Investment Management & Real Estate

Fair value measurements

Make your views count*

IFRS Global Reporting Revolution

April 2007

Fair value measurements: Make your views count

The member firms of the PricewaterhouseCoopers network (www.pwc.com) provide industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 130,000 people in 148 countries share their thinking, experience and solutions to develop fresh perspectives and practical advice. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. 2007 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. Designed by Court Three (04/07).

01

PricewaterhouseCoopers Fair value measurements

Fair value measurements: Make your views count

Overview
The IASB is inviting comments on proposed new guidance designed to make fair value measurements simpler and more consistent (Fair Value Measurements Discussion Paper, November 2006) The starting point for discussion is SFAS 157, the new US fair value measurement standard. The IASB has presented some of its preliminary views on the US standard and asked stakeholders for their comments on specific questions relating to the detailed provisions Using SFAS 157 as a possible basis for a new IFRS standard forms part of plans for closer convergence between IFRS and US GAAP Fair value would be defined as the transfer (exit) price, ruling out the acquisition (entry) price commonly used by private equity funds to value unquoted holdings The mid-market pricing commonly used by investment management firms might be allowed as a practical expedient for valuing listed securities At present, companies are not allowed to apply blockage adjustments to listed securities. The IASB is asking commentators if they think this prohibition should be extended to all securities, including unlisted holdings where they are often applied by private equity and venture capital firms Companies have until 4 May 2007 to put forward their comments, either through their industry associations or directly to the IASB www.iasb.org

02

PricewaterhouseCoopers Fair value measurements

Fair value measurements: Make your views count

The International Accounting Standards Board (IASB) is seeking industry views on a discussion paper setting out proposed new guidance on fair value measurements. The paper includes potentially good news and bad news for investment management businesses, including the possibility of allowing mid-market pricing in financial statements, but prohibiting the use of blockage adjustments in relation to all securities. Marie-Anne Kong and Pauline Wallace look at the key implications of the proposals and how businesses can seek to ensure that the eventual standard reflects their needs and concerns.
In November 2006, the IASB published a discussion paper on fair value measurements. Rather than seeking to change or expand the use of fair value, the proposals aim to improve consistency by codifying, clarifying and simplifying what are at present a number of different approaches to measurement. The starting point for discussion is the new US Statement of Financial Accounting Standards No 157 Fair Value Measurements (SFAS 157), which is presented as an appendix in the IASB paper. The IASB has set out some of its preliminary views on the US standard and asked stakeholders for their comments on specific questions relating to the detailed provisions. Bringing IFRS and US GAAP more closely into line in this way forms part of a commitment to convergence agreed by the IASB and US Financial Accounting Standards Board (FASB).

Exit price
The impact of removing some of the current discretion in interpretation and application of fair value measurement could be significant. One proposal that could affect some funds is defining fair value as the transfer or realisation (exit) price, which would rule out the acquisition or replacement (entry) price commonly applied at present. Private equity funds holding significant unquoted holdings may be affected as they often use what is essentially an entry price approach to value these investments. Hedge funds that use complex derivatives may also find that there is a marked difference between the initial transaction price and the exit price.

Mid-market pricing
While defining fair value more precisely, the proposed guidance might allow the use of mid-market pricing. At present, IAS 39 requires that companies should base the fair valuation of securities quoted in an active market on the current bid price, rather than

03

PricewaterhouseCoopers Fair value measurements

Fair value measurements: Make your views count

on the mid- or last-traded price commonly used by investment managers to determine the fair value of a portfolio of market quoted investments of a fund. Many investment managers have continued to use the mid-or last-traded price for day-to-day valuation purposes and adopted bid pricing purely for their IFRS financial statements. As a result, many investment managers are running parallel systems. Clearly this double counting can be onerous and expensive, as well as potentially confusing for analysts and investors. In setting out the possibility of a more flexible approach, the discussion paper notes that SFAS 157 does not preclude the use of mid-market pricing or another pricing convention as a practical expedient for fair value measurements within a bid-ask spread. Marrying the technical approach with practical industry practice is likely to be welcome news for investment managers. However, the IASB has not yet reached a preliminary view on whether it is appropriate. The responses to the consultations will play an important part in the IASBs decision on what route to take in the eventual standard.

Blockage adjustments
At present, companies are not allowed to apply blockage adjustments to listed securities. The IASB is considering whether to extend this prohibition to all financial instruments whether they are actively traded or not. This includes unquoted investments holdings, where blockage discounts are often applied in the valuation techniques used by private equity and venture capital firms. This proposal goes beyond the restriction in SFAS 157, in which the prohibition on blockage adjustments is limited to securities quoted in an active market.

