Financial Reporting Summit Outlines Problems

World leaders at the G-20 summit in London last week pledged to make accounting reform a pillar of their efforts to restore stability to the global financial system. Accounting rulemakers meeting in the city at the same time, however, voiced concerns that politicians were pushing reform too fast and in the wrong direction.

Most of the spotlight last week went to anti-capitalist protesters in the streets of London, and to the final communiqué from G-20 leaders that listed numerous accounting reforms they want to see by the end of the year.

But one day before that, speakers at the inaugural summit of the International Centre for Financial Regulation painted a different picture of financial reporting. They were already concerned about the pace and volume of rules and proposals coming out of the International Accounting Standards Board and the U.S. Financial Accounting Standards Board.

Mackintosh

Ian Mackintosh, chairman of the U.K. Accounting Standards Board, listed the raft of actions taken by IASB and FASB since the former suspended its due process protocols to rush out guidance on asset reclassification last October. He also said that each board was under political and banking industry pressure to “level the playing field” by matching anything the other did.

Indeed, even as Mackintosh made his comments in London, FASB was approving major revisions to fair-value accounting rules in the United States specifically because Congress ordered FASB to do so. The board approved the changes in a matter of weeks, which is lightning speed for accounting rulemakers.

“We have two major accounting standards boards that are trying to work together, but every now and again they are stepping ahead or behind each other. That is giving us a problem,” he said.

Liesel Knorr, president of the German Accounting Standards Board, told the summit that in times of “great haste” it was difficult to follow due process, “but this is what we should be striving for—not something put out very hurriedly.”

Knorr said the European accounting community had always put a lot of emphasis on financial reporting harmonization, “but we should be talking more about convergence and improvement, not just level playing fields.”

FASB isn’t the only party guilty of caving into political pressure. Knorr noted that the day before the April 1 summit, IASB had rushed out an exposure draft on the derecognition of financial instruments, following a similar paper from FASB.

“Both standards should have been better aligned time-wise because they are talking about the same principles,” she said. “FASB has been struggling with this issue for more than 20 years so the likelihood of us finding a solution in weeks or months is somewhat limited.”

What Comes Next

The G-20 meeting did end with a list of items that world leaders want accounting rulemakers to tackle. Among them: changing the standards on provisions, off-balance sheet exposures and valuation; making “significant progress” toward a single set of global standards; and simplifying the rules on financial instruments.

“We have two major accounting standards boards that are trying to work together, but every now and again they are stepping ahead or behind each other. That is giving us a problem.”

— Ian Mackintosh,

Chairman,

U.K. Accounting Standards Board

The technical detail is spelled out in a paper called “Addressing Procyclicality in the Financial System,” which was published by the Financial Stability Forum and released at the same time as the G-20 communiqué. The forum, which the G-20 has renamed the Financial Stability Board, comprises national financial authorities and central banks.

This paper makes two immediate demands of both FASB and IASB. First, it wants them to issue a statement to regulators, financial firms, and auditors reminding them that existing accounting rules require the use of judgment when making provisions against loan losses. (Earlier recognition of loan losses could have softened the current crisis, the forum believes.) Second, it wants FASB and IASB to reconsider their “incurred loss” provisioning model and review other methods for recognizing and measuring losses.

One of these methods, known as “dynamic provisioning,” is part of a plan favored by regulators to make banks set aside rainy-day funds, so they can use capital built up in the good times to smooth them through lean periods. But speakers at the ICFR summit voiced concerns about how this would work in accounting terms.

Spanish banks have used dynamic provisioning to smooth their profits for years. But Mackintosh said he didn’t support the Spanish approach, where the provisions are charged against profit and loss; he preferred a balance sheet adjustment. “It’s a debate that is still raging. There are split opinions about the correct answer,” he said.

And Knorr said there would be problems deciding when economic conditions were so good that a bank had to make a provision, and when they were bad enough for a bank to dip into them.

Nonetheless, regulators support the general idea of using accounting provisions to create what the Financial Services Authority calls “counter-cyclical capital buffers.”

