How could an accounting standard setter respond to a credit crisis?

By: François Masquelier

Vice President Finance, Treasury & ERM - RTL Group

Axiom Advisory Permanent member

This is a very complex question. Accounting rules are formal ways to translate financial operations. It is a sort of blood test. But, despite a blood test should not be considered as responsible for a disease, some keep considering IAS rules were somehow responsible for the crisis or at least have not helped to maintain financial stability. Because of these critics, demands from European Union (EU) and stakeholders pressures, IASB decided to react.

The IAS Board decided end of 2008 to provide EU with an update of its response to the credit crisis and how they planned to address the various issues. IASB wanted to take number of significant steps to improve accounting guidance based on FSF (Financial Stability Forum). One of the main issues was the fair value measurement when markets are no longer active. Logically, the accounting translation of a financial instrument should not be responsible for its quality and current valuation. However, during such an economic crisis, people feared it could drive to further market deterioration. The first answer from the IASB was to organise round tables with experts to address issues (1). Both international Boards (IASB & FASB) were committed to urgently respond to this unprecedented situation facing financial markets.

The IASB made an amendment to IAS 39 to permit certain reclassifications out of HfT (Held-for-Trading) and AfS (Available-for-Sale) categories. Many financial institutions have in Europe used the fair value option to eliminate or significantly reduce measurement mismatches. However, a virtual disappearance of some markets may have had an impact on the way instruments are managed. The problem comes if you opt for the fair value option and no subsequent change in the classification is permitted.

The need for further guidance in application of the fair value in illiquid markets was identified by the EU, notably on the use of mark-to-model.

Summarized, the EU issues were 4:

1. Ensuring that financial assets presently classified under FVO can be classified into other categories and not measured at FV;

2. Clarification whether CDO’ include embedded derivatives;

3. Adjustments to impairment rules applicable for A-f-S assets;

4. Need for guidance on FV in illiquid markets

Actually, IASB has better defined guidance on application of FV when markets become inactive. It also published in December proposals to strengthen and improve accounting requirements for off balance-sheet items. Furthermore, it published new disclosure requirement related to impairment. The two major Accounting Boards seem to cooperate to accelerate efforts to harmonized positions and solutions. Eventually, IASB is considering some other key issues related to financial instruments, including the FVO, raised at recent round tables and by EU in its letters to the Chairman of IASB. This last issue is certainly more complex than what it seems and some specialists are not fully convinced that reclassification out of FVO would improve financial reporting and enhance investor’s confidence. EACT will have to keep following the solutions IASB will propose.

François Masquelier

Vice President Finance, Treasury & ERM - RTL Group

Axiom Advisory Permanent member

(1) see www.iasb.org – letters from Sir David Tweedie to Jorgen Holmquist 14/11/08