Mark-to-market accounting

Mark -to-market (English, called on German as " contingent valuation ", also re-evaluation process ) is a valuation method in the annual accounts of credit institutions, which in principle requires the measurement of financial instruments according to the current market price.

• 5.1 forex, foreign and security holdings
• 5.2 credits in bank balance sheets

Legal bases

As the term suggests, this method of valuation comes from the Anglo-Saxon accounting practices. Here, the IASB codified ( IAS 39 "Financial Instruments: Recognition and Measurement" ) a strict accounting in accordance with current market prices. On the other hand calls the HGB separated according to fixed and current asset valuation and the valuation conventions acquisition or production costs or lower fair value are used at the balance sheet date.

HGB

When working capital is considered according to the German Commercial Code, the strict lower. This requires that the lower must be taken of the value of conventions Historical cost or value at the balance sheet date ( § 253 paragraph 3 sentence 1 HGB). The current assets at the lower of tempered is a discretionary provision, so that the lower value can be selected ( § 253 paragraph 2 sentence 3 sentence 1 HGB). However, if in this case the impairment permanent, so the lower value must be selected ( sub-clause 2 of the German Commercial Code - determination) even in this case.

Mark -to-market

The mark-to -market valuation method does not know this differentiation according to fixed and current assets. The price of an asset is determined in a liquid market, making it the value to be attributed to the asset on the balance sheet date. However, since not every time market prices are not at all relevant for balancing markets available, the mark-to -market valuation method recognizes three different levels of evaluation.

Level 1

As a "Level 1 " are those assets classified, based on the current market prices are properly assessable ( " mark-to -market" in the narrow sense ). It is fungible, traded in very liquid markets, financial instruments, which are predominantly traded on exchanges or well-organized OTC markets.

Level 2

Here are already working with models ( " mark-to- model" ), the market price is estimated based on observable events. If relevant markets or form only a few prices are much less liquid than usual, the observable market values ​​must be used.

Level 3

However, should the market price be only the result of distress sales or Zwangsliquidierungen, the reporting entity can in a completely illiquid market with unobservable parameters but also on assumptions and complex mathematical models to fall back ( " mark-to- model" ).

Active market

An active market must be in accordance with IAS 36.6, IAS 38.8 and IAS 41.8 cumulatively meet the following conditions:

• The items traded within the market are homogeneous and
• Willing buyers and sellers can normally be found in the rule at any time and
• Prices to the public are available.

A financial instrument is recorded in accordance with IAS 39 as in an active market considered if quoted prices are readily and regularly ( Readily and Regularly) from an exchange, dealer, broker, industry group ( industry group ), a price -service agency (eg Reuters or Bloomberg ), or regulatory agency ( regulatory agency ) are available and those prices represent actual and regularly (actual and regularly) ereignende market transactions on arm's length basis. For quotations on organized markets in the sense of § 2 para 5 WpHG is regularly assumed an active market. The purpose of generating profits from short-term price fluctuations, assumes that financial instruments in an active market within the meaning of § 255 paragraph 4, sentence 1 HGB are traded, because the fair value corresponds to the market price, which is determined on an active market.

An active market no longer exists when, because of the complete and long-term withdrawal of buyers and / or sellers in the market, a market liquidity is no longer observed. Such a sustained market change, for example, occurred when trade thereby come to a halt, that a Market Maker is not a binding prices over a longer period and also no market transactions are observed. If the transactions shown to result solely from a forced transaction, involuntary liquidation or distress sales, this is an indication of a non-active market for the financial instruments in question.

Applicable balance sheet items

The easiest way is to use the mark-to - market method of financial instruments for which market prices are published daily ( marketable foreign currency, foreign currency and securities as underlying). It is more difficult, however, for financial instruments that are less fungible and / or ( temporary or permanent) are traded on illiquid markets. On biggest obstacles applying the method at balance sheet items for which there is no active market in the true sense encounters. Mark -to-market concerns so that both the trading book and the banking book of banks.

Foreign exchange, foreign and security holdings

For this homogeneous financial instruments, respectively, there is a highly organized market with daily exchange listing or price and exchange rate quotation, so that the conditions of an active market pursuant to § 255 paragraph 4, sentence 1 HGB and IAS 36.6 are available. A contingent valuation with these marketable financial instruments can therefore be carried out using the mark-to -market method in active markets.