Consultations extended
Any standard based on these proposals will provide a much-needed level playing field for fair value measurements. Bringing IFRS valuation techniques for investment securities closer into line with US GAAP will be an especially valuable step forward in global financial comparability. The possibility of using mid-market pricing may be another welcome development for investment managers. However, there may be elements of the proposals that some businesses may question, including the blanket prohibition of blockage adjustments. It is therefore vital that as many investment managers as possible take this opportunity to express their views (see page 04 for a list of key questions). It is also important to stress that nothing has been set in stone as yet and the current consultation offers a valuable opportunity to influence the outcome of the debate over valuation.

04

PricewaterhouseCoopers Fair value measurements

Fair value measurements: Make your views count

Key questions for investment managers

Q1 In your view, would a single source of guidance for all fair value measurements in IFRSs both reduce complexity and improve consistency in measuring fair value? Why or why not? Q3 Do you agree that fair value should be defined as an exit price from the perspective of a market participant that holds the asset or owes the liability? Why or why not? Q20 Do you agree with the provision of SFAS 157 that a blockage adjustment should be prohibited for financial instruments when there is a price for the financial instrument in an active market (Level 1)? In addition, do you agree that this provision should apply as a principle to all levels of the hierarchy? Please provide a basis for your views. Q21 Do you agree that fair value measurements should be determined using the price within the bid-ask spread that is most representative of fair value in the circumstances, as prescribed by paragraph 31 of SFAS 157? Alternatively, do you believe that the guidance contained in IFRSs, which generally requires assets to be valued at the bid price and liabilities at the ask price, is more appropriate? Please explain the basis for your view. Q22 Should a pricing convention (such as mid-market pricing or bid price for assets and ask price for liabilities) be allowed even when another price within the bid-ask spread might be more representative of fair value? Why or why not? Q23 Should bid-ask pricing guidance apply to all levels of the hierarchy, including when the fair value measurement includes unobservable inputs? Why or why not?
Source: IASB Fair Value Measurements Discussion Paper, November 2006 Replies to be forwarded in writing to the IASB by 4 May 2007.

The IASB has extended the consultation period for the discussion paper from 2 April to 4 May 2007 to reflect the significance of the issues. This will be followed by a series of roundtable meetings with businesses as part of the development of an exposure draft (please indicate in your response to the consultations whether you would like to take part in the round-tables). The exposure draft is likely to be published in 2008 ahead of a finalised standard in 2009.

05

PricewaterhouseCoopers Fair value measurements

Fair value measurements: Make your views count

PricewaterhouseCoopers Investment Management Industry IFRS Champions

If you would like to discuss any of the matters in the article or the discussion paper as a whole please speak to your usual PricewaterhouseCoopers representative or one of the authors and local contacts listed below:

Global Leader IFRS for the Investment Management Industry Marie-Anne Kong Telephone: +852 2289 2707 marie-anne.kong@hk.pwc.com Australia Craig Stafford Telephone: +61 2 8266 3725 craig.stafford@au.pwc.com Bermuda Andrew Brook Telephone: +1 441 299 7126 andrew.brook@bm.pwc.com Canada Raj Kothari Telephone: +1 416 869 8678 rajendra.k.kothari@ca.pwc.com Cayman Islands Paul Donovan Telephone: +1 345 914 8676 paul.donovan@ky.pwc.com Channel Islands Brendan McMahon Telephone: + 44 1534 838 234 brendan.mcmahon@je.pwc.com Denmark Michael Jacobsen Telephone: +45 3945 9269 mej@pwc.dk

France Marie-Christine Jetil Telephone: +33 1 5657 8466 marie-christine.jetil@fr.pwc.com Germany Anita Dietrich Telephone: +49 69 9585 2254 anita.dietrich@de.pwc.com Hong Kong Marie-Anne Kong Telephone: +852 2289 2707 marie-anne.kong@hk.pwc.com Ireland Jonathan OConnell Telephone: +353 1 704 8737 jonathan.oconnell@ie.pwc.com Italy Elisabetta Caldirola Telephone: +390 2 7785 380 elisabetta.caldirola@it.pwc.com Japan Peter Finnerty Telephone: +81 3 5532 2530 peter.finnerty@jp.pwc.com Luxembourg Mark Minet Telephone: +352 494848 2120 marc.minet@lu.pwc.com

Netherlands Frank van Groenestein Telephone: +31 10 407 6444 frank.van.groenestein@nl.pwc.com Singapore Peter Low Telephone: +65 6236 3348 peter.low@sg.pwc.com South Africa Pierre De Villiers Telephone: +27 11 797 5368 pierre.e.de.villiers@za.pwc.com Switzerland Thomas Huber Telephone: +41 1 630 2436 thomas.huber@ch.pwc.com United Kingdom Marcus Hine Telephone: +44 20 7804 2948 marcus.hine@uk.pwc.com USA Thomas Romeo Telephone: +1 646 471 8048 thomas.romeo@us.pwc.com

www.pwc.com

www.pwc.com