Fair value disclosures to be made simpler for LPs

The Financial Accounting Standards Board (FASB) is asking stakeholders if it should no longer require LPs to categorize their fund stakes within a fair value hierarchy.

The hierarchy, broken down into three levels, reflects the level of judgment someone uses to determine the fair value (or exit price) of an asset. Most private equity assets fall under “Level 3”, meaning non-observable inputs were used to determine its current market price.

Under accounting rules, LPs have to look at the mechanics of the private fund itself, and not the underlying assets, to determine the fair value level of their fund stake. However, because most closed-ended private funds like private equity and real estate offer limited redemption rights and fair value reporting only on a quarterly basis, they invariably fall under Level 3 as well. For hedge fund interests, where liquidity and reporting are stronger, some LPs have struggled to determine whether the fund interest should be disclosed as Level 2 or Level 3.

Ultimately though the disclosure provides little value to users of financial statements, multiple industry sources tell pfm, who expect the proposal to become finalized.

“When you cut right through it, the disclosure requirement just causes LPs and auditors to opine or second-guess each other on something no one really uses,” said David Larsen, managing director at financial advisory and investment banking firm Duff & Phelps.

Under the proposed amendments, investments for which fair value is measured at net asset value (or its equivalent) using the “practical expedient” no longer would be categorized in the fair value hierarchy.

The practical expedient concept allows LPs to rely on a fund’s reported net asset value – on the assumption that it was diligently arrived at by the GP through a fair value estimate of the fund’s underlying assets – to complete their own financial reporting.

Comments on the proposal are due by January 15, 2015.