SUMMIT SOLUTIONS

Outcomes of the London Summit

Leaders of the world’s largest economies have agreed a $1.1 trillion package of measures to restore growth and jobs and rebuild confidence and trust in the financial system. ‘This is the day that the world came together, to fight back against the global recession. Not with words but a plan for global recovery and for reform and with a clear timetable,’ British Prime Minister Gordon Brown said at the end of the London Summit of G20 countries on 2 April.

‘Today we have reached a new consensus, that we take global action together to deal with problems we face, that we will do what is necessary to restore growth in jobs, that we will take essential action to rebuild confidence and trust in our financial system.’

The Prime Minister highlighted that fiscal stimulus measures that countries has already announced would amount to some five trillion dollars by the end of next year, and he announced that at the London summit countries had agreed to inject fresh money into the economy that would support this ‘unprecedented fiscal expansion.’ This $1.1 trillion worth of additional measures included:

an additional $500bn for the IMF $250bn in International Monetary Fund Special Drawing Rights available to all IMF members; and

a trade finance package worth $250bn over two years to support global trade flows

At least $100bn of additional lending by the Multilateral Development Banks

He set out six pledges that that the 21 nations and the European Commission had agreed at the Summit in London’s ExCeL Centre. These were to:

restore confidence, growth, and jobs; repair the financial system to restore lending; strengthen financial regulation to rebuild trust; fund and reform our international financial institutions to overcome this crisis and prevent future ones; promote global trade and investment and reject protectionism, to underpin prosperity; and build an inclusive, green, and sustainable recovery.

Principles to reform the global banking system included: bringing the shadow banking system, including hedge funds, within the global regulatory net; new international accounting standards; regulation of credit rating agencies; and an end to tax havens that do not transfer information on request.

‘There are no quick fixes, but with the six pledges that we make today we can shorten the recession and we can save jobs,’ he told journalists after the Summit ended.

He said the reform of the financial system would include a common global approach to how we deal with impaired or toxic assets. ‘We will clean up the banks, so that they increase lending to families and businesses, and to enable this we’ve agreed for the first time,’ he said.

He said that leaders would meet later in the year to review the implementation of today’s measures and take further action if needed. The site of the next meeting will be announced in the next few days.

Source

London Summit Website: Summit Outcomes (April 2, 2009).

In a presentation to the ICFR summit, David Strachan, director of financial stability at Britain’s Financial Services Authority, agreed that it would be difficult to work out the accounting treatment. But he added: “I don’t subscribe to the view that we cannot make any progress at all unless the accounting treatment is changed to allow more forward-looking and subjective provisioning.”

Others were concerned that a regulatory agenda designed for a few banks that were “too big to fail” might drive financial reporting changes that affected a wider range of businesses.

Too Much Disclosure?

Tattersall

John Tattersall, chairman of PricewaterhouseCooper’s financial regulatory practice, warned about the growing volume of disclosures that regulators wanted companies to make. For the traditional users of financial statements—investors—there was no shortage of data available, he said. The only users that wanted more detail were regulators, he argued, “and they can get anything they want anyway” by using their legal powers.

Company disclosures could be made more relevant, Tattersall agreed, but he added: “I am nervous of the desire of regulators to make more of financial statements than is intended. They are not meant to be prudential reports that allow every investor to be their own macro-economic supervisor.”

Boyle

Tattersall is not the only person to worry. The next day Paul Boyle, chief executive of the U.K. Financial Reporting Council, used a speech at a different conference to warn that politicians and regulators were using accounting “to achieve policy objectives for which it has not been designed.” General-purpose financial statements were not likely to be suitable instruments for contributing to macro-economic stability, he said.

There are questions too about the wider policy focus of writing regulations and accounting rules that are designed solely to create stability. At the ICFR summit Carlo Comporti, secretary general of the Committee of European Securities Regulators, asked: “Are we really sure that we want to establish a new regulatory framework that has a key objective just for financial stability? Is this sensible in the long run?”

Financial stability is important, Comporti argued, but so are investor protection and market efficiency. “We cannot make laws just for extraordinary times,” he said.