ANALYSIS OF ALIGNMENT BETWEEN THE IVS AND THE SPANISH ECO ORDER 805/2003
By Paloma Arnaiz (AEV) & Alexander Aronsohn (IVSC)
The Asociación Española de Análisis de Valor (AEV) is the professional association that represents the Spanish Registered Valuation Companies that carry out around 85% of the valuations for regulated purposes in Spain. Founded in 2012, AEV supports the development of the valuation profession and professional practices that ensure the independence, transparency and technical rigor of its associates.
The IVSC has recently carried out an analysis in conjunction with AEV on the alignment between the International Valuation Standards (“IVS”) and the Spanish national regulations contained within the ECO Order 805/2003 (“ECO Order”).
The ECO Order 805/2003 is the mandatory valuation standard in Spain for valuations carried out for 4 specific regulated purposes: valuation of guarantees of mortgage loans; valuation for accounting purposes of the assets of insurance companies; valuation of assets of collective real estate investment institutions; and valuation of patrimony of pension funds. Thus, its relevance and representativeness within the valuation profession in Spain is considerable, and it was the desire of the AEV to assess to what extent this domestic standard is or isn’t aligned with the IVS, in order to take the necessary actions to ensure, in future revisions of the ECO Order, a greater identification with the IVS.
In undertaking this analysis, the IVSC has noted that the ECO Order broadly aligns with IVS and there are no major contradictions between them. However, whereas the ECO Order was established in 2003, IVS have been through several substantive revisions since this date, with the current recently published edition of IVS having an effective date of the 31st January 2022. Furthermore, the valuation profession has been through many developments since 2003 and, therefore, the AEV and IVSC have prepared this article to highlight any differences between the standards, and to encourage further harmonisation with IVS.
In particular, the authors have highlighted the following themes under which certain differences between the two standards exist today:
- Core Principles of Valuation Standard Setting and Valuation
- Assumptions and Special Assumptions
- More prescriptive use of Valuation Approaches and Methodologies
- Missing concepts, definitions and obligations.
In considering these differences, and taking into account that the ECO Order is a mandatory standard for valuations performed in Spain for the aforementioned specific purposes, for these valuations to be compliant with both standards IVS must be followed for any aspect or issue not expressly specified, defined or interpreted in the ECO Order.
Paloma Arnaiz has been the Secretary General of the AEV since 2018. She is responsible for coordinating the activities and work of the Board of Directors and the different technical boards of the AEV. Paloma is also in charge of the dialogue between the valuation companies and different industry stakeholders: regulatory and supervisory bodies, professional associations and international organizations.
”The ECO Order 805/2003 is the mandatory valuation standard in Spain for valuations carried out for 4 specific regulated purposes: valuation of guarantees of mortgage loans; valuation for accounting purposes of the assets of insurance companies; valuation of assets of collective real estate investment institutions; and valuation of patrimony of pension funds.
1. Core Principles of Valuation Standard Setting and Valuation
The latest edition of IVS has been revised to incorporate the following core principles of valuation standard setting and valuation:
Core Principles of Valuation Standard Setting
- Purpose (Objective)
- Valuation Standards
- Development and Revisions of Standards
Core Principles of Valuation
- Basis (i.e., Type or Standard) of Value
- Date of Value (i.e., Effective Date/Date of Valuation)
- Assumptions and Conditions
- Intended Use
- Intended User(s)
- Scope of Work.
- Identification of Subject of Valuation
- Valuation Methodology
- Communication of Valuation
- Record Keeping
The core principles are adopted by member organisations of the IVSC and comprise the core principles on which valuation standard setting and valuation should be based. IVSC and AEV would recommend that as much as possible these core principles are integrated in both the ECO order and AEV best practice guidance.
The latest edition of IVS now incorporates the following definitions:
- Basis (bases) of Value
- Cost(s) (noun)
- Discount Rate(s)
- Equitable Value
- Fair Market Value
- Fair Value (IFRS)
- Investment Value
- Liquidation Value
- Market Value
- Price (noun)
- Synergistic Value
- Valuation Approach
- Valuation Method
- Value (noun)
In particular, IVSC has now adopted the following definitions for Basis of Value, Valuation Approach and Valuation Method:
- Basis (bases) of Value: The fundamental premises on which the reported values are or will be based (see IVS 105 Valuation Approaches and Methods, para 10.1) (in some jurisdictions also known as standard of value).
- Valuation Approach: In general, a way of estimating value that employs one or more specific valuation methods (see IVS 105 Valuation Approaches and Methods).
- Valuation Method: Within valuation approaches, a specific way to estimate a value.
The IVSC notes that although the ECO Order does not expressly cite or expressly define the concept of “basis of value”, it does refer to a series of specific bases of value, such as market value, mortgage lending value, maximum legal value and fair value. In order to aid further harmonisation of valuation standards both within Spain and globally, IVSC and AEV would recommend that the definition of basis of value is either directly included within any future iterations of the ECO Order or direct reference is made to IVS 104 Bases of Value.
The ECO Order does not make a direct distinction between Valuation Approaches comprising the Market, Income and Cost Approach, and Valuation Methods, which are a subset of valuation approaches and comprise methods such as the DCF Approach. Instead, the ECO Order refers calculation procedures and, though the differences are not conceptual but purely terminological, AEV and IVSC would consider the adoption of these terms within the ECO order would avoid any misunderstanding or misinterpretation and aid harmonisation with IVS.
