Critics demand fair value rethink

A Fitch report endorsing new fair value standards, but calling for greater
disclosure in some areas, fails to address the bigger picture, according to some
fair value detractors.

Tim Bush, director at Hermes Asset Management, said the entire system of
valuing assets where no end market exists needed to be reassessed.

‘Beyond merely requiring additional disclosure, there is the bigger issue of
whether it is ever appropriate to mark-up assets that have not yet been sold,
giving markets a misleading impression of profit, when no cash or contracts
actually exist,’ said Bush.

‘IAS 39 seems to have sanctioned at the heart of the banking system the
booking of profits in 2006 and 2005 which have not materialised as cash – quite
the opposite. It is arguable that whereas oil companies were fined for
accounting irregularities around overstating oil reserves several years’ back,
precisely the same problem has literally been sanctioned by IAS 39, the problem
is recognising profits on assets held for which no end market ultimately

In its report Fair Value Disclosures: A Reality Check released last week,
Fitch Ratings endorsed the new tabulated format required by Statement of
Accounting Standards (SFAS) 157, which distinguishes between level one, level
two and level three valuations, stating that it was ‘clear and easy for readers
to understand’. However, it called for greater disclosure on level two
valuations, which it described as ‘relatively subjective’.

‘The new fair value disclosures are obvious improvements compared to prior
disclosures but do not go far enough,’ said Olu Sonola, director of the credit
policy group at Fitch. ‘Investors and analysts need better and more extensive
disclosure around fair value measurements.’

At present, the tabular format is not yet required under International
Financial Reporting Standards (IFRS). However, the IASB has published a
discussion paper on fair value, and changes to existing standards are expected
in early 2009. Insiders at IASB felt Fitch’s report was a positive development.

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Fiona Westwood of Smith and Williamson.