The news that the European Commission (EC) wants to carry out a “comprehensive check of the fitness of the EU framework on public reporting by companies” – accounting for short – appears to have caught the IFRS Foundation – the international organisation responsible for developing global accounting standards – on the hop.
It is likely that question 19 in the EC’s online survey provoked the foundation’s ire. The question asks whether it is “still appropriate that the [International Accounting Standards] regulation prevents the Commission from modifying [IFRS] given the different levels of commitment” to it across jurisdictions.
Clearly miffed, the chair of the IASB, Hans Hoogervorst, and the chair of the IFRS Foundation’s trustees, Michel Prada, explained in a joint statement: “It is, of course, for each jurisdiction to determine whether and how to incorporate IFRS Standards into its accounting requirements. However, the fact that the questionnaire repeatedly raises the possibility of introducing European carve-ins to IFRS Standards has surprised us for several reasons.”
Their case for keeping things as they are goes like this: “First, for more than 20 years the EU has been the main driving force behind the G20-endorsed goal of a single set of high-quality, global accounting standards. It is not clear why the EU would consider departing from this goal at a time when the EU is rightly concerned about global economic standards being under tremendous pressure more generally.
“Second, the EU has – on two occasions in the last five years – sought feedback on the possibility of introducing a carve-in mechanism to the EU endorsement process, with both reviews cautioning against such a change.”
This is a reference to the 2013 Maystadt Review and the Commission’s own evaluation of a decade of IFRS in 2015. Maystadt concluded that the emergence of an EU-flavour of IFRS could increase the cost of capital, feed lobbying activity and detract from the G20 goal of a single set of globally applicable accounting standards.
Corporate reporting by EU public companies is based on a number of EU directives, regulations and recommendations that have been adopted piecemeal over the past 40 years.
Europe’s first bid to harmonise its accounting regime was with the Fourth Council Directive 78/660/EEC of 25 July 1978. This specified the information that companies must make available such as a balance sheet and profit or loss account – depending on the size of the company – as well as auditing and publication requirements.
Five years later came the Seventh Council Directive 83/349/EEC. This focused on the content of consolidated annual accounts, the notes, and, again, the auditing and publication regime.
But, it was 2002 that saw accounting’s big bang. This came with the EC Regulation on the Application of International Accounting Standards No. 1606/2002 of the European Parliament and of the Council. It meant from 2005, all EU businesses with traded debt or equity securities were obliged to use IFRS for their financial statements. This is why IAS 19 is used for pensions accounting.
“They cannot put words in at the moment; they can only remove words, and what that would mean was they would be able to transfer out of things like the trading account… without any controls whatsoever”
A further directive in 2004 ushered in harmonised transparency requirements, forcing issuers to prepare annual, half-yearly and quarterly financial statements, publish information about large holdings of voting rights and make Market Abuse Directive disclosures.
Perhaps worth passing interest in light of Brexit is Commission Regulation No 1569/2007. This provision introduced a mechanism for the equivalence of third-country Generally Accepted Accounting Principles (GAAP) – it is why US GAAP is recognition across the EU.
The next shake-up was in 2013 with a new Accounting Directive (2013/34/EU). It came into force on 20 July 2013, consolidating and repealing the fourth and seventh Accounting Directives but also modified some of the Transparency Directive’s requirements – in particular, it scrapped quarterly reporting. For the first time, it also regulated business accounting according to five new entities: micro, small, medium large and public-interest.
But why, as the IFRS Foundation muses, this latest move from the EC? Sharon Bowles, a former chair of the Economic and Monetary Affairs Committee of the European Parliament (ECON), says she has the answer: “The point is really how does the EU have influence.
“Presumably this is done via the EC, but we always felt it was the ‘big four’ in control. I think in ECON we regretted that the whole thing had been signed up to with just ‘regulatory scrutiny’ under the Legal Affairs Committee – it was part of company law. I discovered it when some scrutiny email was circulated in the holidays saying ‘Yell if there is anything’, so I sent it to the ECON secretariat and eventually we elbowed in.
“But ultimately, it was buried in the tsunami of legislation following the global financial crisis. Now there is more of a legislative lean time, we should expect more scrutiny. Maybe there is an appetite to fix it? I think the UK should be doing independent scrutiny as well.”
But it is the threat of a carve-in that has had the greatest impact on the IFRS Foundation.
The reaction from the IFRS Foundation is unsurprising. After all, carve-ins are to the IASB what garlic is to vampires. That much emerged at the height of the financial crisis. The EC, faced with the threat of major banks going under, demanded that the IASB amend its financial instruments rules to permit banks to reclassify underwater assets in a bid to delay the recognition of losses.
In evidence to the UK Parliament, then IASB chairman Sir David Tweedie said: “We heard a speech by the Commissioner saying that he had legislation prepared to have a ‘carve out’ from part of our standards. They cannot put words in at the moment (though I suspect that might be thought about); they can only remove words, and what that would mean was they would be able to transfer out of things like the trading account.… without any controls whatsoever.”
Aware of the potential for damage to its reputation of independence, the IASB has, publicly at least, rejected special pleading. But with a carve-in back on the table, could a solution to those German minimum-guarantee pension plans be on the cards?