Fair Value and Derivatives Measurement and Disclosure Jim Laures Deloitte & Touche LLP March 2, 2010
Agenda • FASB Accounting Standards Codification (“ASC”) Topic 815, Derivative and Hedging (formerly, Statement of Financial Accounting Standards (“SFAS”) No. 161, Disclosures about Derivatives and Hedging Activities--an amendment of FASB Statement No. 133) (ASC 815) • FASB ASC Topic 820, Fair Value Measurements and Disclosures (formerly SFAS No. 157, Fair Value Measurements) (ASC 820) • FASB Accounting Standards Update (“ASU”) 2009-12, Fair Value Measurements and Disclosures (Topic 820)—Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (ASU 2009-12) • FASB ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures About Fair Value Measurements (ASU 2010-06) • FASB Staff Position No. FAS 157-4, Determining Fair Value when the Volume and Level of Activity for the Asset or Liability have Significantly Decreased and Identifying Transactions that are Not Orderly (FSP FAS 157-4) • Other
ASC 815 When and Why Issued • Issued March 2008 • Expands existing disclosure requirements to improve transparency of financial reporting and provide users of financial statements with an enhanced understanding of: • How and why derivatives are used • How derivatives and related hedged items are accounted for under SFAS No. 133 • How derivative instruments affect an entity’s financial position and results of operations • Effective for periods beginning after November 15, 2008 (2009 for calendar year entities) • Comparative disclosures required only for periods subsequent to initial adoption
ASC 815 • Qualitative Disclosures • Purpose and objectives for using derivatives, strategies for achieving objectives • Distinguish between instruments used for risk management (hedging) and those used for other purposes (trading) • Further disaggregate current required disclosures by the “primary underlying risk exposure” • interest rate • credit • foreign exchange rate • equity • Describe volume of derivatives activity by type of instrument • Notional amounts • Number of contracts • Etc.
ASC 815 • Quantitative Disclosures – Statement of Assets and Liabilities • No change in current presentation of derivatives on Statement of Assets and Liabilities • No change in disclosure of each derivative by type within the Schedule of Investments or in Footnotes • However, new tabular disclosure of derivatives required • Summarize by primary risk exposure • Identify location (by line item) in Statement of Assets and Liabilities • Period end fair value--gross basis • Even when derivatives are subject to master netting arrangements and qualify for net presentation • Cash collateral payables and receivables associated with derivatives should not be added to/netted against the fair value amounts
ASC 815 • Statement of Operations – Realized & Unrealized Gain (Loss) • No change to existing presentation within Statement of Operations • However, new tabular disclosure of derivatives’ realized and change in unrealized gains/losses required • Summarize by primary risk exposure • Identify location (by line item) in Statement of Operations
ASC 815 • Example Illustration – Statement of Assets and Liabilities – Assets • Fair Values of Derivatives in the Assets section of Statement of Assets and Liabilities (remains unchanged)
ASC 815 • Example Illustration – Statement of Assets and Liabilities – Liabilities • Fair Values of Derivatives in the Liabilities section of Statement of Assets and Liabilities (remains unchanged)
ASC 815 • Example Tabular Disclosure Footnote (Statement of Assets and Liabilities) – for Derivatives not accounted for as hedging instruments
ASC 815 • Example Illustration – Statement of Operations • Excerpt of Realized Gain (Loss) and Change in Net Unrealized appreciation (depreciation) section (remains unchanged)
ASC 815 • Example Tabular Disclosure Footnote (Statement of Operations) – Derivatives not accounted for as hedging instruments [Note: Separate tabular disclosure for realized and for unrealized is not required; realized and unrealized can be combined into one tabular disclosure.]
