Think back to 2006. Armed with a vague plan for its supposedly joint effort with the US Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB) set out to address the measurement challenges presented by so-called contribution-based promises. For its part, we were led to understand that the FASB would tackle financial statement presentation. At some future point - perhaps after another pensions project - the two ends would somehow meet in the middle and deliver us to a pensions measurement Jerusalem.
In reality, half a decade on from its launch, the project has nudged the IASB towards the FASB on the balance sheet but left it widely divergent on the income statement. So when the two boards promised the G20 that they would converge financial instruments accounting, surely they would have learned the lessons of the pensions project? Guess again.
The response to market turmoil from both the IASB and the FASB in 2008 was initially focused on so-called off-balance sheet activities. The US board promised to ‘Kill the Q' - the qualified special purpose entities stuffed with toxic domestic mortgages that had turned into what then FASB chairman, Bob Herz, called "ticking time bombs" - and the IASB turned its attention to consolidation, derecognition, and asset valuation (fair value).
But in a crisis that ultimately put a noose around their necks, both banks and politicians were always going to put pressure on standard setters - the weakest link. In October 2008, the European Commission, no doubt emboldened by Australia's success in forcing an amendment to IAS27 in 2007, adopted the ‘do-it-or-we'll-do-it-for-you' approach and forced the IASB to amend International Accounting Standard 39, Financial Instruments: Recognition and Measurement to permit entities to reclassify toxic assets.
The poster child for reclassification was Deutsche Bank, which switched assets out of the IAS39 categories of held-for-trading and available-for-sale into loans and receivables totalling just shy of €1bn. Next to succumb was the FASB. On 2 April 2009 it published guidance in the form of FASB Staff Positions on fair value measurement and other-than-temporary impairments of debt securities.
Ahead of the April decision, on 19 January 2009, FASB voted to add a comprehensive project on financial instruments to its agenda. Matching the FASB, in a 7 April 2009 statement, the IASB revealed that it "plans to publish proposals within six months" to develop a single converged financial instruments accounting standard - no doubt given added impetus by the knowledge that the standard setters were in a race to the lowest common denominator.
And at this point, you might expect the two boards to sit down around a table and flesh out a unified set of proposals. No chance. Take note, G20 leaders, they did exactly what they did on pensions: they each did their own thing. The FASB insisted that it would develop a comprehensive exposure draft addressing the three main pillars of financial instruments accounting: recognition and measurement, impairment, and hedge accounting. The IASB wanted a phased approach.
And somehow, despite a long history of stalled and failed projects - pensions, income taxes, earnings per share - the IASB managed to convince themselves they could deliver. After all, European banks had more or less dictated that there would be no full fair value model, which mandates some sort of amortised cost classification. That, in turn, requires an impairment model. With two phases of the project pre-ordained, all that is left is whether or not to allow hedge accounting. What could go wrong? Everything.
Addressing a September 2009 meeting of the World Standard Setters (WSS) conference, FASB member Tom Linsmeier explained his board's preference for a single exposure draft. "We believe that in order to have a conversation with our constituents, we need to address all phases of the project," he said. "They need to be able to understand what the effect is going to be on equity from these decisions and on net income. And we are hearing that in order to be able to do that, they need to be able to understand what the impairment model will look like and how hedging will occur - not just classification and measurement."
And when the FASB's single exposure draft did emerge on 26 May 2010, it described a model that would involve a lot more fair value than the IASB classification and measurement model released ahead of it in July. Linsmeier's explanation of why to the WSS meeting was gripping: "In recent financial institution crises, when we talk about that we are thinking about the savings and loan crisis in the US, the banking crisis in Japan, and the current crisis, hundreds, and perhaps even more accurately thousands, of financial institutions have failed with positive net worth and even higher positive regulatory capital just prior to their failure.
"The problem in each of those crises was with loans. And because the problems were with loans, the fact that you have positive equity just before failure suggests that loan-loss reserve accounting is not providing timely recognition of losses in financial institutions. In terms of the current financial crisis, if you go to look at the market where the banks started recognising problems, you can go and look at TED spreads - that's the spread between LIBOR, the rate banks borrow to each other, and US Treasuries - which spiked in the first half of 2007.
Linsmeier continues: "This indicates that the banks recognised that the banks had credit-risk problems in the interest rates they charge each other far earlier, that is in the first half of 2007, than they recognised in their accounting. In many respects they have still not recognised the credit-risk problems. In the second quarter of 2009, we are now requiring banks to report fair values for all financial instruments and second quarter 2009 there was a trillion dollars of losses in fair values of financial instruments in the US that had not been recognised in income.
"The failures of well-capitalised banks and trillions of dollars of lost investor wealth and taxpayer money indicates the current amortised cost model for loans is broken…Some have characterised the amortised cost model as being consistent with the ‘delay-and-pray-strategy'. Delay recognition of losses and pray the economy recovers before the bank fails."
The expectation is that the FASB will row back from the proposal during its re-deliberations on the May exposure draft. In the meantime, the two boards will issue a request for views in a bid to align their non-aligned impairment models based on non-aligned classification models. The document is not predicated on the assumption that the FASB will shift fundamentally on classification and measurement. And if the FASB does fail to shift, it will be the best free entertainment around to watch the boards align hedge accounting.
Reality suggests that the FASB will budge. Speaking during a 10 September 2009 roundtable meeting, Russell Picot, group chief accounting officer at HSBC, warned: "Pragmatically, I can't imagine that the world could afford [the US approach]. If you look around the world's financial system and you look at the disclosed numbers for customer loans at amortised cost and fair value, they are very significantly under water.
"And you would simply wipe out the entire world's banking system. So if you think of the effects of moving to such a model in terms of stability and systemic consequences, it would be very significant. I think it would also drive up the cost of borrowing and have quite significant social costs."