for the third quarter. That's strange, given that the fourth quarter ended Sept. 30, as usual, but legislation making this tax break usable didn't become law until Oct. 3. How often has my source for this nugget - accounting guru Robert Willens of Robert Willens LLC - seen such grandfathering in his 40-year career? "Never," he says.

Of course, this is more about optics than economics. As is mark to market, in my humble opinion. Credit markets have been frozen much of the past 15 months largely because banks haven't trusted the balance sheets of other banks and have thus been afraid to lend to them. I can't imagine that confidence problem being resolved by changing MTM.

There are problems with MTM: It's relatively new, and parts of it seem arbitrary. But its problems have been exaggerated. It's easier to blame accountants for your problems than to admit you made your institution vulnerable by overleveraging its balance sheet and buying securities you didn't understand. Ironically, many of today's whiners adopted MTM a year before they had to, partly because of an arcane provision that let them count as profit the decline in the market value of their publicly traded debt.

The bottom line: Despite MTM's flaws, blaming it for the world's financial problems isn't the answer. Neither is shooting the messenger - or, in this case, the accountant.
By Allan Sloan, senior editor at large, Fortune Magazine

EU: Hands off Fair Value Accounting

Brussels defuses threat of 'fair value' demands
Changes to controversial fair value accounting rules will be left to the accounting rulemakers, European officials said yesterday after a meeting that defused the threat of political intervention. Mounting pressure to ease fair value, which requires companies to mark most of their financial holdings at their current market value, had led to suggestions the European Commission could "carve out" sections of the current rules or even form its own rulemaker.

European Union accounting is set by the International Accounting Standards Board, whose rules are followed, or are being adopted, by more than 100 countries. Yesterday the Brussels meeting, comprised of Commission officials, regulators, banking and insurance representatives, investors and accountants, drew up a modest list of issues that it would like the IASB to consider but stopped well short of the high pressure for immediate action that some had expected.

"Everyone stressed the importance of a solution at a global level," said one par-ticipant afterwards.
Others agreed the meeting had in effect buried any suggestion of a European "carve-out" of the IASB's rules or the creation of a new regional standard-setter - fears that had surfaced publicly beforehand. "There was a very positive outcome, with unanimous support for working within the IASB framework and in line with proper due process," said a spokesman for Charlie McCreevy, EU internal market commissioner.

Last week the IASB eased its fair value rules to align them with US generally accepted accounting principles (GAAP) following pressure from Brussels and a number of banks and insurers. The market seizures of the past year have forced financial institutions to write down billions in the value of their assets, hitting profits and undermining their capital reserves.

The commission will still pursue with the IASB further changes to the rules. Areas likely to be considered include allowing financial institutions to reclassify assets containing embedded derivatives from being marked at fair value to "amortised cost", which would ignore further violent market swings and smooth out their impact on reported profits and capital reserves.

However, this will be done through the IASB's regular processes and not be sought on an emergency basis as were last week's changes, which come into effect for third-quarter accounts that close at the end of this month. Any new changes could instead be brought in for year-end, but not sooner. Earlier this week the IASB and its US counterpart, the Financial Accounting Standards Board, agreed to set up a joint global advisory group to examine accounting issues thrown up by the credit crunch and was expected soon to announce high-profile appointees.
By Jennifer Hughes Nikki Tait of the Financial Times

Don't Change Mark to Market

Accounting rule changes could dent confidence, say analysts
Hasty revisions to controversial accounting rules on how to value assets risk undermining investor confidence in company accounts, a group of senior investors and analysts has warned.

Members of the Corporate Reporting Users Forum, a pan-European group of investors and analysts, urge the European Commission not to make further amendments to accounting rules.

The Commission is hosting a meeting today involving regulators, banking and insurance representatives, investors and accountants to discuss further changes to the rules.

The resulting "wish list" will then be presented to the International Accounting Standards Board, which sets accounting rules for more than 100 countries, including those in the European Union. The so-called fair value accounting rules require companies to mark most financial instruments at their market value.

In the present illiquid markets, values have plunged, forcing banks and insurers into a series of enormous write-downs that have savaged their capital reserves.

