International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  decrease in market activity for an asset or liability, as discussed at 8.1 below.

  Assessing whether a transaction is orderly can require significant judgement. The

  Boards believe this determination can be more difficult if there has been a significant

  decrease in the volume or level of activity for the asset or liability in relation to normal

  market activity. As such, IFRS 13 provides various factors to consider when assessing

  whether there has been a significant decrease in the volume or level of activity in the

  market (see 8.1 below) as well as circumstances that may indicate that a transaction is

  not orderly (see 8.2 below). Making these determinations is based on the weight of all

  available evidence. [IFRS 13.B43].

  8.1

  Evaluating whether there has been a significant decrease in the

  volume and level of activity for an asset or liability

  There are many reasons why the trading volume or level of activity for a particular asset

  or liability may decrease significantly. For example, shifts in supply and demand

  dynamics, changing levels of investors’ risk appetites and liquidity constraints of key

  market participants could all result in a significant reduction in the level of activity for

  certain items or class of items. While determining fair value for any asset or liability that

  does not trade in an active market often requires judgement, the application guidance

  in IFRS 13 is primarily focused on assets and liabilities in markets that have experienced

  a significant reduction in volume or activity. Prior to a decrease in activity, a market

  approach is often the primary valuation approach used to estimate fair value for these

  items, given the availability and relevance of observable data. Under a market approach,

  fair value is based on prices and other relevant information generated by market

  transactions involving assets and liabilities that are identical or comparable to the item

  Fair value measurement 975

  being measured. As transaction volume or activity for the asset decreases significantly,

  application of the market approach can prove more challenging and the use of

  additional valuation techniques may be warranted.

  The objective of a fair value measurement remains the same even when there has been

  a significant decrease in the volume or level of activity for the asset or liability.

  Paragraph B37 of IFRS 13 provides a number of factors that should be considered when

  evaluating whether there has been a significant decrease in the volume or level of

  activity for the asset or liability. The entity must ‘evaluate the significance and relevance

  of factors such as the following:

  (a) there are few recent transactions;

  (b) price quotations are not developed using current information;

  (c) price quotations vary substantially either over time or among market-makers (e.g.

  some brokered markets);

  (d) indices that previously were highly correlated with the fair values of the asset or

  liability are demonstrably uncorrelated with recent indications of fair value for that

  asset or liability;

  (e) there is a significant increase in implied liquidity risk premiums, yields or

  performance indicators (such as delinquency rates or loss severities) for observed

  transactions or quoted prices when compared with the entity’s estimate of

  expected cash flows, taking into account all available market data about credit and

  other non-performance risk for the asset or liability;

  (f) there is a wide bid-ask spread or significant increase in the bid-ask spread;

  (g) there is a significant decline in the activity of, or there is an absence of, a market for

  new issues (i.e. a primary market) for the asset or liability or similar assets or liabilities;

  (h) little information is publicly available (e.g. for transactions that take place in a

  principal-to-principal market)’. [IFRS 13.B37].

  These factors are not intended to be all-inclusive and should be considered along with

  any additional factors that are relevant based on the individual facts and circumstances.

  Determining whether the asset or liability has experienced a significant decrease in

  activity is based on the weight of the available evidence.

  IFRS 13 is clear that a decrease in the volume or level of activity, on its own, does not

  necessarily indicate that a transaction price or quoted price does not represent fair value

  or that a transaction in that market is not orderly. Additional analysis is required in these

  instances to assess the relevance of observed transactions or quoted prices in these

  markets. When market volumes decrease, adjustments to observable prices (which

  could be significant) may be necessary (see 8.3 below). As discussed at 16 below, an

  adjustment based on unobservable inputs that is significant to the fair value

  measurement in its entirety would result in a Level 3 measurement. Observed prices

  associated with transactions that are not orderly would not be deemed to be

  representative of fair value. As part of the PIR feedback some respondents highlighted

  this as an issue where additional guidance is required, however as noted in 1.1 above the

  IASB has decided that no follow-up actions will be undertaken.12

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  14

  8.1.1

  Can a market exhibit a significant decrease in volume or level of

  activity and still be considered active?

  A significant decrease in the volume of transactions does not automatically imply that a

  market is no longer active. IFRS 13 defines a market as active if transactions for the asset

  or liability occur with sufficient frequency and volume to provide pricing information

  on an ongoing basis. While the same factors may be used to assess whether a market has

  experienced a significant decrease in activity and to determine whether a market is

  active or inactive, these are separate and distinct determinations.

