PUBLIC AFFAIRS AND MEDIA RELATIONS BLOG - Veena Hudson

World leaders: action still required

In spite of the embryonic signs of recovery, there are still many challenges facing world leaders. The first is to ensure that they are not too optimistic. The IMF and World Bank are still predicting declining growth and contracting output around the world, and the outlook according other indicators such as unemployment will remain gloomy. Although the steps taken so far may be beginning to yield results, much more work is still needed to ensure the recovery.

Any optimism may actually go further than stopping the recovery in its tracks - it could reignite the financial crisis. Leaders and economic policy makers will need to ensure that they balance their approach: large government deficits could generate inflation and make it more expensive to borrow on international markets. But implementing a shift towards policy restraint too early will impact with considerable force on the fragile recovery.

A further challenge facing world leaders is the waning momentum for change. As some indicators begin to pick up, public and political pressure to push through reforms is decreasing and there is a danger now that the impetus for radical and necessary change will be lost. The result of this would be - except for a few cosmetic changes - the global economy will emerge from this recession looking much as it did before, only smaller and with more people unemployed and angry.

Reform, for example, of the Bretton Woods institutions is something that is not only important - it is something that has to be implemented more quickly. The Western powers need to face up to political reality and offer a reform of governance that properly reflects the distribution of power in the new global economy. Without these reforms, developing economies, particularly countries such as China and Brazil, may begin to reject the institutions on the basis that they are not representative enough to efficiently pursue their primary objectives, ie. stability of the international financial system and the fight against poverty.

The scale of the current crisis has been associated with inadequate regulation and supervision of banks and financial markets. But rushing through new financial regulation in a purely reactive response to the financial crisis would be a mistake. The priority should be to ensure that existing regulation is enforced thoroughly.
 
There have also been many political criticisms relating to fair value accounting rules, alleging that they caused some of the market volatility and may have been a factor in the financial crisis. Fair value did not cause the financial crisis, and world leaders should use this crisis to show commitment to the principle of an accountable, transparent and sound system of international regulatory cooperation, maintaining full support for the move towards a single set of high quality international accounting standards. The globalisation of business means that one set of reporting standards, the principles-based IFRS, is essential.

In addition to bigger businesses, SMEs are vital to driving economic recovery through the role they play in creating jobs, innovation, and macroeconomic growth. It is crucial that leaders recognise the importance of SMEs and find more ways to collaborate and partner with business, civil society and governments in encouraging institutional changes to help improve the operating environment for SMEs.

Finally, while politicians struggle to retain votes and work economies out of recession, it is crucial that they acknowledge the climate crisis as well. Acting early, as key policy documents, economic forecasts and project proposals are urging, will raise our chances of diverting catastrophe at a reduced financial and environmental cost, while building a strong green economy.

Political interference in international standard setting

The accountancy profession's international standards setters are under pressure from national interests, and ACCA is becoming increasingly concerned at political interference in the standard-setting process.

The IASB, for example, has come under pressure from the European Commission, as well as the French and German governments, to relax the IAS 39 standards on asset impairment, while the FASB has been pressured by Congress to loosen FAS 157 standards on fair value and mark-to-market accounting.

The IASB and FASB last year set up an international body, the Financial Crisis Advisory Group (FCAG), to advise them on the standard-setting implications of the global financial crisis and potential changes to the global regulatory environment. Members of the FCAG warned at a meeting in London that political pressure on accounting standard-setters posed a threat to: …the very existence of international accounting standards.

Giving in to political pressure on some crucial rules risks damaging the credibility of not only the standard setters, but also the integrity of the accounting standards, which should be set by experts who justify their decisions appropriately, in the way that central banks set interest rates independently of politicians.

The reliability and predictability of accounting standards are key prerequisites for a sustainable and well functioning capital market, and robust accounting standards are essential for a speedy recovery from the financial crisis. It is important that the integrity of standards is maintained in a transparent way or we may be setting the scene for future financial crises. Indeed, the desire of governments to gloss over risks in the financial system as they increased during the boom years led indirectly to the subsequent bust.

While politicians have a responsibility to ensure there is an effective system for setting accounting standards, decisions relating to accounting methodologies should not be made on political grounds, but should be left to those who have the necessary expertise. Within this context, however, ACCA also acknowledges that standard setters themselves should ensure they consult widely and develop standards appropriate both to business and the wider environment in which business operates.

