(Un)Fair-value Accounting

As the financial year comes to an end, the clamour for suspension of fair-value accounting rules is getting more and more strident. Let me rewrite that sentence. As the financial year comes to an end, the clamour for letting companies hide facts from their shareholders is getting more and more strident.

Hardly a day goes by without some worthy adding his voice to the chorus crying for the suspension of mark-to-market (MTM) accounting rules. This is generally done anonymously. In all the new reports I have read on this issue, those who are arguing for companies to be allowed to hide losses generally don't let their names be revealed. They like to speak to the press 'on condition of anonymity', presumably because if you are part of a company's management and you express your opposition to fair-value accounting openly, then that's equivalent to recording mark-to-market losses in your profit and loss statement.

This parade of hidden faces points to what the real issue is. This is not about accounting rules but about transparency. The main issue here is that corporate managements would like to hide unpleasant facts from the shareholders who have invested in their companies' stock. If a company has bought a financial security for Rs 100 and it's now worth Rs 50 then why should this fact not be factored into the stock market's valuation of that company?

The argument that is generally given is that these are notional losses that are temporarily there because markets are not in a 'normal' state right now. It is generally pointed out that there has been some relaxation of MTM accounting rules in the US and in Europe. This argument is pure spin. The MTM relaxation in those countries is limited to valuation of mortgage-based securities whose market has basically vanished. It's entirely about the way illiquid securities are valued.

In India, all these MTM losses that are being lamented are in currency derivatives and there is nothing wrong with the global currency markets. Currencies have moved more sharply and in different directions than some people expected, but that's hardly a definition of abnormal. That's what markets do. To argue that Indian corporate managements should be allowed to hide currency losses from shareholders because European and American banks have been given some leeway in the valuation of illiquid mortgage-backed securities is just dishonest. There is no connection. The idea that MTM valuation should be modified for securities whose underlying markets have robust volumes has not been even been proposed anywhere else in the world.

The other part of the argument is the supposed unfairness of mark-to-market pricing and fair-value accounting. These are 'notional' losses, not real, not an actual cash outgo, etcetera etcetera. Correct me if I'm wrong, but I have utterly no memory of any corporate management ever protesting about the notionality of MTM profits. Did you ever come across anyone saying, “Part of our profits are merely notional, a result of MTM valuation. Since these are not real profits, we think accounting standards should be changed so that shareholders don't get an unfairly rosy picture of our profitability.” Why is it that fair value accounting feels so unfair only when it shows up losses?