  The determination that a market has experienced a significant decrease in volume does

  not change the requirements of IFRS 13 related to the use of relevant observable data from

  active markets. That is, despite a decrease from recent (or historical) levels of activity,

  transactions for an asset or liability in a particular market may still occur with sufficient

  frequency and volume to provide pricing information on an ongoing basis, thereby

  qualifying as an active market. If there has been a significant decrease in activity, but a

  market is still deemed to be active, entities would continue to measure the fair value of

  identical instruments that trade in this market using P×Q (Level 1 measurement).

  An example of this is related to 2011 trading activity for Greek sovereign bonds. During

  that calendar year, the economic situation in Greece had deteriorated and some had

  questioned whether the Greek sovereign bonds were still being actively traded. In a

  public statement, ESMA indicated that, ‘[b]ased on trading data obtained from the Bank

  of Greece, it [was their] opinion that, as of 30 June 2011, the market was active for some

  Greek sovereign bonds but could be judged inactive for some others.’13 While ESMA

  provided no predictions about the level of trading activity as at 31 December 2011,

  ESMA clearly stated their expectation that a fair value measurement of Greek sovereign

  bonds,
in interim and annual financial statements during 2011 should be a Level 1

  measurement in situations where there was still an active market. Furthermore, ESMA

  expected entities to use a Level 2 measurement method that maximises the use of

  observable market data to measure the fair value of those bonds that were traded in

  inactive markets.

  Similar challenges exist for entities assessing whether a market is active for thinly traded

  investments. While trading volumes may be low, it may be challenging to conclude a

  market is not active when it regularly provides pricing information. Therefore,

  significant judgement will be needed to assess whether a market is active, based on the

  weight of evidence available.

  An entity’s conclusion that markets were not active for particular investments was

  recently challenged by ESMA. In its July 2015 enforcement report, ESMA noted that, in

  order to assess the existence of an active market, the entity had ‘calculated a number of

  ratios and compared them against the following benchmarks:

  • daily % of average value of trades / capitalisation lower than 0.05%;

  • daily equivalent value of trades lower than CU50,000;

  • daily bid-ask spread higher or equal to 3%;

  • maximum number of consecutive days with unvaried prices higher than 3;

  • % of trading days lower than 100%.’14

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  After performing this analysis and considering the limited trading volume, the issuer

  concluded that shares held in three of its listed available-for-sale investments were not

  traded in active markets. As a result, it measured fair value using a valuation technique

  based on Level 3 inputs. The enforcer disagreed with the issuer’s assessment of whether

  the markets were active and thought that the quoted prices for these investments should

  have been used to measure fair value. In reaching this decision, the enforcer specifically

  noted that ‘the indicators used by the issuer were insufficient to conclude that the

  transaction price did not represent fair value or that transactions occurred with

  insufficient frequency and volume. ... [T]he issuer did not gather sufficient information

  to determine whether transactions were orderly or took place with sufficient frequency

  and volume to provide pricing information. Therefore, based on available data, it was

  not possible to conclude that the markets, where the investments were listed, were not

  active and further analysis should have been performed to measure fair value.’15 The

  enforcer also raised concerns that the valuations based on Level 3 inputs were much

  higher than the quoted prices. Care will be needed when reaching a conclusion that a

  market is not active as this is a high hurdle.

  8.2

  Identifying transactions that are not orderly

  IFRS 13 defines an orderly transaction as ‘a transaction that assumes exposure to the

  market for a period before the measurement date to allow for marketing activities that

  are usual and customary for transactions involving such assets or liabilities; it is not a

  forced transaction (e.g. a forced liquidation or distress sale)’. [IFRS 13 Appendix A]. This

  definition includes two key components:

  (i) adequate market exposure is required in order to provide market participants the

  ability to obtain an awareness and knowledge of the asset or liability necessary for

  a market-based exchange; and

  (ii) the transaction should involve market participants that, while being motivated to

  transact for the asset or liability, are not compelled to do so.

