Financial Crisis News Center

FSA Chair Says Bank Fair Value and Loan Loss Accounting Can Add to Systemic Risk; Notes Tension Between Banking and Securities Regulators

This story appeared in Jim Hamilton's World of Securities Regulation.

Fair value mark-to-market accounting and accounting for loan losses as applied to banks can increase pro-cyclicality and pose a systemic risk, said UK Financial Services Authority Chair Adair Turner, and thus is linked to macro-prudential risk regulation. In remarks at a London conference hosted by the Institute of Chartered Accountants of England and Wales, he noted that no other sector of the economy is remotely comparable to banking in its capacity to be a driver of economic volatility. As a result, accounting standards relevant to banks need to reflect these differences.

On a broader level, the FSA Chair acknowledged the rising tension over fair value accounting between banking and securities regulators, which has spilled over into the accounting standard setters. The banking regulators are convinced that banks are different and that the IASB and FASB must consider this difference. The pure securities regulators, conversely, tend to be more sympathetic to the idea that accounts are for investors and must reflect fair value at all times.

IASB Chair Charts Path to New Fair Value Standard; Rejects Interim Adoption of US Standard

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

The IASB is on target to replace the fair value accounting standard embodied in IAS 39 with a new standard that will attain broad global acceptance. In remarks before the European Parliament’s Economic and Monetary Affairs Committee, IASB Chair David Tweedie said that the new fair value rules would be adopted after an extensive consultation that will take into account the views of all stakeholders, including the Committee, ECOFIN, central banks and regulators. The comment period on the proposed reform of IAS 39 has ended, said the Chair, and the IASB received letters from more than 200 individuals and organizations. Additional board meetings have already been held, and will continue to be scheduled as required to complete the project in time for the 2009 financial year.

IASB Assures Obama and G-20 on Fair Value Accounting Reforms

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

Ahead of the G-20 Pittsburgh summit, the oversight body of the IASB has assured the G-20 that the reform of the international standard for fair value accounting in proceeding along the lines of principles outlined by the Basel Committee. Complimentary reform of loan loss provisioning is also on target. In a letter to President Barack Obama, host of the G-20, Gerrit Zalm, chair of the IASB oversight committee, stressed the urgency in completing the first component of the comprehensive revision of IAS 39, the IASB’s financial instrument standard, by year end. In this work, the IASB is guided by principles of transparency and the avoidance of undue complexity enunciated by Basel and recently endorsed by the G-20 Finance Ministers, including Treasury Secretary Tim Geithner. In addition, Basel urges that the standards reflect the need for earlier recognition of loan losses.

Banking Industry Says Proposed Changes to Fair Value Accounting Would Contravene G-20 Goals by Disrupting Convergence and Increasing Procyclicality

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

Ahead of the G-20 meeting, a letter to the Treasury and the Fed from the banking industry emphasized that the fair value accounting changes proposed by the IASB and FASB would increase procyclicality, disrupt the global convergence of accounting standards, and undermine the banking business model. As such, the proposals fly in the face of the G-20’s endorsed reform of accounting standards. The American Bankers Association urged Treasury and the Fed to tell the G-20 conference that the fair value accounting proposals are contrary to the G-20’s own recommendations.

G-20 Finance Ministers Endorse Single Set of Global Accounting Standards Based on Basel Principles

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

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.

G-20 Finance Ministers Endorse Reform of Executive Compensation in Alingment with Long-Term Value Creation

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

In preparation for the upcoming G-20 summit in Pittsburgh, the G-20 Finance Ministers have issued a communiqué calling for a framework on corporate governance and executive compensation practices designed to prevent short-term risk taking and mitigate systemic risk. The new executive compensation regime should be globally consistent and build on and strengthen the application of the Financial Stability Board principles.

OTS Guides on Impaired Securities Accounting Issues

This story appeared in Bank Digest.

Thrifts have been given guidance on how the OTS expects them to apply generally accepted accounting principles (GAAP) to securities that have declined in value to less than their amortized cost on an other-than-temporary basis. Determining whether a security has suffered an other-than-temporary impairment is relevant to a thrift's earnings and regulatory capital, the OTS said. The decision, which the agency said is “complex and involves significant judgment,” must be made by the thrift's management, not by an outside auditor. Factors to be considered include the severity of the decline in value, the term of the decline, the volatility of the security's value, external ratings and the thrift's ability to hold the security until the value has recovered. The agency set out separate tests for debt and equity securities.

European Union Council Urges the Reduction of Pro-Cycality on Many Fronts

James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

The Council of the European Union recently underscored the urgency of addressing the fact that the absence of counter-cyclical buffers and the lack of flexibility of accounting rules in allowing for through-the-cycle provisioning have been important factors in the amplification of the financial crisis. The Council announced its support for the introduction of forward looking provisioning, which consists in constituting provisions deducted from profits in good times for expected losses on loan portfolios, and which would contribute to limiting pro-cyclicality. Accounting standards, such as IFRS, currently do not allow for the recognition of expected losses. The IASB is expected to publish an exposure draft dealing with the provisioning issue, including consideration of an expected loss model, by October 2009.

UK Regulator Rejects Using Financial Accounting Standards to Promote Stability

This story appeared in Jim Hamilton's World of Securities Regulation.

In an effort to refute the growing global consensus that financial accounting must change because its pro-cyclicality contributed to the financial crisis, the UK accounting overseer said that people proposing to amend accounting rules to make them less pro-cyclical must believe that investors cannot be trusted with the unadjusted numbers produced by the application of accounting standards. In remarks at the Financial Reporting Council’s annual meeting, CEO Paul Boyle emphasized that it is dangerous to give accounting an explicit role in promoting financial stability in addition to its traditional role of providing useful information to investors to inform their investment decision.

Financial Industry Groups Ask Congress to Redefine and Improve Fair Value Accounting

James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

Noting that when there is no market, market value does not provide relevant, useful information about a securitized asset, the financial industry told Congress that the fair value accounting mark-to-market standard still needs additional improvement even in the wake of FASB’s recent guidance. In a letter to the leaders of the House Financial Services Committee, groups ranging from the American Bankers Association to the Financial Services Roundtable said that FASB’s emphasis on mark-to-market not only results in misleading information in a distressed market, but can also result in misleading information in a typical market. The current volatility of exit prices for many financial instruments in uncertain economic times has demonstrated how unreliable fair values can be, which can have severe adverse implications when determining total reported capital and undermine public confidence. The groups stopped short of asking Congress to suspend the fair value accounting standard, but they do want it improved.