The IASB has eased its rules to align them with US practice but many banks and insurers believe the standards misrepresent their true financial health and have called for immediate changes.

In a letter to the Financial Times, the CRUF pledges to oppose any steps by the Commission that could lead to a European "carve out" of the IASB's rules or potentially lead to the creation of a new regional standard setter. "Now especially, investors need comparability and transparency, not further uncertainty and inconsistency," the group said.

Although the final "wish list" is not yet known, today's discussions will cover calls for further easing of fair value rules in illiquid markets and for more instruments to be accounted for not at fair value but at "amortized cost" - a practice that would smooth their impact on institutions' balance sheets.

The list could, however, pose a threat to the IASB, which is likely to have previously dismissed many of the requests and could struggle to revisit them without damaging its credibility.

Other countries that have adopted, or are adopting, the IASB's rules include China, Hong Kong, South Africa, Australia and Canada. Many have warned the IASB about the dangers of being seen to be led by one interested bloc.

If the IASB finds it cannot accede to the requests, there have been some private suggestions that Europe would do better with its own accounting rulemaker - a move that would be a death blow to the long-running and almost successful effort to converge all accounting into a single global set of rules.
By Jennifer Hughes in London and Nikki Tait in Brussels for the Financial Times

Blaming the Bean-Counters
Accounting rules did not cause the financial crisis; changing them won't end it.

Inevitably, perhaps, the deepening financial crisis has spawned a search for scapegoats and quick fixes. According to many Republican members of Congress, banking industry lobbyists and financial pundits, the Wall Street meltdown would not be nearly as bad as it is but for the baleful impact of "mark-to-market" accounting rules. These are national standards, adopted in the wake of the savings and loan debacle of the 1980s, that require banks to carry certain financial assets on their books at the current market price. The idea is to give investors the latest and most objective estimate of a company's true financial condition -- as opposed to a company's inevitably self-serving calculation based on original costs.

Now that the markets for mortgage-backed securities and derivatives have seized up, however, their market price is either distressingly close to zero or impossible to determine. Critics argue that marking-to-market when there is no market artificially and irrationally depresses banks' balance sheets, since the assets would fetch near face-value under normal circumstances. Ergo, they contend, the way to shore up bank capital is to relax or eliminate mark-to-market -- and it wouldn't cost taxpayers a dime.

The critics have a point. Undoubtedly the markets, out of irrational fear, are shunning some relatively solid assets as well as actual turkeys. Mark-to-market therefore does force banks to write their books in the panicky language of today's meltdown. Perhaps, once the crisis is over, it would be wise for the Securities and Exchange Commission and the accounting authorities to revisit this "pro-cyclical" aspect of the rule. The recent bailout legislation included a provision requiring the SEC to study mark-to-market's impact. We see no harm in that.

But the critics' arguments against mark-to-market may prove too much. If the rule requires banks to accentuate the negative during bust times, then presumably it is also to blame for all those wonderful financial statements the banks were issuing during the boom. We don't recall anyone demanding its suspension then. Actually, complaints about the rule probably overstate its impact, since financial institutions only have to use it for securities they intend to trade. Loans and securities held to maturity are not covered by mark-to-market; at big banks such as SunTrust, Wells Fargo and Bank of America, such long-term assets represent half or more of all assets.

Markets not only need transparent financial reporting, they need consistent financial reporting. To suspend or abandon mark-to-market now, in the middle of a panic, would simply deepen the confusion and suspicion that are already crippling the financial system. No, today's financial meltdown is not some accidental byproduct of misguided technical rules. It happened because too many firms made too many bad financial bets with borrowed money. Pretending otherwise won't solve anything.
Washington Post Editorial

European Accountants: Don’t Change Fair Value Rules

Hasty revisions to controversial accounting rules on how to value assets threaten to undermine investor confidence in company accounts, a group of senior investors and analysts has warned. Members of the Corporate Reporting Users Forum, a pan-European group of investors and analysts, urge the European Commission not to make more amendments to accounting rules.

