Washington DC, May 28, 2008 — There has recently been renewed discussion of issues relating to fair value accounting and efforts that the Institute of International Finance has been making with regard to certain aspects of this issue.

Current Perspective

Over the last six weeks the IIF has engaged in informal consultations involving market participants, central bank and finance officials, securities and banking regulators, auditing authorities and accounting standard-setters regarding the application of fair value accounting in illiquid conditions. Views differ widely, both within the industry and within official circles, about how best to address a number of complex and important valuation issues. Further discussions are obviously necessary to move toward a consensus. At this juncture, on the basis of initial consultations, the following key points have emerged:

• Fair value accounting remains an essential element of global capital markets as it fosters transparency, discipline and accountability.
• Under current fair value accounting there is already latitude to use mark-to-model approaches where observable market inputs are not available. Appropriate use of such latitude is fully consistent with fair value accounting and has been embraced by accounting standard-setters.
• There is a need for clarification on a number of fronts, such as pricing inputs in illiquid markets. Furthermore, for some products in particular circumstances, there is merit in considering other refinements in valuation methodologies and greater flexibility regarding the transfer of assets between accounting categories (that is trading versus held to maturity).
• However, there is a view that applying new techniques, or greater flexibility, in current circumstances would be fraught with difficulties. There is the risk that, however well-framed the proposals, the intentions of those advocating changes could be misunderstood by investors at this stage.
• What is crucial, and what most parties can support, is that at this time a thorough dialogue among the parties should be pursued in order to address both the many issues that require clarification and the unintended consequences that have arisen, as well as to consider the meaningful medium-term improvements that could help fair value accounting play an even more constructive role for investors, and for the financial system more broadly, in both normal as well as extreme market circumstances. In this connection we are pleased that as a first step the IASB has organized the experts group called for by the Financial Stability Forum (FSF) to look at valuing securities in illiquid markets.

Background

It is useful to place the current discussion in context. The IIF's Board of Directors established a Committee on Market Best Practices (CMBP) last October to address weaknesses in financial markets and to formulate proposals to assist in the rebuilding of market confidence through the development of a set of industry best practices.

The issue of valuation of assets has been important from the outset of the CMBP's work given the uncertainties involved, the declining availability and quality of market inputs for valuation, and the difficulty of making model assumptions when underlying economics are changing rapidly. Further, there is evidence of possible unintended consequences from fair value accounting at times when certain products have migrated from liquid markets where they could be valued in a relatively straightforward way, based on market prices, to illiquid markets where valuation requires extrapolation from market inputs, modeling or other techniques.

It has been and it remains the view of the Institute that fair value accounting has been very useful in promoting transparency and market discipline and continues generally to be a reliable accounting method for securities in liquid markets. The IIF's recent efforts have sought to generate an open debate about strengthening techniques, including mark-to-model, used to arrive at fair values that would be useful, relevant, accurate and transparent.

The difficulties that have arisen in recent months - and the need for a dialogue - have been acknowledged not only by market participants, but by the official sector as well. For example, the Bank of England's Financial Stability Report in April drew attention to the fact that loss estimates based on market prices are likely to overstate significantly banks' losses as they will reflect factors such as illiquidity and uncertainty, which are unrelated to credit fundamentals and should ease over time. More broadly, the Financial Stability Forum (FSF) stated in its report in April: "Financial institutions and auditors have worked together to improve valuation approaches and related disclosures in end-year financial accounts. But further work is needed to provide confidence that valuation methodologies and related loss estimates are adequate, to clearly highlight the uncertainties associated with valuations, and to allow for more meaningful comparisons across firms."

The IIF's actions to catalyze a dialogue under the guidance of its Board of Directors have brought forward a number of ideas. These include alternative valuation methodologies for illiquid market conditions involving the use of underlying discounted cashflow - a concept already present in existing accounting standards. Other concepts for discussion revolve around the potential benefits and costs of seeking both more consistency between FAS and IAS and more flexibility in determining the circumstances under which firms would be allowed to transfer certain assets (again carefully circumscribed) from the "trading" to the "held to maturity" category.

The IIF's Committee on Market Best Practices will be considering these, as well as many other issues, as it prepares its final report, which we expect to be released in July following its review and endorsement by the IIF's Board of Directors. We will also be consulting with other members of the Institute. As a clearer consensus emerges and as the broader dialogue moves forward, approaches to these problems will hopefully become an integral part of a range of steps taken by market participants, regulators, finance officials and standard-setters to strengthen the fabric of the global financial system, and to find a better balance between innovation and discipline, within the framework of effective regulation, than has been evident in recent years.