ASC 815 • Other Key Requirements • Adds credit risk disclosure requirements • Disclose existence and nature of credit-risk-related contingent features that require, upon occurrence of a credit event (e.g., credit rating downgrade), settlement of derivative or posting of collateral • Clarifies that derivatives are subject to “concentration of credit risk disclosures” required by FASB ASC Topic 825, Financial Instruments (formerly SFAS No. 107, Disclosure About Fair Value of Financial Instruments) • Cross-referencing from derivatives footnote to other footnotes required when disclosure information is presented elsewhere in financial statements Resource • Managed Funds Association Discussion Paper on FAS 161 Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (Feb 2010) [member’s only]
ASU 2009-12 • When and Why Issued • Issued September 30, 2009 • Creates a “practical expedient” for measuring the fair value of investments in certain entities (“Investee”) that calculate net asset value per share (NAV) • Prior to issuance, there was diversity in practice in how investors estimated fair value of investments in funds that calculate NAV • NAV is determinative of fair value, without further adjustment as of the reporting date • NAV adjusted to account for impact of the attributes of the investment--e.g., restrictions on redemption (e.g., lockups and gates), unfunded commitments, and intangible benefits • Effective for interim and annual periods ending after December 15, 2009 (2009 for calendar year entities) • Early application is permitted; however, if applied, an entity may defer adoption of the disclosure provisions
ASU 2009-12 • Scope • Applies to an investment in an Investee: • That has attributes of an investment company (as defined in FASB ASC Topic 946, Financial Services – Investment Companies), or • For which it is industry practice to issue financial statements using guidance consistent with the measurement principles of FASB ASC Topic 946 • Does not apply to an investment with a readily determinable fair value • Examples: Potentially In Potentially Out • Certain investments in: • Hedge funds • Private equity funds • Venture capital funds • Real estate funds • Foreign hedge funds • Certain investments in: • Operating entities • Mutual funds • Closed-end funds transacted on an exchange • Closed-end funds transacted in an over-the-counter market
ASU 2009-12 • What it Does • Permits reporting entity to use of NAV per share (or its equivalent) to measure fair value for alternative investments (e.g., hedge funds, private equity funds, etc.) • If NAV is not calculated as of reporting entity’s measurement date, requires reporting entity to adjust NAV for significant market events that may have occurred since the Investee calculated NAV • Investment-by-investment election • Requires either Level 2 or Level 3 classification by the reporting entity determined by ability to redeem • Level 2: ability to redeem at NAV at measurement date • Level 3: will never have the ability to redeem at NAV at measurement date • Level 2 or 3: if can’t redeem at NAV at measurement date (but may be able to redeem at a later date), evaluate “length of time until investment will become redeemable”
ASU 2009-12 • What it Does (continued) • Prohibits use of NAV as a practical expedient if it is probable the reporting entity will sell the investment (or portion thereof) at a price other than NAV. To be considered probable: • Management with authority to approve the action commits to a plan to sell • Active program to locate a buyer or other actions to complete the plan to sell has been initiated • Investment is available for immediate sale subject only to terms and conditions that are usual and customary for such sales • Actions required to complete the plan indicate that it is unlikely that plan will be significantly changed or withdrawn
ASU 2009-12 • Disclosure by major category of investments • Fair value of investments and description of significant investment strategies of the Investee(s) • Estimate of period over which an Investee may liquidate underlying investments (This disclosure applies only to investments (a) that cannot be redeemed and (b) when the reporting entity receives distributions via liquidation of the underlying investments by the Investee) • Amount of reporting entity’s unfunded commitments related to investments in the major categories • General description of terms and conditions upon which the reporting entity may redeem the investments --e.g., quarterly redemption with 60 days’ notice, etc. • Circumstances in which an otherwise redeemable investment might not be redeemable—e.g., because of lockups or gates, etc.
ASU 2009-12 • Disclosures by major category of investments (continued) • For investments that are redeemable but restricted from redemption as of reporting entity’s measurement date: • Best estimate of when restriction from redemption might lapse; or • Fact that an estimate cannot be made. • Other significant restrictions on the reporting entity’s ability to sell the investment as of measurement date. • Sale of investments: • Total fair value and remaining actions required to finalize sale of investments for which it is probable that the reporting entity will sell the investment for an amount other than NAV • However, if reporting entity has not identified the individual investment that it is probable will be sold, reporting entity must still disclose its plan to sell and remaining actions required to complete the sale • Example Case D Disclosure in ASU 2009-12
ASU 2009-12 AICPA Resource • AICPA issued guidance in the form of Technical Questions and Answers (TIS) (commonly referred to as Technical Practice Aids or TPAs) and placed them in TIS Sections 2220, Long-Term Investments, including them in TIS Sections 2220.18-27 (Alternative Investments TPA) • Guidance considered non-authoritative and not part of the FASB Accounting Standards Codification • Available on the AICPA’s Web site.
