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FCAG Says Mark to Market Rules Not to Blame for Procyclical Nature of Market

The Financial Crisis Advisory Group (FCAG) has released its final report indicating that mark to market accounting standards did not fuel the procyclicality of the market. The group, which is the joint effort between the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB), established to tackle accounting standards in the post-crisis world, says the rules actually understated the losses rather than overstated them.

FCAG was established earlier this year and is jointly chaired by Harvey Goldschmid, former commissioner of the US Securities and Exchange Commission (SEC), and Hans Hoogervorst, chairman of the Netherlands Authority for the Financial Markets. The end product of all its work is this final report, published this week, which examines the standard setting implications of the financial crisis and potential changes in the global regulatory environment.

Mark to market accounting has been frequently blamed for deepening the losses of the financial crisis and the rules have since been altered to be more ‘market friendly’, following an extensive lobbying campaign by the industry in the US and Europe. However, the FCAG findings indicate that the majority of global bank assets were not actually being marked to market during the crisis; rather they were kept at their historic value.

“While the crisis may have led to some understatement of the value of mark to market assets, it is important to recognise that, in most countries, a majority of bank assets are still valued at historic cost using the amortised cost basis. Those assets are not marked to market and are not adjusted for market liquidity,” says the report.

Accordingly, the report criticises the pressure that has been heaped on the FASB and the IASB over the past year to alter the rules. In April, the FASB was forced to revise its mark to market legislation following pressure from lobbying efforts by the US Chamber of Commerce, the American Bankers Association (ABA) and the country’s larger financial institutions. Moreover, on 12 March, the FASB was threatened with government action if it did not take action during a hearing of a House Financial Services subcommittee. Government officials told Robert Herz, chairman of the FASB, to get the rule changes implemented in a period of three weeks or face regulatory intervention.

In May, the IASB faced similar pressure when European Union finance ministers kicked up a fuss about the disparity between accounting standards in the region and the now more relaxed rules in the US. As a result, it was forced to expedite its decision making process on the subject in order to appease political lobbyists. The IASB had originally planned a revision of IAS39 to be published in October, but was forced to promise a draft of the revisions for July.

FCAG criticises this lobbying action and warns that more changes in this vein would potentially undermine public confidence in the accounting standards. “We understand why there was pressure. But it becomes undue when changes are prescribed and that line has been crossed a couple of times,” says Hoogervorst.

The group is in agreement on the importance of global standards for accounting and its recommendations are aimed at ensuring consistency across countries. The report suggests that transparency and reduced complexity are key to the future of restoring confidence in the financial markets and points to the bank stress tests in the US as an example of this approach in practice. It notes the current complexity within the standards space for illiquid instruments that means even experts struggle with hedge accounting rules, for example.

“While some complexity may be inevitable because of the nature of the instruments and the diversity of business models, in our view the overall level of complexity is unwarranted. We believe that, for conceptual and/or practical reasons, a simplified mixed attribute model, rather than a full fair value through earnings model, is preferable,” says the report.

In order to tackle these issues of transparency and complexity the FASB and IASB have both pledged to take some action before the year end. This includes the proposal of an “improved, streamlined approach to the classification, recognition, and measurement of financial instruments”, as well as working to converge their own standards in accordance with their memorandum of understanding.

The IASB is also planning to issue proposals on impairment methodology and hedge accounting, in October and December 2009, respectively. The group notes that the IASB and FASB are considering different approaches to these areas at the moment, but pledge to achieve a converged solution by the start of next year.

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