Ball of Confusion: FASB Affirms Fair-Value Principles

Okaying a proposal on how to gauge the price of financial instruments in illiquid markets, the board says that preparers should use their judgment.

Earlier, board staffer Adrian Mills, reading from a staff handout, said that gauging fair value “in a market where there has been a significant decrease in the volume and level of activity for the asset at the measurement date is inherently complex, depends on the facts and circumstances and involves significant professional judgment.”

In another move on Wednesday, the board erased the presumption in the staff proposal “that all transactions are distressed unless proven otherwise.”  FASB acknowledged that its intention wasn’t to exclude relevant transaction information or preclude the use of pricing services or brokers in a fair-value measurement.

Some respondents had believed that the presumption would have enabled reporting entities to ignore relevant market data. Other respondents were concerned about the unintended consequences that could ensue if reporting entities were “forced to dismiss quoted prices provided by pricing services or to otherwise exclude relevant market data.”

In terms of disclosure, the board will require reporting entities to reveal changes in valuation techniques resulting from the application of the new guidance and to quantify the effects of the changes, if that’s practical.

The new guidance will set up a two-step process for reporting entities to use in gauging when a market is inactive and when a financial transaction is distressed. In step 1, asset holders would assess at least seven factors in gauging whether to pronounce a market inactive. (“Those factors should not be considered all inclusive because other factors may also indicate that a market is not active,” FASB cautions.) The factors are:

-There are few recent transactions in the market.

-Price quotes aren’t based on current information.

-The quotations vary heavily, either over time or among brokers.

-Indexes that in the past were highly linked to the asset’s fair values “are demonstrably uncorrelated with recent fair values.”

-Abnormally big liquidity risk premiums or yields on the assets.

-Abnormally wide bid-ask spreads or big hikes in the spreads.

-Little publicly released information.

 After the asset holder does a thorough evaluation using those factors, it must “use its judgment in determining whether the market is active.” If it concludes in step 1 that the market for the asset isn’t active, then it would proceed to step 2.

In step 2, the asset holder must presume that a quoted price stems from a distressed transaction unless the asset holder can prove that there was enough time before the measurement date to allow for normal marketing activities for the asset. There would also have to be many bidders for the asset for the price to be deemed not distressed.


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