FASB Staff Position (FSP) FAS157-4
This statement provides additional guidance in determining the fair value of a security when the volume and level of activity of that security has significantly decreased and identifies transactions that are not orderly.
The key definition for fair value is the same. However further analysis and significant judgment may be necessary in estimating the fair value in such circumstances. Usually it would require the application of multiple valuation techniques in order to estimate a reasonable range of fair value estimates and then determine a point within that range that is most representative of the fair value under current market conditions. The wider the range is the greater the level of additional analysis that will be need.
Significant Decrease in Volume and Level of Activity
The change in the level of activity will be evaluated using the following eight factors:
- Few recent transactions
- Price quotations are not based on current information
- Price quotations vary substantially over time or among market makers
- Indexes that previously were highly correlated with fair values are demonstrably uncorrelated with recent indications of fair value
- There is a significant increase in implied liquidity risk premiums, yields, or performance indicators (for example delinquency rates) for observed transactions or quoted prices when compared with estimated expected cash flows, considering all available market data about credit and other nonperformance risks
- There is a wide bid-ask spread or a significant increase in the bid-ask spread
- There is a significant decline or absence of a market for new issuances
- Little information is released publicly
If the is evidence of a significant decrease, then the quoted prices may not be determinative of fair value and further analysis/ adjustments would be required to estimate the fair value.
Orderly vs. Not Orderly Transactions
The following are some of the characteristics of a not orderly transaction:
- There was not adequate exposure to the market to allow for usual and customary marketing activities for transactions involving such assets under current market conditions.
- There was a usual and customary marketing period, but the seller marketed to only one buyer.
- The seller is in or near bankruptcy or receivership (distressed) or the seller was required to sell to meet regulatory or legal requirements (forced).
- The transaction price is an outlier compared to other recent transaction prices for the same or similar assets.
However, even if there has been a significant decrease in the volume and level of activity, it should not be concluded that all observable transactions are not orderly (that is, distressed or forced).
Estimating Fair Value When Volume and Level of Activity Have Significantly Decreased
Determining if an observable transaction is orderly or not orderly is more difficult when there has been a significant decrease in the volume and level of activity for the asset. Therefore the following decision tree can be used:
- If the weight of the evidence indicates that an observable transaction is not orderly, then little weight should be placed on that transaction price when estimating fair value (or market risk premiums).
- If the weight of the evidence indicates that an observable transaction is orderly, then the observable transaction price should be considered when estimating fair value (or market risk premiums). The weight placed on the observable transaction price compared with the weight placed on other indications of fair value is based on the facts and circumstances such as volume, comparability, and proximity.
If sufficient information is not available to conclude an observable transaction price is orderly or not orderly, then the observable transaction price may not be determinative of fair value and may not be used as the sole or primary basis for estimating fair value (or market risk premiums) and should receive less weight than other inputs.
Comparison with Staff Draft of IFRS on fair value measurement released on August 2010
There is very little difference between the staff draft of IFRS and the principles outlined in the FAS157 standard. These differences would be further reduced once the revised FASB exposure draft and IASB drafts are finalized.