ASU 2010-06 • When Issued and What Changed • Issued January 2010 • Amends ASC 820 (formerly SFAS No.157): • New requirements for disclosures about transfers into and out of Level 1 and Level 2 • Separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements • Clarifies existing fair value disclosures about level of disaggregation and inputs and valuation techniques used to measure fair value • Generally effective for first interim or annual reporting period beginning after December 15, 2009 (2010 for calendar year entities)
ASU 2010-06 • Level of Disaggregation • Existing Disclosure--provide disclosures by each “major category” of assets and liabilities. • Term “major category” often has been interpreted to be a line item in the statement of financial position • New/Amended Disclosure—provide disclosures by each “class” of asset and liability • Determine “class” on basis of nature and risks of securities--consider activity or business sector, vintage, geographic concentration, credit quality, and economic characteristic (consistent with FASB Topic ASC 320, Investments—Debt and Equity Securities) • For other assets and liabilities: • Use judgment to determine appropriate classes • Consider requirements under other U.S. GAAP--e.g., disclosure level for derivatives per ASC Topic 815 Derivatives and Hedging • In addition to nature and risks, also consider placement in fair value hierarchy (i.e., Levels 1, 2, or 3)—e.g., greater number of classes may be necessary for fair value measurements with significant unobservable inputs (Level 3) due to increased uncertainty and subjectivity
ASU 2010-06 • Transfers into/out of Levels 1, 2 and 3 • Existing Disclosure—transfers into/out of Level 3 only • New/Amended Disclosure: • Significant transfers between Level 1 and Level 2 and reasons for transfers • Transfers into/out of Level 3 and reasons for transfers • Consistent application of policies for determining when transfers are recognized and policies should be the same for transfers into/out of Levels 1, 2 and 3
ASU 2010-06 • Level 3 Reconciliation • Existing Disclosure: • No separate disclosures of total gains/losses recognized in OCI • Purchases, sales, issuances and settlements (on net basis) • Transfers into/out of Level 3 • New/Amended Disclosure: • Total gains/losses recognized in OCI • Purchases, sales, issuances and settlements (on gross basis) • Transfers into/out of Level 3 (separately if significant ) and reasons for transfers
ASU 2010-06 • Valuation Techniques and Inputs • Existing Disclosure: • Input and valuation technique(s) used to measure fair value • Discussion of changes in valuation techniques and related inputs, if any, during period • New/Amended Disclosure--for Levels 2 and 3: • Description of valuation techniques and input used to determine fair values of each class • Discussion of changes in valuation techniques, if any, and reasons for them
ASU 2010-06 • Effective Date • Generally effective for first interim or annual reporting period beginning after December 15, 2009 (2010 for calendar year entities) • Requirement to provide Level 3 activity of purchases, sales, issuances. and settlements (on gross basis) effective for fiscal years beginning after December 15, 2010 (2011 for calendar year entities) • In period of initial adoption, not required to provide amended disclosures for any previous periods presented • Early adoption permitted
FSP FAS 157-4 • Timeline of Events April 2009 September 2006 October 2008 December 2008 February 2009 FASB issues FSP 157-4, Determining Fair Vlaue when the Volume and Level of Activiity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly. FSP 157-4 superseded FSP FAS 157-3. FASB Statement No. 157, Fair Value Measurements, established a single definition of fair value and a framework for measuring fair value. The statement also expanded disclosures of fair value measuerment. FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Market when the Market for that Asset is not Active. Primary intent was to reinforce the principles of FAS 157 and to emphasize the ability of an entity to use its own assumptions when obeservable inputs are not available. The Emergency Economic Stabilization Act of 2008 mandated the SEC to conduct a study on market-to-market accounting standards. The study was released in December 2008, concluding that existing fair value accounting requirements should not be supsended and recommended measures to improve the application of such requirements. The Valuation Resource Group provided their views to FASB that additional guidance on inactive markets and distressed transactions was warranted.
