In preparation for the upcoming G-20 summit in Pittsburgh, the G-20 Finance Ministers have issued a communiqué calling for a convergence towards a single set of high-quality, global, independent accounting standards on financial instruments, loan-loss provisioning, off-balance sheet exposures and the impairment and valuation of financial assets. Within the framework of the independent accounting standard setting process, the G-20 encouraged the IASB to take account of the Basel Committee’s guiding principles on IAS 39 and the report of the Financial Crisis Advisory Group. Earlier this year, the IASB set forth a draft for a new fair value standard to replace IAS 39. The comment period on the proposal ends on September 28, 2009. A final standard is expected in the first half of 2010.
One Basel Committee principle is that fair value accounting should not be required for items which are managed on an amortized cost basis in accordance with the firm’s business model. In addition, Basel said that fair value is a proper measurement for trading activities and stand alone derivatives, as well as embedded derivatives which, in current IAS 39 language, are not closely related to the host contract. The new standard should also recognize that fair value is not effective when markets became dislocated or are illiquid. The standard should permit reclassifications from the fair value to the amortized cost category in rare circumstances following the occurrence of events having clearly led to a change in the business model.
The new standard should provide for valuation adjustments to avoid misstatement of both initial and subsequent profit or loss recognition when there is significant valuation uncertainty. For financial instruments that are either not actively traded, or have insufficient market depth, or rely on valuation models using unobservable inputs, there is considerable valuation uncertainty.
Basel recommended partially de-linking the valuation process in mark-to-market from certain aspects of income and profit recognition when significant uncertainty exists. The size of the adjustment could be based on the degree of uncertainty created by the weakness in the data or
underlying modelling approach.
More broadly, Basel calls for increased transparency, the avoidance of undue complexity, and a level cross-border playing field for the global accounting standards. In addition, Basel urges that the standards reflect the need for earlier recognition of loan losses.
In Basel’s view, loan loss provisioning should be based on sound methodologies that reflect expected credit losses in existing loan portfolio over the life of the portfolio. The allowance or provision should be presented separately from total loans. The accounting model for provisioning should allow early identification and recognition of losses by incorporating a broader range of available credit information than presently included in the incurred loss model and should result in an earlier identification of credit losses.
Basel also said that the provisioning approach should allow for the exercise of professional judgment while using leading economic indicators, changes in underwriting standards and collection practices, and other relevant information when estimating provisions or allowances. Judgments related to these provisions should be well evidenced. Finally, the new standard should allow for provisions for groups of loans with similar risk characteristics.
Recently, the FCAG, a joint FASB-IASB expert group, urged the standard setters to develop a single set of high quality, globally converged financial reporting standards providing consistent information, regardless of the geographical location of the reporting entity. In a seminal report, the Financial Crisis Advisory Group simultaneously encouraged all national governments that have not already done so to set a firm timetable for adopting or converging with IFRS. The Financial Crisis Advisory Group is co-chaired by former SEC Commissioner Harvey Goldschmid and Hans Hoogervorst, Chairman of the Netherlands Authority for the Financial Markets.