ED/Ind VS- 302/2018-2019/16

Exposure Draft


Indian Valuation Standard 303
Financial Instruments

(Last date for Comments: May 12, 2018)

Issued by Valuation Standards Board

(Set up under an Act of Parliament)

Exposure Draft

Indian Valuation Standard 303 Financial Instruments

Following is the Exposure Draft of the Indian Valuation Standard 303 Financial Instruments issued by the Valuation Standards Board of the Institute of Chartered Accountants of India, for comments.

The Board invites comments on any aspect of this Exposure Draft. Comments are most helpful if they indicate the specific paragraph or group of paragraphs to which they relate, contain a clear rationale and, where applicable, provide a suggestion for alternative wording.

Comments can be submitted using one of the following methods, so as to be received not later than May 12, 2018.

1. Electronically: Click on http: https://goo.gl/forms/R1ximFDuEO6rvMxt2 to submit comments online. (Preferred method)

2. Email: Comments can be sent to commentsvsb@icai.in

3. Postal: Secretary, Valuation Standards Board, The Institute of Chartered Accountants of India, ICAI Bhawan, A- 29, Sector- 62, Noida – 203209.

Further clarifications on any aspect of this Exposure Draft may be sought by e-mail to valuationstandards@icai.in.

Exposure Draft

Indian Valuation Standard 303
Financial Instruments

SCOPE 5-10
Market Approach 16-20
Income Approach 21- 26
Cost Approach 27-29
Determination of Present Value 37-39
Adjustments for Credit Risk 40-41
Control Environment 42-44

Exposure Draft

Indian Valuation Standard 303
Financial Instruments

The Exposure Draft of the Indian Valuation Standard includes paragraphs set in bold type and plain type, which have equal authority. Paragraphs in bold type indicate the main principles. (This Exposure Draft of the Indian Valuation Standard should be read in the context of Framework for the Preparation of Valuation Report in accordance with Indian Valuation Standards)


1. This Standard establishes principles, suggests methodology and considerations to be followed by a valuer in performing valuation of financial assets, financial liabilities and equity instruments.

2. This Standard supplements the other Indian Valuation Standards by providing specific principles and considerations in relation to financial instruments.

3. Valuation of financial instruments is commonly carried out amongst other matters, for transactional pricing (i.e. buy or sell) and financial reporting purposes. In addition, valuation of financial instruments is also of particular importance in case of business combinations, share-based payments, off-market transactions, risk management, tax allocations, dispute resolution, purchase-price allocations, etc.

4. The principles enunciated in this Standard shall be applied in conjunction with the principles prescribed and contained in the Framework for the Preparation of Valuation Report in accordance with Indian Valuation Standards.


5. A valuer shall follow the requirement of this standard in valuation of financial instruments.

6. For the purposes of this Standard, financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. Equity instruments, derivatives, debt instruments, fixed income and structured products, compound instruments, etc. are certain examples of financial instruments.

7. Considering the multiple categorisation and different usages of a financial instrument valuation, detailed consideration of purpose of valuation and the nuances of the instrument being valued is essential to identify the relevant information available to be perused for valuing the instrument.

8. The principles contained in the other Indian Valuation Standards also apply to valuation of financial instruments. This Standard provides additional guidance for the valuation of financial instruments.

9. In accordance with the Indian Valuation Standard 102 Valuation Bases, a valuer shall select appropriate valuation bases that are relevant in the context of the categorisation of the financial instrument. To arrive at the right valuation base, a valuer amongst other matters should also have an understanding of the relevant regulations governing the functioning of the instrument.

10. The selection of the appropriate approach and method in accordance with Indian Valuation Standard 103 Valuation Approaches and Methods, shall be properly reasoned and shortlisted on the basis of various considerations. Avaluer shall also give due consideration to the complexity of the instrument being valued and the available information while selecting a valuation approach and method.

Valuation Methods

11. Financial instruments being generally aligned to market linked factors, the usage of market linked methods with observable inputs is usually the preferred approach to arrive at a value.Valuation of certain financial instruments, for example, equity instruments, may in situations be based on the inherent business valuation from which the financial instrument derives value. A valuer should give due consideration to Indian Valuation Standard 301 Business Valuation in relation to valuation of such financial instruments.

12. In selection of the approach and method,avaluer shall also give due consideration to the control environment under which the entity and the instrument operates. The control environment consist the entity’s internal governance and control objectives, procedures and their operating effectiveness with the objective of enhancing the reliance on the valuation process and outcome thereof. A valuer shall form independent opinion on the valuation control environment and factor outcome on the valuation method, approach, outcome and reporting thereof.

13. The methods used for the valuation of financial instruments are derivative of the market, income and cost approaches as described in Indian Valuation Standard 103.