FSP FAS 157-4 • What it Does • Provides application guidance • Determining fair value when the volume and level of market activity has significantly declined • Identifying transactions that are not orderly • Fair value is a market-based measurement, not an entity-specific measurement • Use of significant judgment • Reemphasizes the exit price notion • Amends disclosures • Supersedes FSP FAS 157-3
FSP FAS 157-4 • What Changed • Significant changes from Exposure Draft: • Eliminates presumption that all transactions are distressed in inactive markets • Exit price notion under current market conditions vs. hypothetical active market • Focus is on markets with a significant decline in market activity vs. markets which have always been inactive • Effective Date • Effective for interim and annual periods ending after June 15, 2009 (2009 for calendar year entities) • Early application permitted for interim and annual periods ending after March 15, 2009
FSP FAS 157-4 • Decrease in Trading Volume • Description of factors (not all-inclusive) that might indicate a decrease in trading volume occurred: • scarcity of recent transactions • price quotes are not based on current information • substantial variation in price quotes • indexes no longer correlated with indications of fair values • widening difference between present value of future cash flows versus quoted or transaction prices (implying discounts relating to liquidity and other performance indicators) • wider bid-ask spread • less new issuance in the market for similar assets or liabilities • little information is available publicly • If significant decline, transaction price or quoted price may not be representative of fair value; perform additional analysis
FSP FAS 157-4 • Determining Whether a Transaction is Orderly • Must not presume that all transactions are not orderly (forced or distressed) • Assess factors to determine if the transaction is not orderly: • Not adequate exposure to market (before measurement date) to allow for marketing activities that are usual and customary under current conditions • Seller marketed the asset to a single participant • Seller is in or near bankruptcy or receivership, or required to sell to meet regulatory requirements (that is, forced) • Transaction price is an outlier when compared to other recent transactions (for same or similar assets or liability) Note Entities may consider additional factors. Must evaluate the circumstances to determine whether the transaction is orderly based on the weight of the evidence.
FSP FAS 157-4 • Determining Whether a Transaction is Orderly (continued) • A reporting entity shall evaluate the circumstances to determine whether the transaction is orderly based on the weight of the evidence. What does this mean? Entities should “not ignore information that is available without undue cost and effort.”
FSP FAS 157-4 • Quoted Prices • Does not exclude the use of quoted prices (broker quotes or pricing services) • Entities should evaluate whether the quoted price is based on: • Current information that reflects orderly transactions, or • A valuation technique that reflects market participant assumptions (including about risk) • Appropriately weight the quoted price in determining fair value: • Indicative • Binding • If a significant decrease in trading volume, quotes may not represent fair value What does this mean? Entities should assess the nature of the quoted price and, based on its assessment, appropriately weight the quoted price along with other inputs in determining fair value.
FSP FAS 157-4 • Additional Reporting Requirements • FSP amends FASB Topic 820 (formerly SFAS No.157): • Requires disclosure of inputs and valuation technique(s) used to measure fair value and discussion of changes in valuation techniques and related inputs, if any. • Defines major category1 for equity securities and debt securities to be major security types as described in paragraph 19 of FASB Statement No. 115, which states in part: “Major security types shall be based on the nature and risks of the security. An enterprise should consider the (shared) activity or business sector, vintage, geographic concentration, credit quality, or economic characteristic in determining whether disclosure for a particular security type is necessary and whether it is necessary to further separate a particular security type into greater detail.” • 1 See paragraphs 32 and 33 of Statement 157
FSP FAS 157-4 • Additional Reporting Requirements (continued) • Major security types include: • Equity securities (segregated by industry type, company size, or investment objective) • Debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies • Debt securities issued by states of the United States and political subdivisions of the states • Debt securities issued by foreign governments • Corporate debt securities • Residential mortgage-backed securities • Commercial mortgage-backed securities • Collateralized debt obligations • Other debt obligations
FSP FAS 157-4 • Additional Reporting Requirements (continued) • The FSP also requires the reconciliation of beginning and ending Level 3 holdings (i.e., the Level 3 “roll-forward”) to be provided by major security type.
Other FASB ASU 2010-10, Consolidation (Topic 810) – Amendments for Certain Investment Funds (issued Feb 2010) (ASU 2010-10): • Amends consolidation requirements for variable interest entities (“VIEs”) contained in FASB Statement No. 167, Amendments to FASB Interpretation 46(R) [issued June 2009] • FASB No. 167 would have required, under certain circumstances, a reporting entity such as a commodity pool operator (CPO) to consolidate, in its audited financial statements, the funds it sponsors (effective 2010) • Application of the FASB No. 167 consolidation requirements are deferred for certain entities (e.g., mutual funds, hedge funds, private equity funds, etc.) • However, certain disclosures for all VIEs in which the reporting entity holds a variable interest, including VIEs that qualify for the ASU 2010-10 deferral, are required FASB ASU, 2010-09, Subsequent Events (Topic 855)—Amendments to Certain Recognition and Disclosure Requirements (Feb 2010)
Contact Information Jim Laures (Chicago)firstname.lastname@example.org(312) 486-3331