Mark to market
Mark to market (English for "price according to the market" or "set the market value"), also called revaluation or market valuation , is a valuation method in the annual financial statements of credit institutions , which in principle requires the valuation of financial instruments according to the current market price .
Legal bases
As the term suggests, this valuation method comes from Anglo-Saxon accounting practice. Here the IASB ( IAS 39; “ Financial Instruments: Recognition and Measurement ”) codifies strict accounting according to current market prices. On the other hand, the HGB requires a separate valuation according to fixed and current assets, whereby the value conventions of acquisition or production costs or lower fair value on the balance sheet date are applied.
HGB
According to the German Commercial Code, the strict lower value principle applies to current assets . This requires that the lower of the value conventions of acquisition / production costs or value on the balance sheet date must be taken ( Section 253 (3) sentence 1 HGB). The moderate lower value principle applicable to fixed assets only provides for depreciation in the event of expected permanent impairment (Section 253 (3) sentence 3 HGB). In the case of long-term financial assets, there is also the option of depreciating them in the event of a non-permanent decrease in value (Section 253 (3) sentence 4 HGB).
Mark to market
The “ mark to market ” valuation method does not distinguish between fixed and current assets. The price of an asset is determined in a liquid market and is therefore the value to be attached to the asset on the balance sheet date. However, since market prices are not always available in all balance sheet-relevant markets, this valuation method distinguishes between a three-level valuation hierarchy depending on the availability of market prices:
step 1
In level 1, all assets are valued that can be properly valued using current market prices (“ mark to market ” in the narrower sense). They are fungible financial instruments that are traded on active markets.
Level 2
In level 2, comparative values are used due to the lack of directly available market prices. Models are already being used here (“ mark to model ”), with the market price being estimated on the basis of observable processes. If the relevant markets are significantly less liquid than usual or if only a few prices are formed, the observable market values are to be used.
level 3
In all remaining cases, estimates must be made. For this purpose, mathematical models may be used (“ mark-to-model ”), the parameters of which are partly based on assumptions.
Active market
According to IAS 36.6, IAS 38.8 and IAS 41.8, an active market must meet the following cumulative requirements:
- the products traded on the market are homogeneous and
- willing buyers and sellers can usually be found at any time and
- Prices are available to the public.
A financial instrument is considered by IAS 39 as quoted in an active market if quoted prices are readily and regularly (English Readily and Regularly ) from an exchange, dealer, broker, industry group (English industry group ), a price-service agency ( Reuters or Bloomberg) or a regulatory authority are available and these prices represent actual and regularly occurring market transactions on an arm's length basis . In the case of listings on organized markets within the meaning of the Securities Trading Act , an active market can be assumed. The intention to generate profits from short-term price fluctuations presupposes that the financial instruments are traded on an active market within the meaning of Section 255, Paragraph 4, Clause 1 of the German Commercial Code (HGB), since the fair value corresponds to the market price determined on an active market.
An active market is no longer present if, due to the complete and long-term withdrawal of buyers and / or sellers from the market, market liquidity can no longer be determined. Such a lasting market change has occurred, for example, when trading comes to a standstill because a market maker no longer provides binding prices for a long period and no market transactions can be observed. If the transactions can be proven to result exclusively from forced transactions, forced liquidations or distress sales, this is an indication of a no longer active market for the financial instruments concerned.
Valuation practice
The market valuation is easiest for financial instruments for which stock market prices are published daily (marketable foreign exchange, securities and securities as the underlying ). It becomes more difficult, however, for financial instruments that are less fungible or that are traded on illiquid markets. The application of the procedure encounters major obstacles in the case of balance sheet items for which there are no active markets in the strict sense. The valuation method affects both the trading book and the banking book of credit institutions.
Holdings of currencies, types and securities
For each of these homogeneous financial instruments there is a highly organized market with daily stock exchange listing or price and exchange quotation , so that the requirements of an active market according to Section 255 (4) sentence 1 HGB or IAS 36.6 are generally met. The valuation then uses the current market price.
The situation is similar with a futures exchange , because profits and losses from futures transactions are calculated daily. These book profits and losses are then immediately taken into account on the trader's margin account. This adjustment of the margin coverage of open positions to the changing closing prices of futures and / or options on the accounts involved is also called mark to market .
