Saturday, February 12, 2011

New IASB Chair Plans Global Strengthening of IFRS, Calls Accounting Transparency Crucial to Financial Stability

Describing IFRS as the only set of accounting standards that has the potential to be used all over the world, new IASB Chair Hans Hoogervorst said that only IFRS can unleash the full potential of a truly global capital market and make an enormous contribution to economic growth by enhancing transparency and liquidity around the world. In remarks at the European Commission Conference on Financial Reporting and Audit, he also noted that transparency in accounting standard setting reinforces financial stability and that financial statements are not just used by investors but by a broader community of users.

While the interest of the investor will always remain the main focus of accounting standard setting, he said, high quality financial reporting is also of essential importance to depositors and their protectors, to regulators, to suppliers, and to creditors. Indeed, he continued, reliable financial reporting is such an important ingredient for building trust in global markets that it can be said to be of public interest.

In this context, he cautioned that one must never underestimate the public interest of IFRS, which are already the common business language of well over 100 nations. When you look at the fundamentals of IFRS, said the Chair, it is striking that, despite its complexity, IFRS is actually an elegant system of economic reasoning firmly rooted in common sense.

At the same time, the IASB recognizes that financial reporting is not an exact science. Asset valuation is in many respects more of an art than a science. Many financial assets are not homogenous and they often have no active of liquid markets that give reliable price signals. In many cases, asset valuation requires a lot of judgment and common sense. Often there is room for legitimate differences in opinion.

Chairman Hoogervorst detailed four ways that the Board will strengthen the worldwide sense of ownership of IFRS. First, the quality of the IASB’s standards should always be first rate. While there may be differences of opinion about content, he noted, the quality of the Board’s work should always be beyond doubt.

Second, the IASB will have a first rate system of due process. The IASB already follows very strict rules for due process in which exhaustive consultation takes place around the world. The IASB’s deliberations and voting procedures are broadcast live on the internet, making it one of the most transparent standard setters in the world. Still, the Chair said that the Board must build on existing outreach efforts to ensure that participants around the world are heard and that their views are given due consideration. The opening of a regional office in Japan is an important step in that direction.

Third, the IFRS‐foundation must be fully aware of the challenges that can be involved in the implementation of IFRS. While standards need to adapt to rapid economic developments, in the timing of changes the Board must take into account the user’s capacity to digest them.

Fourth, independence needs to be accompanied by a strong system of accountability. The governance of the IFRS Foundation is now being reviewed by the Foundation itself and by the Monitoring Board. He believes that the governance of their relationship can be strengthened and looks forward to proposals to that effect. It is very important that the IASB develop an inclusive governance structure under which all jurisdictions using IFRS feel adequately represented.

On the separate and burning question of whether the purpose of financial reporting should primarily be transparency or the furtherance of market stability, the Chair believes that the question creates a false contradiction since transparency is a necessary precondition of stability. In his view, the current crisis was largely caused by a lack of transparency in the financial markets. Huge risks were allowed to build up on and off balance sheet without being noticed. Without proper transparency about risks, he emphasized, stability is bound to collapse in the end.

He therefore believes that accounting standards can contribute to stability by enhancing transparency, citing examples of how accounting standard setters are doing just that, often in close consultation with securities and banking regulators. He mentioned the tightening up of conditions for off balance sheet financing, the proposed convergence to eliminate differences between US GAAP and IFRS in the netting of financial assets and liabilities, and the proposed introduction of the expected loss model to enhance loss recognition in the loan portfolio in a timely stage.

Accounting standards can also be useful for stability purposes by avoiding artificial noise in the balance sheet and the income statement. This was an important reason for the IASB to continue with a mixed attribute system with regard to financial instruments. Financial instruments that have basic loan features and which are managed on a contractual yield basis are valued at amortized cost. For such instruments, cost is deemed to provide more relevant information than short term market fluctuations.

Accounting standard setters will thus remain committed to their main goal of providing transparency and by doing so make a great contribution to stability. The difficult task of making the financial industry safer is the responsibility of the banking and securities regulators. He is convinced that they can strengthen their mandate of guarding stability by using more effective transparency as a preventive instrument. For example, in his view, the regular publication of rigorous stress test, such as mandated by the Dodd-Frank Act, can do a lot to help them in their difficult task of imposing adequate capital levels on the financial industry.