Mark to market needs refining, not scrapping - SEC

Christopher Cox, chairman of the US Securities and Exchange Commission (SEC), backed fair-value accounting in a speech to the American Institute of Certified Public Accountants last week, but said some aspects, particularly rules on impairment, needed improvement.

Cox said the majority of investors and bankers agree fair value is an effective and relevant measure for assets. He also underlined the importance of safeguarding the independence of the Financial Accounting Standards Board (FASB) and the need for transparency in financial reporting.

The chairman did, however, acknowledge deficiencies in the FASB's impairment model. Under FASB rules, investments in loans and available-for-sale securities are not marked to market through earnings for each quarter, but are subject to stringent other-than-temporary impairment requirements. Often securities are marked down irreversibly, causing substantial losses for the entity that holds them.

"If you look at the model the International Accounting Standard Board (IASB) uses for accounting for debt securities, they use the FASB's model, but they've made improvements to it," explains Donna Fisher, senior vice-president in tax and accounting at the American Bankers Association. "One of those improvements is that other-than-temporary impairment for held-to-maturity securities is based only on credit losses."

Under the Emergency Economic Stabilisation Act (EESA), the SEC is required to conduct an inquiry into fair-value accounting, the results of which are due on January 2, 2009. The SEC has already chaired two roundtables to discuss issues surrounding fair value, including impairment, which were attended by a wide range of industry representatives.

Some bankers have criticised fair-value accounting for exacerbating the financial crisis, causing entities to make unnecessary writedowns. Banking lobbyists have been calling for the practice to be amended, arguing the current system is inappropriate in illiquid markets.

"It's like adding oil to the fire," says one high-level executive at a major US bank. "Special treatment is required during these abnormal market conditions."

Auditors, on the other hand, argue wholesale amendments to fair-value accounting could erode investor confidence in financial institutions, particularly any measure that could reduce transparency on financial statements. They also deny fair value is responsible for the market turmoil.

"Did fair value contribute to the failure of US banks? Preliminary findings say No: the failures were due to bad loans, bad credit, bad underwriting - very little of a bank's assets in the US, maybe 15%, are subject to mark to market," said Conrad Hewitt, chief accountant at the SEC.

The IASB and the FASB recently created a joint global advisory panel, which is due to report back in the first half of 2009. The financial crisis has provoked further calls for the two accounting standards to be aligned, to create a more robust and comparable market. Last year, the SEC issued a concept release on permitting US institutions to prepare financial reports under IASB rules. The SEC also published a proposed roadmap last month that could see US institutions using the IASB's accounting standards by 2014.

See also: Fair-value accounting critics call for action
SEC to ease mark-to-market rules