IT IS one of accounting's more obscure technicalities, but mark-to-market rules have become a debating flashpoint amid the financial crisis.
The rules, also known as fair value accounting, have been cited by politicians, policy analysts and pundits as causing much of the turmoil but others maintain their practice is relevant and must be kept.
Suspending it, they say, is in essence suspending reality.
Fair value accounting forces banks and other institutions to value assets not at the original purchase price or 'historical cost' but at current market value - what they can get for the asset right now, in other words.That has meant that such exotic instruments as collateralised debt obligations and other products containing sub-prime mortgages are basically worthless as no one will buy them. It does not matter that in five or 10 years they may have regained value and have found a market.
That is why many banks have had to bite the bullet and make massive writedowns of these products.
As banks took more hits to their balance sheets, others simultaneously recognised losses. This triggered fire sales, as others used the new lower benchmark, in turn leading to a vicious downward spiral that sucked the air out of markets.
This has sparked calls that the fair value rule be altered or suspended.
While a temporary suspension may be an attractive idea on the face of it to help calm the downward spiral in credit markets, the question still surfaces: What do you put in its place?
'I think the model is the best we have,' said Mr Tham Sai Choy, head of audit at KPMG in Singapore.
'Companies, auditors and standard-setters need to work together to refine the application of fair value accounting in illiquid markets.'
While fair value accounting is costly to adopt and not easily understood by companies, it is easy to see why investors welcomed it in the name of transparency.
Mr Yeoh Oon Jin, PricewaterhouseCoopers' (PwC) head of assurance practice, said that Japanese banks had in the 1980s held these bad loans on their books, but the fair value of the assets was not exactly known. In the end, the whole economy stagnated for a decade, he said.
Accountants say the focus on fair value accounting detracts investors from the fact that banks made decisions during boom times that are coming back to bite them now.
'We need to ask what inhibited bank boards from asking the right questions and understanding the risks being run by their managements,' said ACCA Singapore country head Penelope Phoon.
But most Asian jurisdictions are unlikely to experience so much of this extreme volatility in financial performance associated with standards like fair value accounting, said PwC Malaysia's executive chairman, Mr Johan Raslan.
This is because a lot of exotic derivatives and other financial instruments are not available in markets here or are kept off their books, but there are exceptions, he said.
Singapore's local banks are certainly susceptible to potential mark-to-market losses, say analysts.
In a report titled 'Treasury mark-to- market risk: Another reason to avoid DBS for now', Goldman Sachs analyst Kelvin Teo examined local bank securities/treasury portfolios and said DBS has the largest portfolio in absolute size at $54 billion and relative exposure at 23 per cent of total assets.
This article was first published in The Straits Times on October 18, 2008.