The Commission is hosting a meeting on Tuesday involving regulators, banking and insurance representatives, investors and accountants to discuss changes to the rules. The resulting “wishlist” will then be presented to the International Accounting Standards Board, which sets accounting rules for more than 100 countries, including the European Union.

The so-called fair value accounting rules require companies to mark most financial instruments at their market value. In the present illiquid markets, values have plunged, forcing banks and insurers into enormous writedowns that have savaged their capital reserves.

The IASB has eased its rules to align them with US practice but many banks and insurers believe the standards misrepresent their true financial health and have called for immediate changes.

In a letter to the Financial Times, the CRUF pledges to oppose any steps by the Commission that could lead to a European “carve out” of the IASB’s rules or potentially lead to the creation of a new regional standard setter. “Now especially, investors need comparability and transparency, not further uncertainty and inconsistency,” the group said.

Although the final “wishlist” is not yet known, today’s discussions will cover calls for easing of fair value rules in illiquid markets and for more instruments to be accounted for not at fair value but at “amortised cost” – a practice that would smooth their effect on institutions’ balance sheets.

The list could, however, pose a threat to the IASB, which is likely to have previously dismissed many of the requests and could struggle to revisit them without damaging its credibility. Other countries that have adopted, or are adopting, the IASB’s rules include China, Hong Kong, South Africa, Australia and Canada.
By Jennifer Hughes in London and Nikki Tait in Brussels for The Financial Times

PricewaterhouseCoopers' Survey: Bank, other Financial Services Board Members Say Mark to Market is Not to Blame for Crisis

Pricewaterhouse Coopers recently completed a survey of 300 board members, two-thirds of whom sit on the audit committee of financial institutions, taken between September 22nd and October 4th at the 2008 PricewaterhouseCoopers Financial Services Audit Committee Forum.

Respondents were surveyed about mark to market accounting: Nearly two-thirds (65%) of financial services board members surveyed agree that mark-to-market accounting, also known as fair valuation, creates volatility in the markets. However, 83 percent disagreed with the statement that mark-to-market accounting is to blame for the current credit crisis.

About the current financial crisis:

• 30 % view the situation as a reminder of the need for more disciplined risk taking during periods of growth
• 20 % say it is a reflection of too much focus on the short-term (investing, reporting, compensation).
• 13% found the positive in the tumultuous economic climate and regard the situation as an opportunity that will eventually strengthen the financial services industry.
• 25%sees this as an example of the urgent need for modernization of the financial services regulatory framework to reflect today's global, integrated capital markets system.

Other findings:

• 96 percent of board members said they think that financial institutions that retain risks to off-balance sheet entities should in the future publicly disclose aggregate information on a regular and timely basis, including the quantity and sensitivity to credit, market and liquidity risks and any changes to those risk exposures over time.
• 65 percent of respondents feel that corporate boards lack the tools and transparency to properly assess risks and exposure.
• 88 percent said the scope of risk management for financial institutions does not adequately account for their exposure to off-balance sheet entities.
• 80% feel they could do more to reduce the chance of future industry instability, according to findings of a survey released today by PricewaterhouseCoopers' Financial Services Industry Group. However, the survey also revealed a desire for greater transparency to accurately measure exposure to risk.
• More than 95 percent of the board members asked said they believe greater clarity is required as it relates to what is and what is not reported on an organization's balance sheet
• 77 percent said existing valuation tools are not robust enough.
  

When asked to rank their four top priorities over the next twelve months, audit committee board members ranked them as follows (in order of importance):

• Transparency and financial reporting
• Internal controls and tightened margin/collateral controls
• Enterprise-wide risk management and buy-in from business lines
• Systematic risk management across the industry

Japan Calls for Change to Mark-to-Market Rules

Japanese Finance Minister Shoichi Nakagawa said on Friday he wants an emergency adjustment in mark-to-market accounting rules to avoid systemic risks emerging in the financial system. He said he had asked a body that sets accounting rules for Japanese companies to make a decision quickly on such a change.

'This has been discussed by the United States and Europe amid an emergency situation at previous G7 meetings,' he said. Japan is looking at easing accounting rules that require companies to assess financial holdings at market value, joining other global authorities in a bid to contain the fallout from the credit crisis.