Importantly, this method is also on the futures exchange, because gains and losses on forward contracts are calculated daily. This book gains and losses are then taken into account immediately on the margin account of trader. This adaptation of the margin cover of open positions on the changing closing prices of futures and / or options on the participating accounts also are called marking to market.

Loans in bank balance sheets

More difficult to market-consistent valuation is, however, in evaluating credit risk in banks. Loans are not homogeneous and not fungible (except for the standardized promissory notes). Therefore, the German commercial law sees in principle, the nominal value principle for the evaluation procedure as for receivables from deliveries and services ( § 253 paragraph 1 No. 1 HGB) and requires that doubtful accounts at their probable value are to be used, are as uncollectible write off ( § 252 paragraph 1 No. 4 HGB).

If you wanted to try to subdue the loan receivable balances of credit institutions the mark-to -market standards, is the first question to answer is whether there is a functioning market for that financial instrument. Is at best a secondary market with no or only small price transparency ( credit trading ) for bank loans. They lack in addition to the homogeneity nor the sufficient number purchase or sale willing market participant. Therefore credit receivables meet the requirements of the mark-to -market method, first mostly not. On the other hand, after the mark-to -market standard by a rating downgrade or higher credit spreads increased credit risk arising without the reasons for a loan termination are present or even cause failure of the borrower. Commercial law are here the conditions for classification as doubtful receivables not yet available, as long as the Loans are repaid according to the contract, so that the reasons for a reduction in value of (still) do not exist. Credits will be evaluated by mark-to -market, are not only the reduction in value of or even the credit default during the loan term, a credit event, but any change in credit risk, which can manifest itself by rising credit spreads.

Models have been developed for loans with the help of the mark-to- market method can be used. An example of such a mark-to -market credit risk model is the " Credit Metrics " by JP Morgan. This model simulates the possible events such as failures or rating changes and determined in the next step of a large number of simulation runs important indicators, such as the so-called " credit value- at-risk ." Mark -to-market in this case means that not only credit risk, but also the possible changes in credit ratings are considered. Jovic and Volkart see in this approach to involve loans in the mark-to -market method, larger future potential. It is expected that international accounting rules will be adjusted accordingly and prescribe loans for a categorization in level 1 to 3.

Criticism

The criticism of this valuation method has intensified because the mark-to -market valuation method has exacerbated the critical situation in the financial statements, particularly in banking and insurance, accounted for by valuation losses since the financial crisis of 2007. The valuation losses while not occurred, as recorded in the stocks to be assessed. Thus, the mark-to- market method pro-cyclical and exacerbating the crisis. Banks are thus forced to report losses even those that are not yet realized.

Legal regulation

The mark-to -market valuation can lead to considerable fluctuations in value, which are pro-cyclical and therefore can affect reinforcing crisis. With the new legislation, however, the principle of prudence in the HGB reserves remains a priority. This is illustrated by the fact that the " fair valuation " for non-banks is still not permitted. For credit institutions, however, the "Fair value measurement " only for financial instruments in the trading book is true. Due to the international accounting standards here was a complete renunciation of the "Fair value measurement " is not possible. In addition, - similar to IFRS - a reclassification opportunity created.

The financial crisis has shown that in exceptional cases with credit institutions as a reclassification from trading book must be possible in the banking book. Without reclassification rights it may at changing market values ​​to stronger earnings fluctuations (volatility) come and trigger increased in times of crisis write-downs, which leads to losses at banks. This reclassification must be specified and justified in the Appendix according to § 35 para 1 RechKredV. By force since April 2009 special provision of § 340e paragraph 3 HGB, the requirement of the existence of an active market falls away, so that the scope of fair value accounting in banks also includes financial instruments in the trading book that are not traded in an active market. In such cases, the fair value is calculated using actuarial valuation models by mark-to -model is done (ie, Level 3). The special provision of § 340e paragraph 3 HGB concerning the scope of § 253 paragraph 1 sentence 3 HGB - ie the initial measurement of financial instruments at cost and the mandatory subsequent measurement at fair value - concerns has been extended now for credit institutions.