14. The following are some of the factors that a valuer shall consider while determining the appropriateness of the method (or a combination of methods) that should be used for performing the valuation:

(a) the basis of the instrument being valued;

(b) the purpose of valuation; and

(c) other considerations including the control framework of the entity and input data sets.

15. Valuation of certain financial instruments involves significant uncertainty with regard to the method used or market aberrations. In such situations, a valuer shall document the nature of the uncertainty. A valuer shall also document the inherent nature of the complexity in detail to enable the user to understand the assumptions that impact the value of the instrument.

Market Approach

16. Market approach is a valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable (i.e., similar) assets, liabilities or a group of assets and liabilities, such as a business.

17. In market approach, the value of the financial instrument is determined by considering traded prices of such instrument in an active market; or prices and other relevant information generated by market transactions involving identical or comparable (similar) assets. A valuer shall follow the detailed guidance provided in Indian Valuation Standard 103 for application of the market approach.

18. An example of the market approach is the price obtained from active trading of financial instrument on an exchange as it is normally the preferred indication of the market value of an identical instrument. In absence of an active market benchmark price, comparable consensus pricing or private transaction pricing may also be considered.

19. Further, valuation techniques consistent with the market approach often use market benchmarks derived from a set of comparable operating in a similar framework. Benchmarks might be in a range with a different pricing benchmark for each comparable. The selection of the appropriate comparable and its pricing benchmark within the range requires close evaluation of comparability, consideration of qualitative and quantitative factors specific to the measurement of the financial instrument and judgement.

20. In case, the financial instrument being valued is characterised by certain different terms than the identical quoted instrument, the valuer shall adjust the comparable price to reflect the different terms and characteristics.

Income Approach

21. Income approach is the valuation technique that converts future amounts (eg, cash flows or income and expenses) to a single current (i.e., discounted) amount. The fair value measurement is determined on the basis of the value indicated by current market expectations about those future amounts.

22. In income approach, value of a financial instrument is determined based on the expected economic benefits by way of income, cash flows or cost savings generated by such financial instrument and level of risk associated with such financial instrument. It generally involves discounting future amounts to a single present value after adjusting inherent risks.

23. The use of income approach especially the discounted cash flow model requires usage of present-value techniques that are deployed to ascertain the present value of future cashflows basis of certain assumptions. Paragraphs 37-39 of this Standard further elaborates on the considerations involving present value techniques.

24. Black-Scholes-Merton formula or a binomial model and similar other pricing models are examples of income approach, that incorporate present value techniques and reflect both the time value and the intrinsic value of an option.

25. In situations where a financial instrument does not give rise to committed contractual cash flows, an estimation of future cash flow basis of various available estimates would aid the income approach. A valuer shall follow detailed guidelines provided in Indian Valuation Standard 103 for use of discounted cash flow model.

26. Apart from the cash flows that the entity expects to realise the cash flow, the terms of a financial instrument, amongst other matters, also typically cover:

(a) the timing when the entity expects to realise thecashflows related to the instrument;

(b) the basis of calculation of the cash flows, eg. the interestcoupon rate, underlying index or indices, etc; and

(c) the terms and timing for any conditionalities in the contract, eg., put or call, lock-in, prepayment, extension, conversion options, residuary right.

Cost Approach

27. Cost approach is a valuation technique that reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost).

28. From the perspective of a market participant seller, the price that would be received for the
asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility.

29. The usage of cost method is of more predominance in valuation of non-financial assets. A valuer shall follow the detailed guidance provided in Indian Valuation Standard 103 for application of the cost approach.

Valuation Techniques and Inputs

30. A valuer shall use valuation techniques that are appropriate in the circumstances and for which sufficient data is available to measure fair value, maximising the use of relevant observable inputs and accordingly minimising the use of unobservable inputs.

31. A valuer shall use valuation techniques that enable him to form an opinion to estimate the price at which an orderly transaction to sell the financial instrument would take place between market participants at the valuation date under valuation date market conditions. Valuation techniques differ in their application based on the three approaches mentioned in paragraphs 16-29 or sometimes even a combination thereof.

32. A valuer may choose basis of either a single valuation technique or a combination of multiple valuation techniques to perform the valuation. If multiple valuation techniques are used to measure fair value, the results shall be evaluated considering the reasonableness of the range of values indicated by those results. Appropriate weightage can be provided to the outcome derived from the deployment of multiple valuation techniques. A fair value measurement is the point within that range that is most representative of fair value in the circumstances.