The Accounting Standards Board of Japan said on Thursday it would closely watch changes in global accounting standards and would review Japan rules accordingly. Under mark-to-market or fair-value rules, companies are obliged to regularly adjust the valuation of assets they hold to reflect changes in their actual price on the market.
Yuzo Saeki at Forbes

FASB, IASB Get Together

*******************************************************

U.S., International Boards Abandon Plan to Drop Net Income Item
U.S. and international accounting rulemakers abandoned a proposal to eliminate the reporting of net income on financial statements, saying investors rely on the calculation to assess a company's health.

The International Accounting Standards Board and the U.S. Financial Accounting Standards Board ``have chosen to proceed with proposals that build on established practice,'' IASB Chairman David Tweedie said in a statement today. A staff proposal last year had included an option to replace net income with a line called total comprehensive income.

``Net income is clearly a starting point for many users of financial statements and therefore it was decided to leave it in,'' Mark Byatt, a spokesman for the London-based IASB, said in an e-mail.

The London-based IASB, which sets accounting standards followed in more than 100 countries, and FASB, the U.S. board based in Norwalk, Connecticut, are seeking to make financial statements clear and help investors identify potential risks. The groups today released a 126-page ``discussion paper'' and will seek public comment until April 14.

``This idea of eliminating net income was basically taking away the one key measure of performance that investors hang their hats on,'' Charles Mulford, an accounting professor at the Georgia Institute of Technology in Atlanta, said in an interview. ``You can't just take away net income and expect everyone to grab onto something else right away.''

The joint project on financial reports is part of a broader effort by the IASB and FASB to adopt a single set of standards. The U.S. Securities and Exchange Commission in August approved a ``road map'' that might require some U.S. companies to switch from U.S. accounting standards to international rules by 2014.

Separately, the IASB and FASB today said they will create a ``global advisory group'' of regulators, company executives, auditors and investors to discuss issues related to the current economic crisis. Members of the panel have not been named.
Ian Katz at Bloomberg

IASB and FASB create advisory group to review reporting issues related to credit crisis

The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) today announced that they will create a global advisory group comprising regulators, preparers, auditors, investors and other users of financial statements. The advisory group will help to ensure that reporting issues arising from the global economic crisis are considered in an internationally co-ordinated manner.

At their forthcoming joint meeting on 20 and 21 October, the boards will discuss the initial topics for the advisory group to consider. They will also discuss how they can appoint the group and schedule its first meeting expeditiously. The boards will report on the first meeting and will consider the group’s discussions immediately thereafter. In developing their approaches on issues resulting from the discussions the boards will follow appropriate due process. In the interest of transparency, the advisory group will meet in public session with Webcasting facilities available to all interested parties.

Sir David Tweedie, chairman of the IASB, said: “Recent statements from the G7 and other world leaders highlight the need for an internationally co-ordinated policy response to the credit crisis. The IASB has acted quickly to issue amendments on reclassifications, fair value measurement guidance for illiquid markets, and disclosures. We are pleased that the European Union has acted quickly to accept our amendments on reclassifications. The new advisory group will help the boards to develop rapidly a co-ordinated response to the economic crisis, and will provide additional global perspective to both standard-setting organisations as we address the increasingly complex issues that investors are facing.”

Robert Herz, chairman of the FASB, said: “Ongoing developments in the global financial crisis and actions by governments and regulators are reshaping the financial markets here and around the world. All of this is likely to raise important issues in financial reporting, both here in the US and across the international capital markets. The advisory group that we and the IASB are establishing is aimed at helping both boards identify reporting issues arising from ongoing developments in the global financial markets so that we can develop common solutions that promote sound reporting and enhance transparency.”

Accountants, Auditors Fire Back at Bankers on Fair Value

Don't Suspend Fair Value, Cox Urged
Investors and auditors call on the Securities and Exchange Commission chairman to resist urgings to suspend mark-to-market accounting.
Two days after the president of the American Bankers Association asked Securities and Exchange Commission Chairman Christopher Cox to, in effect, weaken the Financial Accounting Standards Board's fair-value measurement rules, investor and auditor representatives fired off a letter to Cox urging him to let mark-to-market accounting stand as is. Note: You can read the letter here.

