CPAs see risks in complex financial instruments and derivatives

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Financial instruments are becoming increasingly complicated, and a new survey of CPA financial executives by the AICPA found concern about the valuation of instruments such as derivatives, with fears it might potentially lead to a financial crisis.

A 55 percent majority of the CPA business executives expressed concern about financial instrument valuations. The derivatives market exceeded $594 trillion in total value in 2018. When asked about their own company’s financial statements, 59 percent of the CPAs surveyed reported having complex financial instruments such as mortgage-backed securities, interest rate swaps or other derivatives on their company balance sheets.

Of the survey respondents who said they have complex financial instruments on their organization’s books, 69 percent expect financial instruments to become more complex (57 percent slightly more complex, 12 percent substantially more complex) over the next one to three years, compared with 1 percent who expect them to decrease in complexity. In addition, 53 percent believe there is not enough market awareness of complex financial instruments to prevent a financial crisis, compared with only 22 percent who believe there is adequate awareness. Fifty-five percent said they are concerned about the valuation of derivatives with 6 percent reporting significant concern and 49 percent reporting slight or moderate concern. Fifty-six percent said it would be easier to figure the value of complex financial instruments if they were measured and reported on a consistent and transparent basis.

The difficulty of valuing complex financial instruments, such as collateralized debt obligations, was one of the culprits behind the 2008 financial crisis. The derivatives market exceeded $594 trillion last year. More than a quarter (28 percent) of the survey respondents indicated they anticipate financial instruments to become a larger percentage of their balance sheets over the next one to three years, while only 15 percent see that percentage decreasing.

“With financial instruments growing in complexity and taking up an increasing share of balance sheets, it is imperative that executives and finance teams understand these potentially risky investments,” said Ash Noah, managing director of CGMA learning, education and development at the Association of International Certified Professional Accountants, in a statement. “A uniform framework to value financial instruments will provide companies the information they need to make better decisions and offer greater transparency to investors and other stakeholders.”

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