kpmg When fair value bridges a revolution International Valuation Standards 28 October 2003 KPMG Financial Advisory Services Herve Richard, Partner, KPMG Romania

ABCD KPMG Financial Advisory Services 1 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association..  A global capital market  The EU initiative Strategic implications IFRS for Financial Instruments  Applications in the Banking Sector and Impact on the Valuation Metrics  Changes Expected in the Banks’ Valuations  Changes Expected in the Valuations Models  Stipulations of the IVS Conclusions The Background Content

ABCD KPMG Financial Advisory Services 2 A global capital market © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. Providers of capital nowadays operate on a truly global basis. As a result, they increasingly expect the financial information on which these decisions are based to be presented in a comprehensive, transparent and commonly understood format. Providers of debt and equity capital make their investment judgments.

ABCD KPMG Financial Advisory Services 3 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. Council of Ministers decided in June 2002 that all listed enterprises within the EU will have to convert their consolidated financial reporting to IFRS, starting with 1 January EU member states may eventually extend the IFRS requirement to non-listed companies. It is hoped that raising capital within the EU will become a cheaper and more competitive process in relation to other global markets, especially the US. European-wide use of IFRS will improve comparability between and scrutiny of quoted companies. In the context of the expected accession in 2007, Romania is taking steps towards implementation of the IFRS. The EU initiative

ABCD KPMG Financial Advisory Services 4 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. The Background  A global capital market  The EU initiative IFRS for Financial Instruments  Applications in the Banking Sector and Impact on the Valuation Metrics  Changes Expected in the Banks’ Valuations  Changes Expected in the Valuations Models  Stipulations of the IVS Conclusions Strategic implications Content

ABCD KPMG Financial Advisory Services 5 Strategic implications © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS is intended to: Enhance transparency by requiring companies to account for transactions in a more consistent way and to disclose new and different aspects of their business; Enable companies to be compared more easily with their peers; Promote efficient cross-border investment access to capital; Facilitate merger and acquisition transactions;

ABCD KPMG Financial Advisory Services 6 Strategic implications (cont’d) © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS is more than just an accounting matter; it’s also a business issue. Better comparability with other businesses reporting under IFRS in the same sector and, often, greater transparency about a company’s activities to outsiders increase the need for openness. The implementation of IFRS will result in investors and analysts asking new and different questions of listed companies. Key factor to consider is the increased volatility IFRS may reveal in performance figures. These developments provide both a stimulus and an opportunity for companies to improve their communications with all stakeholders. The implementation of IFRS is expected to widen a company’s access to capital and, therefore, lower its cost of capital.

ABCD KPMG Financial Advisory Services 7 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. The Background  A global capital market  The EU initiative Strategic implications  Applications in the Banking Sector and Impact on the Valuation Metrics  Changes Expected in the Banks’ Valuations  Changes Expected in the Valuations Models  Stipulations of the IVS Conclusions IFRS for Financial Instruments Content

ABCD KPMG Financial Advisory Services 8 IFRS for Financial Instruments © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS accounting for financial instruments highlighted below is expected to have a significant impact for companies in all industries because of:  difficulties in implementing these rules due to their complexity and documentation requirements;  increased potential volatility to earnings and equity on an ongoing basis;  challenges in helping investors and analysts to understand the impacts; These impacts could create disincentives for companies to use certain financial instruments, potentially changing their risk management practices. The change in accounting for convertible bonds and derivatives, for example, could reduce interest in them.

ABCD KPMG Financial Advisory Services 9 Applications in the Banking Sector and Impact on the Valuation Metrics © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS has particular consequences for banks relating to accounting for and valuation of financial instruments:  Under IFRS, the majority of a bank’s investment portfolio is likely to be required to be carried at fair value rather than being measured at cost;  All derivatives are to be recognized on balance sheet and measured at their fair value; … under this treatment, such changes are to impact the valuations metrics.

ABCD KPMG Financial Advisory Services 10 Changes Expected in the Banks’ Valuations © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. Accounting for financial instruments will become increasingly complex All financial instruments and liabilities must be recognised in the balance sheet and all derivatives, including those embedded in other instruments, measured at fair value To apply hedge accounting, detailed conditions need to be met. Changes in fair value for non-hedging derivatives must be recorded in the income statement Instruments with debt and equity features are accounted for as separate debt and equity components Earnings and equity under IFRS maybe more volatile (and, thus, less predictable) than under other GAAPs Some grossing up of assets and liabilities may affect gearing ratios EBITDA/EBITA P/E ratio ROCE/ROIC IFRS Accounting Treatment Financial Statement Implications Valuation Metrics Impacted

ABCD KPMG Financial Advisory Services 11 Changes Expected in the Valuations Models © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS TreatmentPotential Effects on Valuation Models Only certain categories of financial instruments may be held at cost Trading items and all derivatives are stated at fair value with gains/losses flowing through the income statement Analysts may back out the short- term volatility to the income statement, but not the long-term valuation fluctuations For long-term fluctuations, valuation may be done using "sum of the parts“ DCF analysis and exclude earnings multiples Fair Value

ABCD KPMG Financial Advisory Services 12 Changes Expected in the Valuations Models (cont’d) © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS Treatment Potential Effects on Valuation Models Derivatives Comprehensive, complex requirements for hedge accounting All derivatives recorded on the balance sheet at fair value IFRS treatment of derivatives increases the complexity of a bank’s financial statements. The market could penalise companies it perceives to be more complex Debt / equity Instruments with debt and equity features are accounted for as separate debt and equity components Earnings based valuation models and balance sheet-based measures could be affected

ABCD KPMG Financial Advisory Services 13 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. IFRS Treatment Potential Effects on Valuation Models Impairment Impairment must be recognized when there is objective evidence that the asset is impaired A financial asset is impaired if its carrying amount is greater than its estimated recoverable value Discounted expected cash flows must be used to determine loss reserve Adoption of IFRS accounting treatment for impairment should make net asset value (NAV) more comparable across industries Analysts currently have difficulties adjusting for differences, due to lack of disclosure Changes Expected in the Valuations Models (cont’d)

ABCD KPMG Financial Advisory Services 14 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. Stipulations of the IVS The valuation of financial interest involves highly specialised considerations and a Valuer must adapt the valuation approach or approaches to the nature of the financial interest subject to valuations. There is a direct relation between the International Valuation Standards and International Financial Reporting Standards through the International Valuation Application 1 – Valuation for Financial Reporting adopted in 2003 within IVS.

ABCD KPMG Financial Advisory Services 15 © 2003 KPMG Romania SRL, Registration Code KPMG Romania, a company incorporated under the Romanian Act, is a member of KPMG International, a Swiss association.. The Background  A global capital market  The EU initiative Strategic implications IFRS for Financial Instruments  Applications in the Banking Sector and Impact on the Valuation Metrics  Changes Expected in the Banks’ Valuations  Changes Expected in the Valuations Models  Stipulations of the IVS Conclusions Content

ABCD KPMG Financial Advisory Services 16 The application of IFRS does impact the outcomes of valuations metrics. IVS not only supports, but complements and provides the means of translating IFRS requirements into practice Conclusions