Fair value revisions would hurt hedge fund industry, says Pluris

Date: Monday, April 6, 2009
Author: Hedgeweek.com

Proposed revisions to the 'fair value' accounting standard, FAS 157, would weaken the standard and create inconsistencies in valuations, according to Espen Robak, president of Pluris Valuation Advisors.

In a comment letter filed with the Financial Accounting Standards Board, Pluris said the standard (FSP) might help some banks, but would hurt hedge funds and companies that have been diligent about complying with 'fair value' accounting standards.

'The FSP appears to be designed to alleviate capital adequacy problems at banks and credit unions - indeed, many financial institutions have requested retroactive application,' Robak (pictured) said. 'In our view, those issues are best addressed by regulators and law makers, not by the FASB, which has the vital role of setting Generally Accepted Accounting Principles for the US.'

Because hedge funds typically allow redemptions based on a net asset value determined in accordance with GAAP, recognising those assets at a value greater than the exit price could be damaging, according to Robak. At a time when many hedge funds are struggling to survive, they could end up redeeming limited partner interests for an amount greater than the exit price. The revisions may also affect open-ended mutual funds that have some portion of their portfolio in inactively traded securities.

'As redemptions cause sales of securities, those sales are likely to be at prices below the 'fair value' NAV of the fund, under the FSP,' said Robak.  'Clearly, this will damage the interests of remaining LPs, which again increases the pressure to redeem.'

The changes could also have an impact on margining, risk management and other operational factors, Robak added.

Problems Robak cited include: proposed revisions assume that 'inactive' markets are the same as 'distressed' markets; few funds will be able to achieve Level 2 status when valuing illiquid or distressed securities and, as a result, the assets will be classified in Level 3, which is a step backward from existing rules; most funds will face significant challenges in meeting the tight deadline required for the proposed amendment; and the revisions are ambiguous - many terms are undefined and the one example given provides inadequate guidance.

If the FSP is approved, it will reduce investor confidence in financial statements, according to Robak, and 'we will no longer have balance sheets we can believe in.'