Merger Changes Hit IFRS; London Listing; More

Businesses that file financial statements according to International Financial Reporting Standards have been warned to study carefully how recent changes to merger accounting under IFRS might affect them.

The International Accounting Standards Board recently finished revisions to its standards for mergers and acquisitions as part of a joint project with the U.S. Financial Accounting Standards Board to harmonize merger accounting on both sides of the Atlantic. FASB unveiled its amended rules in December; IASB did the same earlier this month.

Bringing the two accounting regimes into line required much bigger changes to U.S. Generally Accepted Accounting Principles than to IFRS, but business advisers have warned companies reporting under IFRS that the changes are significant nonetheless—even though they might look like just a tidy-up.

Tokar

Mary Tokar, an IFRS specialist with KPMG in London, says companies should look especially closely at the new treatment for the purchases and sales of non-controlling shareholdings. She also warns that several other changes could have an immediate effect on reported profits. For example, if a company has an existing equity stake in the acquired business, it would have to record that at fair value on the acquisition date and then recognize any loss or gain in its income statement. Furthermore, companies will have to expense transaction costs—such as advisers’ fees—that they are currently able to capitalise.

The revisions to IFRS appear in changes to two existing standards: IFRS 3, Business Combinations, and International Accounting Standard No. 27, Consolidated and Separate Financial Statements. The new rules take effect on July 1, 2009, but IASB encourages earlier adoption. FASB’s changes are housed in Financial Accounting Standard No. 141R, Business Combinations, and FAS 160, Non-controlling Interests in Consolidated Financial Statements. They take effect for financial years beginning after Dec. 15, 2008.

Will Rainey, global director of IFRS services at Ernst & Young, says that the most controversial change arises when, after gaining control, a company holds less than 100 percent interest equity.

The new requirements offer a choice of how that non-controlling interest (NCI) is measured. If management measures NCI at its fair value, it will effectively result in goodwill relating to the entire business—not just the percentage acquired—being recognized. Management can also stick with the traditional method and measure NCI at the share of the fair value of the net assets acquired, which makes goodwill significantly lower.

Rainey

“On the face of it, this doesn’t appear to be a big deal,” Rainey says. But if management later acquires the outstanding minority interest, no additional goodwill can be recorded—which means that any company planning to acquire 100 percent of a target would be better off stating the fair value of the NCI when it gains control. “But this will require management to consider their longer-term objectives of the transaction, which will then be obvious to the market,” Rainey warns.

Rainey also advises companies to review the terms of any deal to pay more money to former owners who stay as employees if the acquisition works out. The new rules make it harder for companies to avoid treating such payments as compensation, rather than a cost of the deal.

London Listing Rules May Get Tougher

Foreign companies with a listing on the London equity markets could have to follow stricter corporate governance rules in future. The idea is one among many floated by the Financial Services Authority, the United Kingdom’s lead market regulator, as part of a recently announced review of London’s listing regime.

Foreign companies with a listing on the London equity markets could have to follow stricter corporate governance rules in future. The idea is one among many floated by the Financial Services Authority, the United Kingdom’s lead market regulator, as part of a recently announced review of London’s listing regime.

Currently, foreign companies only have to disclose whether or not they comply with the corporate governance regime in their country of origin, and whether their corporate governance practices are significantly different from those set out in the Combined Code on Corporate Governance, which British-based listed companies follow.

But unlike U.K. companies, foreign issuers do not need to state whether they comply with the Combined Code and explain any practices that do not comply. The FSA’s review paper questions whether this is fair.

The paper also discusses revisions to the distinction between London’s Primary and Secondary Listing segments. Companies need to clear a much higher hurdle to get a Primary Listing, including a three-year record of earnings, an unqualified working capital statement, and a named sponsor (typically an investment bank) to advise it on the market’s rules. The bar is lower for companies that want a Secondary Listing. Foreign companies can choose which option they go for, but British companies are not allowed to take the easier Secondary Listing option. Again, the FSA is questioning whether this is fair.

One proposed solution is to rebrand the Primary and Secondary categories and clarify the requirements, so that investors understand that some listed companies follow tougher rules than others.

The paper asks for comments by April 14. The next step will be to publish a feedback statement in the summer, with a detailed set of proposals to follow.

Early reaction suggests a restructuring to the listing regime could be controversial. Saul Sender, a partner at law firm Reed Smith Richards Butler, says making a second-tier listing available to U.K. companies could devalue London’s brand. Tim Stocks, partner at law firm Taylor Wessing, says allowing domestic companies to join the Secondary category could undermine London’s Aim market, which offers lighter-touch regulation. “This seems almost identical to a listing on Aim, leaving the junior market almost redundant in some cases,” he says.

London Companies Slack on Code

While the Financial Services Authority considers making foreign companies comply with its corporate governance rules if they want a London listing, many United Kingdom companies that already do have a listing are not following the rules, according to new research.

Almost 6 out of 10 companies in the FTSE 350 index still do not claim full compliance with the Combined Code on Corporate Governance, says a study from accountants Grant Thornton.

It is a basic tenet of the Combined Code that companies do not have to comply, but should then give their reasons for not doing so. Grant Thornton found that 4 percent of companies not in compliance gave no explanation at all, and 34 percent provided a disclosure that the firm said was “only the barest minimum.” That finding suggests “a significant number of companies that may need to revisit their attitude to the principles of governance,” says Simon Lowe, head of Grant Thornton’s business risk services.

The good news: Grant Thornton does this survey every year, and the proportion of companies claiming full compliance rose from 34 percent in 2006 to 41 percent in 2007.

Germany Urged to Rethink ‘Concert Party’ Law

The German government is coming under increasing pressure to rethink proposed laws on shareholder “concert parties” that would, according to critics, hamper efforts to improve corporate governance at German companies.

The European Corporate Governance Service, a coalition of governance research and advisory groups, has written to Eduard Oswald, chair of the finance committee of the German parliament, to express its concerns with the proposed laws.

The letter said that under the new law, two or more shareholders who engage with a company independently to raise a shared concern without knowing of each others’ intentions, would be considered as “acting in concert” whenever a significant or permanent shareholder is involved. The consequence could be that if the shares of the concert parties exceed 30 percent of shares, they would have to make a takeover bid for the remainder of the company.

The ECGS says this would lead to legal uncertainties and discourage institutional investors from voting or engaging with companies, or with each other, to improve corporate governance at listed companies.

“At a time when governance standards are a competitive advantage between different capital markets across the continent of Europe, we do not believe that the proposed restrictions on investor actions, or transparency between investors and issuers will prove advantageous for the competitive position of the German market,” said Alan MacDougall, an ECGS spokesman.