Fair value measurement has become a cornerstone of modern financial reporting, offering a transparent and consistent approach to assessing the value of assets and liabilities in today’s dynamic economic environment. With today’s market ever evolving and financial instruments growing complex, the need for accurate, reliable, and comparable fair value determinations has never been more critical.

The main challenges, when it comes to fair value determination, are the need to focus on structural complications in combination with market shifts, as well as considerations for the accuracy and reliability of input parameters. Francisco Jimenez and our team delve deeper into the relevant challenges and best practices below. 

General market climate

With rate cuts from several central banks and a steady volatility index, we understand the fair value estimation would be pushed upwards for securities that rely on expected future cashflows. Reliability of the valuation model will also increase as a result of narrowing credit spreads, reducing the gap between floor and ceiling values.

On the other hand, we understand investors need to pay attention to drying up liquidity, as this tends to increase bid-ask spreads and imposes uncertainty in fair value hierarchy assessments. As less inputs would be directly observable, more securities could shift from level 1 to level 2, or even borderline level 3 with sufficient assessment.

Our insight on current challenges and pitfalls

In light of market movements and their impact on valuation, we have released a new version of our Fair value measurement handbook 2024, which shares our Insights as well as practical guidance when applying Topic 820 and IFRS 13 Fair Value Measurement.  

The handbook focuses on the below pillars of fair value measurements. Accordingly, we have observed the following challenges and pitfalls associated with each topic from our engagements with clients.

Methodologies and assumptions

Challenge remains to find the most appropriate valuation technique to use for determining fair value. Whilst a market-based approach is desirable, assessments on using a suitable income approach and assumptions come with it can be challenging.

As we understand, fair value could be distorted, should inaccurate methodologies and assumptions be used given the rapidly changing market conditions.

Selecting a reasonable comparable when modelling a target bond requires a few key assumptions and would need to be carefully considered with adjustments – noting this would impact not only the fair value, but also the levelling associated with the security.

Inputs

Thorough assessments are needed when pricing services is considered, and this leads to the assessment of both the relevance and the reliability of them.

In our exposure, relevance signatures whether the inputs are reflecting current market practice, while reliability highlights the quality of the data.

Challenges commonly lie within the assessment of reliability on a case-by-case basis. We understand this requires a breakdown at an asset class level and considering market climates.

Market

It is a common practice across the market to use the principal market if one can be identified.

However, we see cases where certain instruments can trade on an active basis while the prices are not actually representative of the fair value, this challenge usually emerges along with geopolitical tensions.

It also imposes a challenge to determine the fair value when there is low trading activity, or when one has limited access to certain markets.

Our exposures show that having access to multiple service providers, exchanges, or maintaining a lookback period usually help with this matter.

Fair value hierarchy

In our view, there is no “golden rule” to determine the fair value hierarchy, and it is all about one’s professional judgement and assessment of different metrics.

It is common for us to see in clients that a “family approaches” is taken, which groups certain financial instruments into one bucket – We believe this is incorrect, for each security can be different in nature, and more considerations need to be implemented.

For example, not all fixed income securities trade the same way, their issuers, creditworthiness, payment structure and key events can all impact the levelling.

Furthermore, the utilisation of unobservable inputs and the assessment on market value’ sensitivity towards them can hinder pitfalls when determining fair value hierarchy – for it requires systematic and consistent analysis and can only be done on an individual level.

How can KPMG help

  • KPMG can assist you in determining fair value by providing expert guidance and ensuring that the valuation process adheres to industry best practices and relevant standards, along with assisting in the determination of a fair value hierarchy for securities.
  • We provide assessments of various factors for fair value hierarchy, including the analysis of unobservable inputs on a security basis.
  • KPMG monitors the changing nature of each asset, market conditions, and the applicable financial reporting standards to help clients stay ahead of the current.
  • We leverage a wide range of proprietary and third-party data sources to assist in accurate pricing and fair value determination.
  • We provide detailed reports and disclosure outlining the fair value determination process, assumptions used, and the conclusions drawn, ensuring that all stakeholders understand the valuation.

Get in touch

We put value at the heart of everything we do. We understand the needs of our clients and endeavour to help them respond to the evolving market environment and business needs. Our team of experienced subject matter experts are focused on delivering quality outcomes for our clients.

Our access to KPMG’s global network of professionals ensure that we can draw on their experience to have the right support, advice and services you need.

To get the support for determining fair value and to go through relevant assessments, reach out to our KPMG Financial Instruments (KFI) team.
 

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