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1 September 2013 Position Paper

Fair Value Accounting & Long-Term Investing in Europe

Investor Perspective and Policy Implications

  1. CFA Institute

Investors support the drive by European policymakers to stimulate investment and financial innovation as a backbone of Europe’s economic regeneration. To that effect, the effectiveness of the accounting framework is an important element of encouraging investors who are suppliers of financial capital to be confident enough to invest in the economy, financial services sector and innovative financial instruments. For investors to be confident they need to be well informed about the financial health, prospects, and risk profile of investee firms. This overall financial profile is primarily communicated through the reported annual and interim accounts, and this heightens the importance for investors and other stakeholders of effective accounting policies.

We similarly acknowledge that there has been considerable debate in Europe and elsewhere regarding whether fair value accounting was a contributing factor to the financial crisis and whether it has resulted in adverse economic consequences. That said, we emphasize that there is support for fair value measurement by investors because the benefits of fair value information for the investment community outweigh several commonly cited concerns. CFA Institute member surveys have consistently shown widespread support for fair value measurement by all types of investors. Also, we are not aware of any fundamental differences between long-term versus short- term investors in their view regarding the relevance of fair value information.

Our overarching message is that whilst addressing accounting issues, the emphasis of policymakers should be on enhancing the overall transparency of financial reporting information. The enhancement of financial reporting information should be primarily influenced by capital market investor perspectives rather than by that of financial intermediaries (i.e., banking and insurance industry players). As discussed below, the priorities of capital market participants would likely differ from the often emphasized need by financial intermediaries for ‘business-model-based’ accounting of financial instruments.

Fair Value Accounting & Long-Term Investing in Europe View the full article (PDF)

Our Position

We further explain CFA Institute positions on fair value accounting and investor financial reporting priorities. The following issues are addressed:

  • Important role of financial reporting in stimulating investment in Europe;
  • Investor financial reporting priorities;
  • Relevance of fair value information for investors, including views reflected in several CFA Institute member surveys and highlighting the difficulties in distinguishing between long-term and short-term investing for accounting purposes;
  • Concerns regarding the elevated importance of ‘business-model-based’ accounting; and
  • Refuting criticisms of fair value accounting (i.e., short termism by investors, procyclical effects, measurement unreliability and inconsistent application).

Main Points

As noted earlier, European policymakers should focus on enabling initiatives that aim to enhance the overall transparency of annual and interim reports. These include those aimed at enhancing financial instruments risk disclosures. In addition, a critical analysis shows that the benefits of fair value measurement for all investors outweigh the often cited concerns and that its application is required by investors.

We have emphasized that fair value information is relevant for short-term and long-term investors, who undertake fundamental valuation of investee companies. Long-term investors have to monitor the value of their investment assets on an ongoing basis, even when they choose to hold such assets for long periods. The similarity in information required for fundamental valuation, irrespective of the investment horizon, highlight the difficulty in distinguishing long-term versus short-term investing for accounting purposes. It also highlights the inappropriateness of making a ‘business-model based’ distinction for determining whether to apply fair value measurement for financial assets.

Going forward, the focus of policymakers should be on ensuring the following:

  • Consistent implementation of fair value measurement requirements by reporting entities.
  • Enhanced presentation of the comprehensive income statement including, a clearly defined purpose of OCI. Enhanced presentation can help investors to better distinguish between realized and unrealized gains or losses, for analytical purposes.
  • Enhanced disclosure of fair value measurement related information including comprehensive disclosures about the methods used to determine fair value and the sensitivity of reported fair value amounts.

The above will contribute to the overall transparency of annual and interim reports, which in turn will increase investor trust and willingness to invest in the economy, financial services sector and innovative financial instruments.

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