The economic consequences of fair value reclassifications under IFRS

Abstract

At the peak of the financial crisis in October 2008, the IASB forwent any regular due process to issue an emergency amendment to IAS 39 in order to relax fair value accounting. These amendments leave banks reporting under IFRS with the choice to retroactively reclassify financial assets that were previously measured at fair value into categories which require measurement at amortized cost, i.e. to effectively abandon fair value accounting for these assets. This decision sharply contrasted the IASB’s general strategy in reporting for financial instruments (IASB, 2008a) and its strong initial position against reclassifications. However, the board eventually surrendered to severe political pressure by the EU Commission and EU leaders, most prominently the French president Nicolas Sarkozy. They repeatedly voiced their concerns about the procyclicality that fair value accounting may introduce and requested to align accounting rules for European banks with those that apply to its US competitors, for which a similar reclassification option already existed under SFAS 65 and 115. In contrast, opponents of easing fair value rules, such as the British Prime Minister Gordon Brown, who stressed that fair values simply reflect current economic reality, went unheeded. This conflict at the top political level in the heat of the financial crisis has been the culmination of a longtime controversial debate in standard setting (e.g. Joint Working Group of Standard Setters, 1999; IASC, 1997) and academics (e.g. Barth, 2006; Landsman, 2007; Ronen, 2008) about the pros and cons of fair value accounting.