From the October 2010 issue of Treasury & Risk magazine

Fair Value Effects Knock On


The push by accounting regulators to measure assets and liabilities at fair value may soon expand the reporting duties of treasurers. And while plenty of valuation platforms already exist, not all will meet treasurers' needs. Valuation platforms sprang up after the Financial Accounting Standards Board (FASB) issued new requirements in the late 1990s on reporting the value of derivatives in either the profit-and-loss (P&L) section of the income statement or in other comprehensive income (OCI), which lies outside the P&L. The vendors include giants such as Thomson Reuters and Bloomberg, and smaller players focusing on hedge accounting, such as Reval and Chatham Financial.

Proposed amendments to that standard and another, more recent FASB proposal clarifying the notion of fair value would require most financial assets and liabilities, including those not hedged by derivatives, to be reported in P&L; if certain tests were met, the change in fair value would be reported in OCI.

Jiro Okochi, CEO and founder of Reval, describes the amendments as the "last nail in the coffin for amortized cost and a final step toward complete fair value."

FASB's changes, along with the credit crisis, will push treasurers to use more third-party valuation services. "Historically, there's been a huge reliance by corporations on their investment bank or commercial bank to provide valuations," says John Jay, senior analyst at Aite Group. The financial firms' meltdowns made people "realize it was too much of a reliance," he adds.

Even the fair value of plain-vanilla assets such as money market funds can become difficult to assess during turbulent times--recall the Reserve Fund's "breaking the buck" two years ago. FASB's proposed changes would also require that liabilities, such as bank loans, be reported at fair value.

Most third-party valuation platforms focus on derivatives, but their systems tend not to be designed to value unhedged exposures, although some vendors, including Reval and Chatham, have moved into that realm.

For example, a company might finance a real estate acqusition with a bank loan. "If the real estate loses value, the amount of financing it can support will change, and so the value of the existing loan will fluctuate," says Mark Henderson, director of valuation services at Chatham.

Using real estate appraisals provided by the client, Chatham's models can determine the fair value of such a loan, as well as other types of liabilities and illiquid assets. "By finding the value of the loan, the company has a better idea of how much it will cost to refinance it," Henderson says.

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