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Firms Face More Data Disclosure Around Level 3 Asset Valuations, Following FASB and IASB Agreement on Fair Value

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Regulators may be at odds with each other this week regarding the definition of what constitutes a firm that is systemically risky, but significant progress has been made on the standards front by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in agreeing a global definition for “fair value”. The two standards setting bodies have been wrangling over the definition for some time, as the move will require firms to disclose much more data about their hard to value assets, but agreement on the subject brings the US and the rest of the rest of the world one step closer towards alignment on asset valuation rules.

This is all part of the work to bring US Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS) closer together and the aim is to provide a more consistent definition of “fair value” in this context. Accordingly, the requirements do not extend the use of fair value accounting, but provide guidance on how it should be applied where its use is already required or permitted by IFRS or GAAP.

Firms will, however, be required to disclose more about their Level 3 assets, which comprise hard to value, illiquid or riskier assets that require evaluated pricing methodologies rather than market prices. Firms will therefore have to disclose more about the models, processes and assumptions that have gone into the fair valuation methodology used to price these assets.

Much like stress and scenario testing in the risk management space, pricing and valuations teams will also be required to detail what would happen to the valuations if the input factors were to change. This is to take into account market stresses and volatility that have been prevalent in the post-crisis market environment.

Firms will also have to disclose whether any of the securities they value have moved from the Level 1 bracket to Level 2, or vice versa. This is to ensure the regulatory community is apprised of these market dynamics and any potential systemic risks in the making are flagged.

In terms of adoption dates and transition procedures, the boards have noted that for public entities, the amendments are effective for interim and annual periods beginning after 15 December 2011. For non-public entities, the amendments are effective for annual periods beginning after the same date. They state: “In the period of adoption, all entities should disclose the change, if any, in valuation technique and related inputs resulting from application of the amendments and should quantify the total effect, if practicable.”

Despite this international agreement, the US Securities and Exchange Commission (SEC) has not yet voted on whether the US should go the whole hog and move entirely from GAAP to IFRS. SEC staff is still working on executing a work plan, the results of which it said will aid the regulator in its evaluation of the impact that the use of IFRS by US companies would have on the US securities market. Included in this work is consideration of IFRS, as it exists today and after the completion of various convergence project” currently underway, of which this fair value determination is only one.

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