Loans on bank balance sheets
The market-based assessment is more difficult when assessing credit risks at banks. Credit claims are not homogeneous and not fungible (except for the standardized promissory note loans ). For this reason, German commercial law basically provides for the nominal value principle for the valuation as for trade receivables (Section 253 (1) No. 1 HGB) and requires that doubtful receivables are to be entered with their probable value, while uncollectible receivables are to be written off ( Section 252 (1) No. 4 HGB).
In order to arrive at the market valuation of the loan receivables, the question of a functioning market must first be answered. For bank loans, there is at most a secondary market with little price transparency ( loan trade ). There is a lack of homogeneity and a sufficient number of market participants willing to buy and sell. Therefore, credit claims usually do not meet the requirements of a sufficiently active market. An assessment is usually carried out with the help of a credit risk model, which divides the credit claims into creditworthiness classes (assignment of rating codes ). This may be by a rating gradation or higher credit spreads higher credit risk arising without reasons for credit termination are present or there is a failure of the borrower at all. Under commercial law, the requirements for classification as a dubious claim are not yet met as long as the loans are serviced in accordance with the contract, so that there are no reasons for a partial write-off (yet). If loans are subject to market valuation, it is not only the partial write-offs or even loan defaults during the loan period that are a credit event , but also any change in the credit risk that can manifest itself through rising credit spreads.
Credit risk models have been developed for loans that can be used for market valuation purposes. One example is JP Morgan's CreditMetrics model. Such models simulate the possible events such as failures or rating changes and determine important key figures such as the so-called “credit value at risk” from the large number of simulation paths. The market valuation not only includes the credit risk, but also the change in creditworthiness. In 1999, Jovic and Volkart saw greater future potential in the market valuation of loans. It is to be expected that the international accounting rules will be adapted accordingly and also prescribe loans for categorization in levels 1 to 3.
criticism
The criticism of this valuation method has intensified because the market valuation process has exacerbated the critical situation in annual financial statements, especially for banks and insurance companies, since the financial market crisis in 2007, due to valuation losses to be posted. However, the valuation losses have not occurred as long as the stocks to be valued are retained. The mark-to-market method thus has a procyclical effect and aggravates the crisis. As a result, banks are forced to report those losses that have not yet been realized.
New legal regulation
The mark-to-market valuation can lead to considerable fluctuations in value, which are procyclical and can therefore exacerbate the crisis. With the new legal regulations, however, the principle of prudence of the HGB continues to take precedence. This becomes clear from the fact that the “fair value assessment” is still not permitted for non-banks. At banks, on the other hand, the “fair value assessment” only applies to financial instruments in the trading book. Due to international accounting regulations, it was not possible to completely dispense with the “fair value measurement”. In addition - similar to IFRS - a reallocation option will be created.
The financial market crisis has shown that, in exceptional cases, banks must be able to reclassify them from the trading book to the banking book. Without reallocation rights, changes in market values can lead to greater fluctuations in results (volatility) and, in times of crisis, trigger increased write-downs that lead to losses for banks. This reallocation must be specified and justified in the appendix according to Section 35 (1) of the RechKredV . The special provision of Section 340e (3) HGB, which has been in force since May 2009, eliminates the requirement for an active market, so that the scope of fair value accounting at credit institutions also includes financial instruments in the trading book that are not traded on an active market. In such cases, the fair value is determined with the help of financial mathematical valuation models according to mark-to-model (i.e. level 3). The special provision of Section 340e (3) HGB, which relates to the scope of Section 253 (1) sentence 3 HGB - i.e. the initial valuation of financial instruments at cost and the mandatory subsequent valuation at fair value - has now been expanded for banks.
Individual evidence
- ↑ Institut der Wirtschaftsprüfer, IDW position paper on accounting and valuation issues in connection with the subprime crisis , December 2007, p. 2.
- ↑ IdW circular HFA 9, No. 76 f.
- ↑ Institut der Wirtschaftsprüfer: IDW position paper on accounting and valuation issues in connection with the subprime crisis , December 2007, p. 3.
- ↑ Stephan Germann: Strategic Implications of Credit Risk Management at Banks , 2004, p. 80.
- ↑ Dean Jovic, Rudolf Volkart: On the use of credit risk models at banks , in: Der Schweizer Treuhänder 10/99, pp. 953–962.
- ^ The hidden risks in the balance sheet , Handelsblatt dated February 6, 2009.
- ↑ Increasing criticism of the "mark-to-market" rule , Neue Zürcher Zeitung Online from August 12, 2009.
- ↑ Amendment to Section 340e HGB on May 29, 2009