By Jane Fuller, former financial editor of the Financial Times and co-director of the Centre for the Study of Financial Innovation think tank
UK politicians spent considerable time in January holding hearings on tax, audit and accounting under the auspices of the Parliamentary Commission on Banking Standards.
Having advocated electrifying the ring-fence between retail and investment banking, the PCBS has galloped onto a wide range of other subjects. Now this joint body of both houses of parliament has got to accounting standards.
Comments have been gathered via a questionnaire, published on 4 December with a 21 December deadline. Genuine users of accounts had to scramble to meet even the informal extension to early January – here I will declare an interest as I chair the financial reporting and analysis committee of the CFO Society of the UK.
It was very important that we did respond. The questions betrayed some preconceptions: ‘What was the role of accounting standards and reliance on fair value principles in the banking crisis’? ‘Fair value principles’ seem an odd way to describe an accounting model for financial instruments that is a hybrid between fair or current market value and amortised cost.
Another underlying assumption seemed to be that marking to market, or to model, would not give a ‘true and fair’ view of the value of a trading instrument. Leaving aside the point that fundamental valuation techniques rely on models, neither cost nor stale prices would be relevant for derivatives and many asset-backed securities.
The running on this issue has been made by corporate governance experts from respected UK instutions, all ‘long-term’ shareholders. They have produced a Concerns with IFRS in the EU paper that champions prudence over neutrality in the accounting, and suggests the EU should resist International Financial Reporitng Standards (IFRS), which they view as tainted by US influence.
Users of accounts who disagree must make themselves heard.
There is no contradicition between neutrality and a true and fair view – both tell it how it is in a cyclical and volatile world. Yes, judgements must be made, but why aim for something a bit worse than your best estimate?
Prudence should be located in management’s business decisions and in the judgement applied by boards, investors and regulators. But all should start with data that is as unbiased as possible. Auditors should indeed curb optimisim but pessimism is no panacea.
If the real problem is banks’ ability to absorb losses, then building up equity capital – as is happening – is the best solution. In the run up to the cirism bank balance sheets showed assets ballooning and equity suppressed. Failures of corporate governance, prudential supervision and investor oversight were far more importanct than any accounting weakness.
IFRS is not perfect. It develops in response to abuse and poor practice. IFRS 9 addresses concerns on fair value measurement and will switch the loan-loss model to expected losses, so why delay endorsement in the EU?
What is the alterantive to IFRS? A return to UK GAAP? Surely it would now have a standard for financial instruments that chimed with US GAAP. International standards are not only what the G20 wants, but users of accounts want. As for an EU version of IFRS, variation so far has been for the dubious reason of placating preparers.
Accounting standards are an odd scapegoat for the financial crisis. Accounts provide evidence that can be used with other information – from stress test results to environmental risks – to form a picture of a company and its prospects. It is what is done with the information that matters, and long-term investors are in the best position to take a dispassionate, or a prudent view.
This article first appeared in Accounting and Business, UK edition, February 2013