The current financial crisis has put the fair-value debate into bas relief: on the one side are the bankers, who contend that the FASB rules, especially FAS 157, have speeded up the downhill slide; on the other are accountants, investors, and others who feel that mark-to-market accounting should be upheld even in illiquid markets as a way of keeping financial reporting transparent.

Today's letter seems to be a direct response to the ABA's letter to Cox [read the ABA press release here]. "We are writing to express grave concern regarding recent calls for the SEC to override guidance issued by the Financial Accounting Standards Board (FASB) and the Commission’s staff that would effectively suspend fair value or mark-to-market accounting," according to today's letter, which was signed by Cindy Fornelli, executive director of the Center for Audit Quality; Jeffrey Diermeier, president and chief executive officer of the CFA Institute; Barbara Roper director of investor protection of the Consumer Federation of America; and Jeff Mahoney, general counsel of the Council of Institutional Investors. "We believe such urgings are decidedly not in the public interest."

In his letter to Cox on Monday, Edward Yingling, the president and chief executive officer of the ABA, Yingling attacked FASB's position that the risk of a lack of liquidity must be included in measuring the cash flow of distressed assets when they're sold. The recently enacted financial rescue law, the Emergency Economic Stabilization Act of 2008, affirms the SEC's power to suspend mark-to-market accounting "for any issuer" and orders the commission to launch a study of whether fair value contributed to the crisis.

To the mark-to-market advocates, however, a "move by the SEC to suspend fair value accounting would be a disservice to the capital markets, would be inconsistent with the views of investors, would harm the credibility and independence of the standards setting process, and would run counter to fundamental notice and comment principles," they wrote. "With third quarter financial statements now in process and year-end 2008 imminent, such a change could jeopardize already-fragile investor confidence."

Along with Sir David Tweedie, chairman of the International Accounting Standards board, and other advocates, they contend that "the current crisis of liquidity, credit, and confidence was not caused by fair value accounting; rather, sound accounting principles helped expose the problem."
David M. Katz, CFO.com

Following two Bloomberg reports refer to the two sides on this debate:

ECB's Noyer Says Accounting Rules May Deepen Market Crisis
European Central Bank governing council member Christian Noyer said asset-valuation rules may be deepening the financial crisis and should be reconsidered.

The mark-to-market rule, also called fair value, requires companies to review holdings each quarter and report losses when the values decline. Noyer said it should be shaped ``so as to set the right incentives throughout the economic cycle.''

``In adverse market conditions, marking to market, together with solvency regulations, may generate a feedback loop from expectations of market-price changes to portfolio and balance sheet adjustments,'' Noyer wrote in the Bank of France's October financial-stability review.

``This may reinforce price volatility and exacerbate financial distress,'' wrote Noyer, who is also the governor of the Bank of France.

Still, the fair-value rules shouldn't be changed in the middle of financial turmoil and have the advantage to spur ``ex ante discipline in financial institutions' risk and capital management,'' Noyer also wrote. Other methods, based on amortized historical costs ``are not clearly superior, not least because they tend to delay recognition of impaired assets.''
Sandrine Rastello at Bloomberg

Reverse Leverage of Mark-to-Market Wrecks Banks
The world's banking system is caught in a vicious trap, with a forced sale of assets at one institution wiping out capital at others holding similar assets. Think of it as extraordinarily high reverse leverage.

You can blame mark-to-market accounting, the advent of new indexes that supposedly track values of a wide range of assets, or a market mind-set that assumes every asset is part of a bank's trading book.

Like the old Pac-Man character, this combination is devouring financial institution capital at a voracious rate. The question is whether it will gobble up even the new capital injections into banks by the U.S. and foreign governments.

It's way past time to suspend mark-to-market accounting -- or somehow to make investors and analysts understand that fire- sale transactions aren't supposed to be having such broad implications.

Of course, suspending mark-to-market would be greeted by screams of outrage by its devotees, including those at the Financial Accounting Standards Board and the Securities and Exchange Commission. After all, the mark-to-market rules are supposed to provide investors with needed information about the true state of a company's balance sheet.

