So claimed the White Queen in Alice Through the Looking Glass when Alice complained of the impossibility of the world into which she had entered. The radical changes being proposed to the International Valuation Standards may make some valuers empathise with Alice and her struggles to come to terms with a world where memory worked backwards and unbelievable creatures expounded irresolvable riddles.
Before I explain why I think this to be so, I will get the procedural explanation out of the way. The Exposure Drafts of the changes have been released in two stages. The first released in early April consists of four separate drafts. The closing date for comments on these proposals is 7 July. The second flight of drafts was released on 2 June and includes changes to all the remaining existing standards. The closing date for comments on these is 31 August. All drafts can be viewed and downloaded from the IVSC website. Anyone can comment, so if anything I highlight could affect the way you practice valuation, let the IVSC know what you think.
Valuology has submitted its own detailed comments on the first set of drafts, which you can read here. In this article I highlight six of the main proposals in these drafts and why, unlike the White Queen, I am struggling to believe them at any time, let alone before breakfast!
1 IVSC Proposal: To make everything in the standards mandatory.
The standards have always contained rules that have to be followed to produce an IVS valuation. These sit alongside defined concepts designed to ensure consistent interpretation and guidance providing advice on how the rules can be applied to different situations. Versions of the standards issued prior to 2010 also sought to make all this material mandatory. The impracticality of this was highlighted by many users, who wanted a clear distinction between the mandatory and advisory elements. Since 2010 the standards have sought to make this distinction.
My view: Anything mandatory has to be expressed as a clear direction to take specific action, in other words, a rule. In a set of standards intended for global application, these rules have to be confined to high level principles. The applicability of the concepts and guidance provided to help consistent application of these rules will depend on the facts of each valuation. This guidance cannot be mandatory as professional skill and judgement is required to choose the most appropriate solution. Guidance within the IVSs can therefore be influential and even persuasive, but not mandatory.
2 IVSC Proposal: To move all guidance into the standards.
The IVSC responded to the earlier calls for a clear distinction between rules (identified as “Requirements” in the current IVSs) and supporting guidance by placing the latter in a “Commentary”. In view of the strong opposition from some to the IVSs containing material that could be deemed “educational”, these Commentaries were kept brief. More detailed guidance that had appeared in earlier IVSs was reviewed and moved into “Technical Information Papers” (TIPs), which it was intended would also be the vehicle for similar future guidance. However, it has become clear that many constituents feel the status of the TIPs is unclear, and confusion is caused by guidance appearing in both the IVS commentaries and TIPs.
My View: If a clear distinction is maintained in the Standards between requirements and guidance, this proposal would appear to be sensible, although only if the fallacy that guidance can be somehow be mandatory is dropped.
3 IVSC Proposal: To remove standards for financial reporting and secured lending valuations.
Valuations for financial reporting were the original reason for the IVSC being established as they were creating a need for cross border consistency. Since the 1990s, the IVSC has liaised closely with the IASC, the IASB and the FASB. As recently as 2014 it agreed a formal “Statement of Protocols” with the IFRS Foundation. The inclusion of a standard for valuing real property for secured lending dates from 2005. It is the most common purpose for which real estate valuations are required in most countries.
My View: Given the history of the IVSs, the proposal to remove the current standard on Financial Reporting is extraordinary. This is even more so given the commitment made by the IVSC in the recent Statement of Protocols to ensure that standards and guidance issued by the IVSC on how to measure fair value are “comprehensive and well-developed.”
The valuation of real estate for loan security has significant public interest ramifications in view of the risks to financial stability created by the debt driven real estate bubbles that have occurred in many economies over the last century or more. Removing this standard and the guidance it contains is hardly consistent with the stated objectives of the IVSC. It would also create difficulties for organisations that use the standards for this purpose and set back progress on cross border consistency, one of the objectives of the European Union Mortgage Credit Directive which specifically authorises the use of the IVSs.
4 IVSC Proposal: To remove generally understood concepts and principles from the Framework
From the very first edition, concepts fundamental to generally accepted valuation principles have been an integral part of the IVSs. Examples include the differences between price, cost and value, markets, market participant versus entity specific considerations and the effect on value of how assets are grouped or aggregated. These concepts all appear in the current IVS Framework, along with discussion of common valuation bases and valuation approaches.
My View: Without common understanding of these concepts there can be no consistency in the way in which valuations are undertaken in different countries or markets. The importance of this foundation material is demonstrated by some of the new guidance presented on bases of value and valuation approaches which is inconsistent with these long established and generally accepted principles.
5 IVSC Proposal: To make Valuation Bases mandatory.
The current IVS Framework includes discussion of different valuation bases (the hypothesis on which a valuation is based). It includes three defined bases of value to cover the scenarios which can be summarised as “value to self”, “value between two” and “value to many”. It also recognises that there are very many different definitions that exist, each with different nuances on these basic scenarios. There is no compulsion to use one of the IVS defined bases, just a requirement to use one appropriate for the purpose and to state the source of the definition. It is now proposed to remove this discussion from the Framework and replace it with a new “mandatory” standard. This proposed new standard also includes examples of other bases and discussion of a number of other valuation terms.
My View: There are already requirements in IVS 101, 102 and 103 to select, define and use a basis of value appropriate for the purpose, so this additional standard is superfluous. If the purpose requires a basis that is not listed, which is quite likely, what exactly can be mandatory about those that are? Further confusion arises from the discussion of matters which are not valuation bases in this standard, for example the effect on value of different circumstances under which a sale takes place or how assets are presented to the market. Are these observations of how prices in a market are normally influenced by different factors really mandatory? What happens if the circumstances are such that the normal conventions do not apply?
6 IVSC Proposal: To make the use of certain Valuation Approaches mandatory.
The current IVS Framework includes a brief description of the three principal valuation approaches: market, income and cost. There are also TIPs providing guidance on discounted cash flow and the cost approach. This all provides high level information about common approaches and methods to assist consistent interpretation and application across borders. IVS 103 currently requires selection of the most appropriate approach or approaches to use after consideration of various factors, but there is no compulsion to use any approach. Although a completely novel narrative is provided on the cost approach, the proposed new standard includes similar material to the existing guidance on the market and income approaches. However,directions are now given as to when each approach should be used as the primary approach, and the explanatory narrative declared to be mandatory.
My View: The illogicality of trying to introduce mandatory requirements for the approach or method to be used is revealed by the statement in the draft that it does not provide a comprehensive list of all possible methods being followed by the words “It is the valuer’s sole responsibility to choose the appropriate method…” So it is mandatory to use the specified method as the primary indicator of value but also mandatory for the valuer to choose the most appropriate method! Lewis Carrol could not do better. Furthermore, the confusion of terminology, the muddling of inputs and outcomes and failure to understand the difference between cost and value demonstrated by the narrative on the cost approach places it firmly on the other side of the looking glass from current IVS guidance or other published authorities on this subject.
There are many ways in which the current standards can be improved, mainly by clearly and consistently explaining the status and relationship of different types of content. This is an issue faced by many other standard setters and some have found solutions that are clear and effective. Ironically, a far better model has been recently produced by the IVSC itself, in the form of the recent exposure drafts of proposed International Professional Standards for Valuers. Perhaps a look across the desk rather than through the looking glass would be more helpful?