French experts explain fair value during a crisis

International accounting experts have backed fair-value, saying they do not
endorse views that the standard be rejected in favour of historical cost values.

The experts – Jean-François Lepetit, a member of France’s national accounting
board; PWC partner Etienne Boris and Didier Marteau, a professor at ESCP-EAP,
the European School of Management – said they strongly opposed the way fair
value is applied during a crises.

‘In these circumstances, market value is no longer fair value, in large part
because of the much reduced volume of transactions. Arbitrageurs – including
banks’ own trading desks and hedge funds – withdraw from the trades that
normally deal with the temporary differences that naturally arise between the
market price of an instrument and its intrinsic value.

‘Market prices are hence squeezed by a “crisis discount” as investors also
avoid all credit assets, regardless of intrinsic quality,’ they wrote in the

The three suggested an ‘upgraded fair value’ which would stop pro-cyclical
effects of mark-to-market and to allow trading assets to be measured
consistently with their intrinsic values.

‘As soon as the accounting regulator in the country concerned considers the
“crisis discount” abnormally high, banks would be required to discontinue
mark-tom-market measurements of credit assets in their trading books that no
longer represented fair value.

‘They would switch to a fair value measurement based on a “mark-to-model”
approach using initial parameters set by the regulator, chiefly probabilities of
default and recovery rates. These data would be established using fundamental
analysis of assets’ credit quality, eliminating “crisis discount”.’

The three experts say the rule could be applied to impaired assets or
structured instruments, whose underlying assets were impaired, such as
‘subprime’ assets.

‘This approach obviously creates an accounting gain, equal to the difference
between the “upgraded fair value” and the market price. We recommend recording
this gain in the income statement and disclosing details of the adjustment in
the notes. These gains would correct the negative impact of any losses already
recognised. The earlier the regulator acts, the less significant the adjustment
to income,’ they said.

Further reading:

FRC cautions ‘inappropriate’ development of IFRS

Related reading

Fiona Westwood of Smith and Williamson.