Specter of Divergent Interpretation Haunts Basel II and IFRS

As the implementation dates for the new Basel Capital Accord grow closer, concern is also growing over a number of issues connected to the multi-jurisdictional implementation of Basel II. Since the US is implementing the accord after the European Union, there are timing issues. Of more lasting concern, however, are issues relating to differing interpretations of Basel II down the road. These issues were recently discussed by Financial Services Authority Chairman Callum McCarthy in speech given in Singapore.

What the chair called the ``striking difference’’ between the EU implementation of the new accord in about three months and the US timetable of Jan 1, 2009 can be worked out, in his view, since it is a transient difference. For EU financial institutions with substantial US operations, he continued, there will be complexity and costs. But, again, since the timing issues are transient, the impact is not that great.

A far more serious concern is that different interpretations of the accord in different jurisdictions could threaten the consistent convergence of Basel II. If I may be permitted to make an analogy, this concern strikes me as very similar to the fear of the IASB that differing interpretations of international financial reporting standards will ultimately defeat the effort to converge financial accounting standards. Since about 100 countries have adopted IFRS, including the EU, this is a real fear. As the IASB wrestles with how to combat this menace to convergence and consistency, the FSA chair’s remarks on the issue have import beyond the implementation of Basel II. I will go further. I believe that the specter of differing interpretations is the greatest threat to consistent IFRS, as well as Basel II.

In the senior official’s view, when the FSA is the primary regulator of financial institutions with activities in other jurisdictions, such as the US, the FSA will not start with the presumption that its interpretation must be applied throughout all the groups comprising the financial institution. Instead, the FSA will seek to incorporate the judgments of US regulators in its assessments, so long as the FSA has confidence in them. This approach strikes me as eminently reasonable. Admittedly, the determination of whether the confidence level in the non-UK regulator is sufficient to allow incorporation is a subjective one. Perhaps, in future remarks, the chair can set forth some objective guidelines to aid in this determination. But, that said, he has made an important contribution to this debate, which is crucial to the consistent global application of financial standards.