IFRS13 – Fair Value Measurement: Fair value is not enough!
The introduction of IFRS13 will entail a major change in the fair value measurement of asset and liability. For starting accounting periods beginning on or after 1 January 2013 it is mandatory to take credit risk into account while valuing both assets and liabilities.
IFRS-13-Fair Value Measurement is a set of directives about fair value measurement under IFRS. It does not give requirements on when fair value measurement is required but prescribes how fair value is to be measured. It applies to all transactions and balances (financial or non-financial) for which IFRSs require or permit fair value measurement. It applies for accounting periods beginning on or after 1 January 2013.
IFRS13 provides a new definition of fair value measurement: “the price that would be received to sell an asset or paid to transfer a liability” also called “exit price”. The key change here is the notion of exit liability rather than settle liability. Another important change in IFRS13 is that it is made mandatory to take credit risk into account while valuing both assets and liabilities. This is an evolution compared to IAS39. The lack of transparency in the old definition has led to different interpretations about the use of credit risk.
The implementation of counterparty credit risk (Credit Value Adjustment) and their own credit risk (Debit Value Adjustment) will be the most challenging adjustments for corporates. Several considerations have to be taking into account. Which market data have to be used? Is the market data available? How do you incorporate the CVA/DVA calculation into your valuation models?
It is generally admitted that credit default swaps (CDSs) are a good provider of credit spread and probability of default. This data is mainly available for the counterparties (financial institutions), so it is possible that this data is not available for the company itself. Alternative solutions have to be sought; one can think of market data based on peer group, sector, country and rating.
Depending on the availability of data and the type of instrument, different models with different degrees of complexity may apply. The simplest approach is to add the CDS spreads to the discount curve. The limitation of this approach is that, over the lifetime of some instruments (interest rate swaps, cross-currency swaps), the market value may be an asset or a liability. A second, more complex, approach is to compute the probabilities of default from the CDS curve and calculate the loss given default for each future flow.
- The CVA/DVA can be calculated at a portfolio level but should be redistributed at instrument level based on a pre-defined key.
- Any collateral agreement or netting agreement should be taken into consideration. The threshold from the agreement will act as a cap (maximum loss possible) for the CVA/DVA.
- The effectiveness test of the hedge relations will be impacted by IFRS13 as only the hedging instruments will carry CVA/DVA and not the hedged items.
IFRS13 will apply for the first time for many corporates during their Q2-2013 disclosures and several treasury systems may not be able to easily perform the valuations. Zanders is already helping several companies to integrate the CVA and DVA calculations on their financial instruments. Do you have any questions on how to implement this new regulation, on the capabilities or your actual system, on which data should be used or on the impact on your hedge relations? Don’t hesitate to contact Zanders.