Furthermore, we would recommend either full adoption of the definitions contained within IVS or the inclusion of the IVS definitions within an appendix of the ECO Order to aid harmonising and avoid any misinterpretation of key terms.
3. Assumptions and Special Assumptions
IVS 104 Bases of Value states that “in addition to stating the basis of value, it is often necessary to make an assumption or multiple assumptions to clarify either the state of the asset in the hypothetical exchange or the circumstances under which the asset is assumed to be exchanged. Such assumptions can have a significant impact on value.”
IVS further states that assumptions generally fall into one of two categories:
“(a) assumed facts that are consistent with, or could be consistent with, those existing at the date of valuation (Assumptions), and
(b) assumed facts that differ from those existing at the date of valuation (Special Assumptions).”
The ECO Order does not make such a distinction between assumptions, but Chapter III regulates the issuance of phrases in the form of “caveats” and “provisos” in those cases where certain assumptions have to be made by the valuer. The ECO Order also qualifies the type of observation that should be issued depending on the severity of the specific assumption, highlighting situations in which certain investigations have not been carried out or where the necessary documentation has not been made available to prove certain facts with absolute certainty.
The ECO Order also refers certain situations in which the value is calculated under a “special hypothesis” such as the following assumptions:
- Completed development
- Vacant Possessions
- Free of Liabilities
These “special hypotheses” are akin to “special assumptions” contained within IVS and in actuality there is very little difference between these terms. However, IVSC and AEV would recommend the adoption of these terms to aid alignment with IVS and in keeping other national valuation standard setters, who adopt these terms to support compliance with IVS.
4. Prescriptive use of Valuation Approaches and Methodologies
The ECO Order provides more prescription in relation to the use of Valuation Approaches and Methodologies than within IVS, and this is partly due to the focus of this standard on valuation purposes in which the interests of third parties other than the valuation client shall be protected (investors on mortgage bonds, insurance companies, pension funds and real estate investment institutions).
An example of this is in relation to cash flow discounts for turnover related properties. The discount period for valuations under the ECO Order can include significantly longer terms than those undertaken under IVS. This is because under the ECO Order the discount period must cover the “period of time in which the exploitation is expected to continue”, which usually coincides with the remaining useful life of the property on the valuation date.
However, as stated within the IVS Framework ,“the requirement to depart from IVS pursuant to legislative, regulatory or other authoritative requirements takes precedence over all other IVS requirements.” Therefore, although this prescriptive approach does not exclude IVS compliance, it is worth the valuer noting there may be a difference, particularly if they are reporting the valuation solely under IVS.
Another example refers to the valuation of Residential properties (houses or apartments) that are likely to be perpetually rented. One of the key inputs to determine their value would be the value obtained by a discounted cash flow. Doubts may arise as to the possibilities of using the discounted cash flow method for this type of properties, due to what is stated in Article 45 of the ECO Order:
“Art. 45.2.b) In leased property or property that is unoccupied but intended for lease, with the exception of housing, the DCF value and comparison value, adjusted where appropriate, shall be calculated in the event the properties are free of tenants, and the lower of the two values shall be taken as the appraised value.”
However, as the ECO Order does not prohibit the simultaneous calculation of both values for this use (housing), but only considers it unnecessary, it can be concluded that the consideration of this growing market reality, considered by IVS, can be adequately treated under the umbrella of the ECO Order.
5. Missing concepts, definitions, and obligations
In relation to the concepts of ‘Replacement Cost’ and ‘Reproduction Cost’ contained within IVS, the ECO Order does not make explicit reference to the Reproduction Cost. However, the ECO Order does state that the Replacement Cost is the “sum of the investments that would be necessary to build, on the date of the valuation, another property of the same characteristics (capacity, use, quality, etc.).”
For their part, IVS state that a Reproduction Cost might be necessary in the following circumstances:
When “(a) The cost of a modern property of equivalent utility is greater than the cost of recreation of a replica, or when
(b) The utility provided by the property can only be provided by the recreation of a replica, and not with an equivalent modern property.”
So, even though the concept of Reproduction Cost is not explicitly defined in the ECO Order, its applicability is possible within its framework when, to obtain the same characteristics in terms of utility of a property, it would be necessary to make an exact replica of it, therefore not contradicting what is established by IVS in this respect.
It should also be noted that, in relation to replacement cost and depreciation of assets, IVS references economic, functional and physical depreciation, whereas the ECO Order only references physical and functional depreciation.
Economic depreciation under IVS is the “loss of utility due to economic or geographical factors external to the property. It can be temporary or permanent”. As the concept of “loss of utility” is also included in the ECO Order under functional depreciation, this does not create an issue with IVS compliance.
Even though the ECO Order broadly aligns with IVS and there are no major contradictions between them, in order for the ECO Order to be fully compliant with the current edition of the IVS and to aid harmonisation of valuation standards, the IVSC and AEV would recommend the following additions to the ECO Order:
- Adoption of IVS Core Principles of valuation standard setting and valuation
- Adoption of the definitions contained within the IVS Glossary
- Inclusion of a section on compliance with IVS within valuation reports
- Inclusion of a Scope or Work or Terms of Engagement as per IVS 101 Scope of Work
- Inclusion of minimum report contents as per IVS 103 Reporting
- Inclusion of sensitivity analysis for the determination of values based on unobservable or estimated inputs, as this is particularly helpful during periods of uncertainty such as during the recent coronavirus pandemic.