  According to IFRS 13, ‘circumstances that may indicate that a transaction is not orderly

  include the following:

  (a) There was not adequate exposure to the market for a period before the

  measurement date to allow for marketing activities that are usual and customary

  for transactions involving such assets or liabilities under current market conditions;

  (b) There was a usual and customary marketing period, but the seller marketed the

  asset or liability to a single market participant;

  (c) The seller is in or near bankruptcy or receivership (i.e. the seller is distressed);

  (d) The seller was required to sell to meet regulatory or legal requirements (i.e. the

  seller was forced);

  (e) The transaction price is an outlier when compared with other recent transactions

  for the same or a similar asset or liability’. [IFRS 13.B43].

  These factors are not intended to be all-inclusive and should be considered along with

  any additional factors that may be pertinent to the individual facts and circumstances.

  978 Chapter

  14

  An entity must consider the following when measuring fair value or estimating market

  risk premiums:

  • if the evidence indicates that a transaction is not orderly, the entity places little, if

  any, weight (compared with other indications of fair value) on that transaction price;

  • if the evidence indicates that a transaction is orderly, the entity must take that

  transaction price into account. The amount of weight placed on that transaction

  price (compared with other indications of fair value) will depend on facts and

  circumstances, such as:

  (i) the volume of the transaction;

  (ii) the comparability of the transaction to the asset or liability being measured;

  and

  (iii) the proximity of the transaction to the measurement date; and

  • if an entity does not have sufficient information to determine whether a transaction

  is orderly, it must take that transaction price into account. However, it may not be

  representative of fair value, particularly where it is not the only or primary measure

  of fair value or market risk premium. Therefore, the entity must place less weight

  on those transactions (i.e. transactions the entity cannot conclude are orderly) and

  more weight on transactions that are known to be orderly. [IFRS 13.B44].

  IFRS 13 acknowledges that the determination of whether a transaction is orderly may

  be more difficult if there has been a significant decrease in the volume or level of

  activity. However, the standard is clear that, even when there has been a significant

  decrease in the volume or level of activity for an asset or liability, it is not appropriate

  to conclude that all transactions in that market are not orderly (i.e. distressed or forced).

  [IFRS 13.B43]. Instead, further assessment as to whether an observed transaction is not

  orderly generally needs to be made at the individual transaction level.

  IFRS 13 does not require an entity to undertake all possible efforts in assessing whether

  a transaction is orderly. However, information that is available without undue cost and

  effort cannot be ignored. For instance, when an entity is party to a transaction, the

  standard presumes it would have sufficient information to conclude whether the

  transaction is orderly. [IFRS 13.B44]. Conversely, the lack of transparency into the details

  of individual transactions occurring in the market, to which the entity is not a party, can

  pose practical challenges for many entities in making this assessment. Recognising this

  difficulty, the IASB provided additional guidance in paragraph B44(c) of IFRS 13, which

  indicates that while observable data should not be ignored wh
en the reporting entity

  does not have sufficient information to conclude on whether the transaction is orderly,

  the entity should place less weight on those transactions in comparison to other

  transactions that the reporting entity has concluded are orderly (see 8.3 below for

  further discussion). [IFRS 13.B44(c)].

  8.2.1

  Are all transactions entered into to meet regulatory requirements or

  transactions initiated during bankruptcy assumed to be not orderly?

  Although an entity may be viewed as being compelled to sell assets to comply with

  regulatory requirements, such transfers are not necessarily disorderly. If the entity was

  provided with the usual and customary period of time to market the asset to multiple

  Fair value measurement 979

  potential buyers, the transaction price may be representative of the asset’s fair value.

  Similarly, transactions initiated during bankruptcy are not automatically assumed to be

  disorderly. The determination of whether a transaction is not orderly requires a

  thorough evaluation of the specific facts and circumstances, including the exposure

  period and the number of potential buyers.

  8.2.2

  Is it possible for orderly transactions to take place in a ‘distressed’

  market?

  Yes. While there may be increased instances of transactions that are not orderly when

  a market has undergone a significant decrease in volume, it is not appropriate to assume

  that all transactions that occur in a market during a period of dislocation are distressed

  or forced. This determination is made at the individual transaction level and requires

  the use of judgement based on the specific facts and circumstances. While market

  factors such as an imbalance in supply and demand can affect the prices at which

  transactions occur in a given market, such an imbalance, in and of itself, does not

  indicate that the parties to a transaction were not knowledgeable and willing market

  participants or that a transaction was not orderly. For example, a transaction in a

  dislocated market is less likely to be considered a ‘distressed sale’ when multiple buyers

  have bid on the asset.

  In addition, while a fair value measurement incorporates the assumptions that sellers,