ACCA believes that the role of fair value should be carefully examined in the context of a wider review of the role of accounts and financial statements. 'Knee jerk' reactions, in terms of watering down its impact, are the wrong response. We should not be shooting the messenger. Any attempt to reduce transparency of accounting should be resisted: rather, the opposite should apply. Transparent accounting is in the interests of all stakeholders in business, including the wider public.

Addressing the challenges facing the global economy

The global economy is at a crossroads. The impact of the financial crisis around the world has taken many people by surprise, and the full extent of the macroeconomic impact is not yet known. What is certain, however, is that few countries, industries, or businesses will be left unaffected.

The accountancy profession has rightly come under criticism and has lessons to learn, but it also has a lot to offer in helping the world out of the recession. ACCA has been actively involved in the debate around the financial crisis and has run a series of events, discussions and roundtables to feed in our expertise and to help build a global solution to the financial crisis.

As part of this, Richard Aitken Davies hosted the recent President's debate, which brought together broadcaster and journalist, Robert Peston, CEO of Bramdean Asset Management, Nicola Horlick, and the UK's Shadow Minister for the Treasury, David Gauke, to discuss, under the Chatham House Rule, how to address the challenges facing the global economy.

The current situation

Richard Aitken Davies opened the debate, stating that the financial crisis has been a crisis of governance and ethics and that the response should be two-fold. He called for a US-style examination of the actions for the stewardship of the great financial institutions that have collapsed over the past months and a long-term goal, to promote, via educational, professional and legal systems, the concept of ethical behaviour.

Other panel members agreed that failures of governance were key, saying that boards took too much on trust and failed to take the trouble to find out what the products really were. The institutional ownership structure failed miserably.

At the moment it is difficult to see whether there will be a regulatory over-reaction such as when Sarbanes Oxley followed Enron. Crucially, the current situation was not a failure of light-touch regulation or a lack of regulation, but a combination of a supervisory failure and the 'box-ticking' culture, which saw to-the-letter compliance with regulation. The panel concluded that the best kind of regulation is effectively enforced and principles-based, with a strong punishment if organisations misbehave.

The underlying belief heretofore has been that financial innovation is by definition a good thing. It was beyond the comprehension of many of the world's economic leaders that banks would fail to adequately check the creditworthiness of the people they were lending to, a situation which ultimately led to the sub-prime issues in the US. The scale of the industry's repackaging of products into AAA rated packages was astounding, and has shown that the credit ratings system is not the right system.

In a similar vein, the panel concluded that complexity was a key contributor to the financial crisis, stating that if it is not possible to explain a product in plain English to a relatively informed person, then the product should be avoided. This was the case with the 'alphabetti spaghetti' of investment products (MBSs, CDOs, CDSs etc), which were too complicated to be understood by investors, credit rating agencies and even the big banks and brokerage firms. The current generation of structured products has little or no transparency. As a result, they mask the risks being taken and how the potential rewards are being apportioned.

Moving forward

One key thing that was missing from the G20 discussions according to the panel, was a commitment from the great surplus nations to reduce these surpluses and to rebuild their economies based not on debt, but on saving and investment. Unless we address our indebtedness, there is likely to be a further recession in two or three years. And due to the levels of debt being accumulated in bailing various countries out of the financial crisis, debt, especially in terms of public finances, will be the defining issue around the world over the next five years.

In the UK, the Government's predictions of how long it will take the country to pay off these accumulated amounts may be overly optimistic. Although, it is likely that the country will emerge from the recession towards the end of 2009, it is unlikely that the economy will be growing by 3 per cent of GDP by 2012.

In particular, the outlook for the Western world is pessimistic, as it is likely to decline at the same time as some emerging economies, especially China , are likely to rise. At the moment, countries in the East are dependent upon the West buying their goods, but over the next decades, they will begin to innovate, and to see steep growth. In discussions in or around the G20 summit, China adopted an outspoken stance, calling for an overhaul of the global monetary system, a new global reserve currency to replace the dollar and a greater say for developing countries in the world order. The question now is whether, as the West emerges economically weakened and politically humbled, this heralds a significant, permanent power shift in global politics.

There are no easy solutions to the challenges facing the global economy, and finding our way out of the current situation will involve many tough decisions. ACCA will continue to engage with and lend our expertise to forums such as the G20, in order to assist in finding a way out of the global financial crisis.