Fair value on steroids

Your average pension plan investing in private equity or real estate will usually report their first quarter numbers sometime in May (though some are as early as April). Meanwhile, in the weeks after the quarter closes, their GPs are tallying up their own quarterly estimates for reporting purposes. Most limited partnership agreements give the manager 45 to 90 days to get that job done (or 90 to 120 days for the annual report). Often, the delivery of their respective reports won't sync up – but with a few simple tweaks to account for any investments, divestments or wild market swings during the intervening period, LPs can always use whatever the latest report they received from the GP was to figure out the fund's current fair value. In accounting lingo, this is known as a practical expedient.

And for a long time that's always worked; not least because LPs never really had hard and fast rules on fair value accounting to follow. But that's all changing now. And the ramifications may be significant for the firm's finance team.

Earlier this year, the Governmental Accounting Standards Board (GASB) – which sets accounting standards for state pension plans and other public sector LPs – put out an exposure draft codifying how state and local governments should define and measure fair value. The rules, expected to be finalized early next year, are relatively straightforward and largely mimic what the Financial Accounting Standards Board has done with Topic 820. But now that GASB has ended its silence on how exactly LPs should go about reporting the value of their private fund holdings, one consequence may be that public pension plans require more rigorous and timely reporting by GPs.

Going back to our hypothetical pension plan, then, it may no longer be possible for LPs subject to GASB to give GPs the standard 45 to 90 day grace period for Q1 estimates. If the pension plan has a duty to report numbers by end of April, say, it may push its GPs to provide the numbers earlier. If not, LPs can still rely on the practical expedient concept (where they adjust the latest reported fund NAV) – but now that auditors will be examining their financial statements with stricter fair value rules in place, investors will want the GP report to be as close as possible to their own measurement date. Some in the industry wonder whether this will push LPs to negotiate for GPs providing quarterly reports within 30 days of the end of a quarter, or even more quickly.

What's more, nobody's really sure how auditors will evaluate GASB's new fair value standard. As such, expect some LPs to play it safe by digging deeper into the fund's valuation methodologies – and by demanding more documentation from GPs about their fair value practices. LPs were already headed in this direction, but GASB is sure to accelerate the trend.

In fact, this (inter alia) is the topic of our September issue, which should land on doorsteps soon. Our special report on accounting takes a much deeper dive into the effects GASB’s new fair value rules will have on CFOs, while also discussing other accounting hot topics like disclosure notes. We’d encourage you to check it out right away – but we'd also sympathize if LP demands are eating up too much of your time.