Not Fair

In response to the financial turmoil, EU lawmakers weigh in on fair-value accounting. Not everyone is happy about that.
Jason Karaian and Marie LeoneNovember 3, 2008

It takes something extraordinary to interest politicians in accounting standards. But these are clearly extraordinary times, and officials in Europe are digging deeper into accounting practices than ever in response to the financial turmoil. Specifically — and somewhat improbably — they are preoccupied with paragraph 50 of IAS 39, the standard covering financial instruments.

Addressing reclassifications of financial assets, EU lawmakers last month adopted changes to the text proposed by the International Accounting Standards Board, allowing companies to reclassify certain instruments to avoid marking assets to market in “rare circumstances.” The reclassification rule, which can be applied to third-quarter results, mirrors an existing American standard — FAS 115. Fair-value rules have been a lightning rod for criticism, as some have demonised the mark-to-market methodology for exacerbating the crisis.

Further revisions of the fair-value rules may be on the way. The IASB and its US counterpart have convened a special advisory board comprising “regulators, preparers, auditors, investors and other users of financial statements” to deal with financial reporting issues that have bubbled up from the credit crunch. It is likely that one of the first topics to be addressed will be the application of fair value in illiquid markets.

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Accounting issues are also likely to be discussed among leaders of the 20 largest industrialised countries, who will meet this month to hammer out a global response to the financial crisis. Plans for the summit were announced when French president, Nicolas Sarkozy, a particularly fierce critic of fair-value accounting, and European Commission head, José Manuel Barroso, met with US president, George Bush, last month.

Sarkozy can count on the support of many companies in his campaign to roll back fair-value rules. When announcing a large writedown last month, Herman Agneessens, CFO of Belgian bank KBC, noted that profits would be boosted by €500m if the firm were allowed to reclassify collateralised debt obligations according to the altered accounting rules. Meanwhile, the CFO Forum, a group of finance chiefs from European insurers, is urging a broader scope to the alterations. It would, for example, allow insurers to reclassify quoted bonds in their portfolios in order to use amortised value instead of marking them to market, according to Denis Duverne, CFO of Axa and chairman of the forum.

Investor groups, on the other hand, are largely critical of the rule changes. In a survey of nearly 600 of its members, the CFA Institute, an association of investment professionals, found that 79% opposed the suspension of fair-value standards. Peter Elwin, an analyst at Cazenove, wrote in a recent note that “a Never Neverland approach to accounting that denies the existence of mark-downs” would do investors a disservice. Sarah Deans and Dane Mott, analysts at JPMorgan, were even harsher. Further changes to accounting rules would “reduce consistency, comparability and transparency,” they claim. “We do not think it is exaggerating to say that the credibility of European accounting is at stake.”