By : | April, 1 2009
Mutual fund industry players said the mark-to-market initiative passed today by the Financial Accounting Standards Board, could have detrimental effects on the mutual fund industry in the form of inconsistent valuation modeling among firms. FSP FAS 157-e, as the initiative is called, will also likely result in increased administrative costs and a greater burden on investment managers, brokers and pricing vendors that will have to make fair value determinations.
“While I understand the objective that FASB is heading at, I think it’s putting more subjectivity into the process,” said Charlie Rizzo, chief financial officer at John Hancock Funds. “When you have complexes like ours that have almost 10,000 fixed-income positions, the documentation requirements and processes that would have to be put forth to establish whether markets are liquid would be quite burdensome.”
The new initiative outlines a two-step process through which firms can determine if a market for a certain asset is inactive. FASB clearly states that this is not a suspension of mark-to-market standards, but rather that it loosens the tie between asset valuation and quoted market prices during times of turbulence. Firms would then use internal models or those of pricing vendors to determine the value of such assets. Mutual fund industry players noted that such methodic inconsistency could cause valuation problems. “With flexibility comes potential inconsistency. If everyone’s doing it differently, it’s hard to value assets,” said one fund lawyer.
Ianthe Zabel, spokeswoman for the Investment Company Institute, declined to comment, but referred FA to ICI’s comment letter issued on March 31, which addressed ICI’s two main concerns. “First, the two-step analysis required to assess whether markets are inactive and associated quotes are distressed will be particularly difficult for funds to implement into their daily valuation process. Second, we believe the Proposal will, in certain instances, require funds and other reporting entities to disregard market quotes that may be the best indicator of fair value in favor of alternative valuation techniques,” said ICI in its letter.
Espen Robak, president of Pluris Valuation Advisors, told FA the move away from mark-to-market valuations could lead to a run on funds in a worst-case scenario. “It’s unlikely to happen, but it is a concern. If people realize they can get more money by redeeming now than they would get later on, it could become a race for the exits,” he said. Robak said that despite FASB’s assurances that FSP FAS 157-e is not a suspension of mark-to-market standards, it will become one in practice. “If we only want the exit price in a normal market, we have moved away from the exit price on measurement dates” as required by fair valuation guidance laid out in FAS 157, said Robak.
The system will require firms to create internal valuation models if they do not already have them, which could burden smaller firms that don’t have the resources. It could also throw a wrench in the independent auditing system. “We’re moving farther away from independent valuation. The auditors are now going to have to rely on the management’s pricing determination,” said Rizzo.
Robak predicted that FASB would eventually revert to the mark-to market valuation practices as they were before FSP 157-e passed. “I wouldn’t be surprised if mark-to-market and fair value return once we get a couple of scandals with obviously incorrect evaluations,” he said.