In the midst of this financial crisis, mark-to-market isn't necessarily telling the truth. The notion of pricing assets on the basis of what they would bring if sold today -- even if an institution doesn't have to sell them -- creates a paper loss that reduces capital and restricts lending.

Federal Reserve Chairman Ben S. Bernanke has expressed reservations about mark-to-market on these grounds.

Great Depression
Nobel laureate Milton Friedman and his co-author, economist Anna Schwartz of the National Bureau of Economic Research, describe in their seminal work, ``A Monetary History of the United States, 1867-1960,'' how a similar process forced the closure of many banks at the beginning of the Great Depression.

``The impairment in the market value of assets held by banks, particularly in their bond portfolios, was the most important source of impairment of capital'' that caused them to shut down, not ``defaults of specific loans or of specific bond issues,'' they wrote.

``Friedman and Schwartz argue that during financial panics, forced asset sales bring down good assets as well as bad,'' said Lee Hoskins, former head of the Cleveland Federal Reserve Bank.

Appropriate Assumptions

Instead of this mark-to-market approach, Hoskins said, ``What I would like to see is someone do a present-value calculation on mortgage-backed security holdings at banks using appropriate assumptions about future home prices and default rates.''

For individual loans or groups of similar loans, banks are supposed to set aside loan-loss reserves when questions arise about whether they will be repaid. If the risk of default is sufficiently high, interest payments, which normally are treated as income, are supposed to be booked as payments to principal.

However, adding to loan-loss reserves is a far cry from valuing a loan as if it were to be sold immediately -- which is the foundation of mark-to-market accounting.

For instance, on Oct. 9, some lists of highly leveraged loans being offered for sale were circulating in Europe. Included on them were assets seized from banks that had just been taken over by the Icelandic government.

The news that the loans were on the market caused the Markit LCDX, a benchmark credit default swap index used to hedge against losses on leveraged loans, to drop more than 6 percent over two days.

``This will affect the mark-to-market for all loans,'' Louis Gargour, chief investment officer at LNG Capital, a London-based hedge fund, who is setting up a distressed debt fund, said on Oct. 9.

The FASB staff on Oct. 10 issued additional guidance on the fair-value rules that could limit the fallout from forced sales. However, Gargour's view seems to be widespread in the market.

Saved by Forbearance

Back in 1982, when the world was a simpler place, the six largest U.S. banks -- Citicorp, Bank of America, Chase Manhattan Bank, Morgan Guaranty Trust Co., Manufacturers Hanover Trust Co. and Chemical Bank -- were in deep trouble. Collectively they had loaned more than $1 trillion to Latin American countries, which couldn't service their debts.

Had the banks been forced to recognize on their balance sheets how badly their loans were impaired, they would all probably have been declared bankrupt. Instead, the Federal Reserve and other bank regulators exhibited so-called forbearance -- letting the institutions continue in business without recording those losses. Had they done otherwise, it would have crippled the banking system in the middle of what was already the worst U.S. recession since the 1930s.

Added Capital

At the end of the 1980s, new international standards required banks to increase their capital bases substantially, though the current crisis has shown that the added capital wasn't adequate either.

Asset writedowns and credit losses are approaching $600 billion at the world's biggest banks and securities firms, and the $443 billion worth of capital raised to cover them hasn't been enough to reassure investors. I wonder what that balance would be if the world weren't fixated on mark-to-market accounting.

According to Bloomberg figures, Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. have all raised more capital than their writedowns and losses. Nevertheless, the stock prices of the first two have been hammered since the crisis began more than a year ago. (JPMorgan Chase has fared better.)

So one has to ask: How much capital will the U.S. government have to inject into these and other banks -- along with other actions -- to thaw the world's credit freeze? Given the mark-to-market climate, it may take more than the $700 billion authorized in the recent rescue package.

Harvard University economist Kenneth Rogoff said on Oct. 10 that it likely will take much more than that. If it does, the next president will have to demand that Congress provide it.
John M. Berry at Bloomberg