IASB Chair Tells U.K. Parliamentary Panel that Dialogue between Outside Auditors and Financial Regulators Should Be Required

In testimony before the U.K. Parliamentary Subcommittee on Tax, Audit and Accounting, IASB Chair Hans Hoogervorst endorsed in principle the idea of a statutory requirement that outside auditors dialogue with financial regulators. Regulators don’t see anything, he said, despite all the leverage. For example, the IASB Chair believes that outside auditors were and probably are relying on the regulators to take care of going concern and, thus, were not so very critical. Outside auditors need to be more critical, he emphasized. While recognizing that auditors are in a very difficult position if they raise going concern issues in public, Chairman Hoogervorst said that they should raise going concern with the regulators.

Lord Lawson, Chair of the Subcommittee, said that during the financial crisis the independent auditors did leave it for the regulators, and yet the auditors were not speaking to the regulators. Equally, the regulator was not speaking to the auditors. It is common sense that they should be, posited Chairman Lawson, from the point of view of the regulator. It would be desirable, for example,  for there to be a statutory duty for the auditors of banks and the bank regulator to be in dialogue, so that auditors concerned about a bank can express their concerns to the regulator, and if the regulator is concerned about a bank, it can ask the auditor to look more deeply into it. Chairman Hoogervorst agreed that such a statutory duty would be helpful.

Chairman Hoogervorst also emphasized the need for global accounting standards. But Lord Lawson questioned how IFRS can be a global set of standards when the United States is going its own way with U.S. GAAP. The IASB Chair reaffirmed his belief, which has become a refrain, that the United States will come on board, but it will probably take a little longer than is desirable. The United States has had to decide on adopting IFRS in a very difficult economic time, he said, during the financial crisis. He wondered if the European Union would have been able to take such a position in the middle of economic upheaval.

Prudence. Referencing recent remarks by Chairman Hoogervorst, Lord Lawson said that the old definition of prudence that was written into accounting standards was spot on, but was removed to achieve convergence with US GAAP, which does not have prudence. Chairman Lawson noted that it is now clear that there is no need for convergence since the U.S. is going ahead with its own system. Therefore, he asked if that makes a conclusive case for writing prudence back into IFRS. Chairman Hoogervorst replied that putting the concept of prudence back into accounting standards would not make a fundamental difference. He pointed out that prudence was removed only in 2010, well after the outbreak of the crisis. In the period before the crisis, prudence was in the accounting standards.

He also said that the concept of prudence, which basically means that if you are in doubt about results, please be cautious, is still ingrained in the work of outside auditors. The reason why it was removed was because the IASB felt that it was being abused, or misunderstood, to underestimate artificially the value of assets, and the Board likes financial accounts to be as neutral as possible.

Expected Loss Model. Chairman Hoogervorst also noted that the Board is finalizing the expected loss model to replace the incurred loss model, which gave banks too much leeway to procrastinate about recognizing their losses and facing reality, which caused too low a level of provision. Under the expected loss model, banks will have to take some provisioning for all assets, even if they are not impaired. The trigger for taking a full lifetime loss will be much lower than in the current incurred loss model. Banks that have looked at the new model and have done calculations assume that their level of provisioning will go up, some say 30%, others say 100%, but it can safely be assumed that it will be quite substantial.

Finally, the IASB Chair noted that financial statement accounting will remain complex since the reality is extremely complex, especially with the different types of derivatives. Once you have derivatives, he observed, you have a lot of complexity. Regulators can do a lot to reduce it, but to eradicate it would be very difficult.