33. Once the valuation technique has been shortlisted and deployed, such valuation technique used for valuation shall be applied consistently. However, in certain circumstances a change in a valuation technique or its application is appropriate if the change results in a measurement that is equally or more representative of fair value in the circumstances. Examples of instances when a change in valuation technique may be necessitated are:

(a) change in terms or regulations governing the instrument;

(b) new markets development;

(c) new informationbecomes available;

(d) information previously used is no longer available;

(e) valuation techniques improvement; or

(f) market conditions change.

34. Usage of unobservable inputs carries a reasonable degree of judgment and assumptions, and hence may be considered as a choice of input in circumstances where observable inputs are unavailable. Therefore, unobservable inputs shall also reflect the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. In addition to that a valuer shall place a higher degree of emphasis on the entity control framework and integrity of data used in deriving the unobservable input.

35. A valuation technique based on unobservable inputs values a probability of outcome using certain assumptions (or range of assumptions). A valuer would be expected to factor a risk element that may be inherent to the probability or the assumptions. Accordingly, assumptions about risk include the risk inherent in a particular valuation technique used to measure fair value or the risk inherent in the inputsto the valuation technique. It would be incorrect not to consider appropriate levels of risks inherent in valuation of financial instruments.

36. In using unobservable inputs, the valuer would evaluate whether the unobservable inputs have
been developed using the adequate information available inthe circumstances. The unobservable input shall also factor in the information about market participant assumptions which is reasonably available.

Major Considerations

Determination of Present Value

37. Present value is an integral tool used in the income approach to link future amounts(eg. cash flows or values) to a present amount using a discount rate.

38. Paragraphs 21-26 of this Standard refers to income approach as a valuation approach/method.

39. The valuation of a financial instrument using a present value technique captures all the following elements from the perspective of market participants at the valuation date:

(a) an estimate of future cash flows for the asset or liability being measured;

(b) expectations about possible variations in the amount and timing of the cashflows representing the uncertainty inherent in the cash flows;

(c) the time value of money, represented by the rate on risk-free monetary assets that have maturity dates or durations that coincide with the period covered by the cashflows and pose neither uncertainty in timing nor risk of default to the holder (i.e. a risk-free interest rate);

(d) the price for bearing the uncertainty inherent in the cash flows (ie, a risk premium); and

(e) other factors that market participants would take into account in the circumstances.

Adjustments for Credit Risk

40. One of an important characteristic of valuing afinancial instrument is to understand the risk associated with the following:

(a) instrument; and

(b) the issuer including the respective credit risk

41. The following are some of the influences that need to be considered in measuring credit risk:

(a) Credit and counter party risk: The credit-risk measurement is influenced by the financial strength ofthe issuer or any guarantors and will involve the following major considerations:

(i) present and projected financial performance of the parties; and

(ii) performance and prospects for themacro industry sector in which the entity/business operates.

The due consideration shall also be given to the credit exposure of any counter parties to the asset or liability being valued.

(b) Capital leveraging: The amount of borrowing deployed to operationalise the assets from which an instrument’s return is derived, or the overall capital leveraging profile of the issuer can affect the volatility of returns to the issuer and also the credit risk of the instrument.

(c) Security hierarchy: Establishing the security hierarchy of an instrument is important inassessing the credit risk. Lower hierarchy in security charge would usually result in a higher credit risk profile.

(d) Collateral and default protection: For the purposes of measuring credit risk, it is relevant that the estimate of expected cash shortfalls reflect the cash flows expected from collateral and other credit enhancements that are part of the contractual terms. The estimate of expected cash shortfalls on a collateralised financial instrument reflects the amount and timing of cash flows that are expected from foreclosure on the collateral less the costs of obtaining and selling the collateral, irrespective of whether foreclosure is probable. A valuer needs to understand whether there is recourse to all the assets or only to specified assets. The greater the value and liquidity of the assets to which an entity has recourse in the event of default, the lower the credit risk of the instrument. Protection might take the form of a guarantee by another party or a credit default swap. Credit risk is reduced if subordinated instruments take the first losses on the underlying assets and therefore reduce the risk to more senior instruments.

(e) History of default: Default occurred in the recent past in payment obligations on borrowings, payables, etc. is relevant in evaluating the financial stress and resulting credit risk therefrom.

Control Environment

42. The consideration for control environment in valuation of financial instruments gains enhanced importance in the event the valuation is based on unobservable inputs. Unobservable inputs and calculation models are usually prepared by the entity that owns or issues the financial instrument.

43. The control environment of an entity consists of the governance and control procedures that are set in place by an entity with the objective of increasing the reliance on the valuation process and conclusion.

44. A valuer placing reliance upon an internally performed valuation, shall consider the reliance on the control environment, its adequacy and independence.

Effective Date

45. Indian Valuation Standard 303 Financial Instruments, shall be applied for the valuation reports issued on or after…. , 20181.

1 Date to be specified by notification

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