Fair play - An update on IPEV Guidelines

Given the current financial and economic conditions, fair value has become a much discussed and disputed topic of debate. The lack of comparables in the current market caused by low transaction volumes and the constantly increasing requirement of transparency from investors and third parties are some of the items that call for the global adoption of a common valuation guidance to reduce the subjectivity of the fair value estimation. In September 2009, the International Private Equity and Venture Capital (the "IPEV") Valuation Board released an update to the International Private Equity and Venture Capital Valuation Guidelines (the "IPEVCVG"), primarily to provide a number of clarifications and eliminate certain confusions, but also to ensure consistency with the recent changes in IFRS and US GAAP accounting principles. These new Guidelines apply to reporting periods after 1 July 2009.

Among the amendments, one should note that the definition of the fair value has been reshaped to fit both US GAAPs standards and the IFRS exposure draft 2009/5 on fair value measurement. From now on, the fair value shall be defined as "the price at which an orderly transaction would take place between market participants at the reporting date".

One of the main noticeable changes to this definition is the emphasis put on the "market participants" which suggest that fair value is measured on "the market" for the asset. This market is the one on which the private equity fund would sell or transfer the asset to potential or actual willing buyers when neither is under compulsion to buy or sell and both parties have reasonable knowledge of relevant facts and the ability to perform sufficient due diligence. Additionally, this measure needs to be performed on each reporting date, which assumes the private equity fund has access to the market as of those dates. It is therefore on the assumption that the asset would be exchanged on this market that an appropriate valuation methodology should be applied. This amendment clarifies further the context in which an appropriate methodology should be selected.

A second noticeable change is that the Guidelines now insist on the fact that the fair value must take into account the current market conditions at the reporting date. This amendment clearly forbids any fair value based on assumptions that the asset will be sold at a later stage in different market conditions. While this clarification will increase the volatility and the accuracy of the fair value, it will also generate a fundamental change in the perception of fair value certain valuers still have.

A third noticeable change is the removal of the fair value concept limitation to assets. Thereby, the IPEVCVG open the door to liabilities fair valuation, with the following main issue: liabilities are rarely sold in the marketplace because of contractual restrictions preventing their transfer, whereas some of them are traded in the marketplace as assets; so if an identical liability is not available on the market, a company should measure fair value using one alternative approach. However, the IPEVCVG are presently wordless on this topic, as we understand both the IASB and the FASB are currently working on this subject: the FASB is studying the techniques to estimate the fair value of a liability (FSP FAS 157-f) whereas the IASB has recently issued a discussion paper to examine whether current measurements of liabilities (including fair value) at initial recognition and subsequently should incorporate credit risk.

Overall, while fair value remains a forward-looking concept, these substantial changes will have a major consequence to limit further the flexibility of the concept by increasing the impact of the market conditions on the assessments. This should enhance the comparability across the industry, but might trigger new challenges for the valuers.

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