![Sample our Economics, Finance,Business & Industry journals, sign in here to start your access, latest two full volumes FREE to you for 14 days]({"type":"image" , "src" : "/sda/5931/TOC-Subject-Sample-2021-Economics-Finance-Business-Industry.jpg"})
Abstract
We use an integrated approach to analyse the reasons behind the discount on the balance-sheet fair value of illiquid financial instruments held by European banks and classified into the Level 3 Fair Value hierarchy under IFRS 7. We believe that the potential sources of misalignment are (1) the lack of disclosure, (2) earnings management, and (3) the lack of liquidity. We show that the discount implicit in market values is linked to the lack of mandatory additional disclosure required by IFRS 7 and that this result supports the strong enforcement activity made by national authorities.
Notes
1 Chapter 8 – Phase Manual – March 2014, ‘LEVEL 3 FAIR VALUE EXPOSURES REVIEW’, p. 214.
2 ESMA is an independent EU authority that contributes to safeguarding the stability of the European Union’s financial system.
3 In January 2013, Isvap (an institution for the security of private and of social interest insurances) was dissolved. All its powers were transferred to the newly established IVASS (an institution for the security of insurance companies).
4 Bank of Italy-Consob-Isvap Document no. 4 of 3, March 2010, downloadable at: http://www.bancaditalia.it/vigilanza/att-vigilanza/accordi-altre-autorita/accordi-aut-italiane/tavolo_coordinamento/fin_reports09_10.pdf
5 See, for example, Barth (Citation1994). Barth (Citation1994) noted that investment security gain and losses are not captured by financial markets, because of measurement error in their estimates.
6 A market as defined in IAS 39-AG71: a market in which ‘the quoted prices are readily and regularly available from an exchange, dealer, salesman, industry, agency determination the price, regulators and those prices represent actual market transactions that occur regularly in a normal market’; or, equivalently, in IFRS 13: ‘IFRS 13 defines an active market as a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing.’
7 There is no definitive evidence that Level 3 is statistically different from Level 2.
8 Net financial assets = financial assets − financial liabilities.
9 Those statistics are not comparable to the information provided by ESMA in the follow-up statement on application of disclosure requirement issued in October 2010. The ESMA sample was based on companies within FTSE Eurotop index, which includes nonbanking institutions.
10 Level 3 reconciliation of changes disclosures has been provided for 90% to 95% of CESR sample, that considers nonbanking institutions and focuses exclusively on large companies (ones that most likely are required by stockholders to disclose further information). The sample considered in our analysis shows a lag effect on full adoption of IFRS 7; the disclosure result for year 2012 is perfectly in line with CESR data.
11 Reference is made to net amounts, in coherence with the denominator.
12 For the sake of brevity, cross-sample statistics are omitted, and the most interesting ones are presented within the paragraph. Additional tables are available upon request.
13 December 31 of each accounting year, once verified that every bank within the sample closes at the same date.
14 Market capitalization and consolidated accounting figures at year-end reflect acquisition activities. Previous year-end capital measures exclude the effect of acquired entities, causing inconsistency between income measures (extracted at year-end) and capital measures (extracted as of previous year-end). Deduction of net income from end of the year book value overcomes the issue.
15 See Nissim and Penman (Citation2007).
16 Considering assets and liabilities separately would lead to a doubling of explanatory variables.
17 Common equity is the algebraic sum of assets and liabilities: if assets and liabilities are expressed at fair value, this is definitely reflected in common equity.
18 Capital in excess over regulatory requirements (Basel 3).
19 This choice avoids unnecessary correlations between trading activities and fair value net assets considered within the analysis.
20 Also, those additional variables can be seen to provide an incremental effect on Level 3 net assets valuation, by considering that year-end net assets consist partially of changes those assets incurred during the year.
21 Where x stands for 1, 2 or 3.
22 Recall that the absolute value of Level 3 assets is greater than the absolute value of Level 3 liabilities, so negative transfers (positive FROM_L3 variable) are associated with a low transferring activity.
23 Song scales accounting figures on number of shares. The Level 3 coefficient in Song is 0.683 and represents a 32% discount (1 − 0.683 = 0.317) on book values for Level 3 net assets.
24 The fair value of any asset can be valued by discounting earnings generated by the asset at the cost of capital, which reflects the risk of the asset. Additional disclosure gives to investors all the information about the amount of earnings generated by the specific asset under valuation and its risk.
25 Since FROM_L3 assets are not, at year-end, Level 3 assets anymore, we tested a different specification considering the sum of this variable with L1 and L2 assets. Results do not change significantly, and the coefficient diagnostic does not change by any means.