22 April 2015

IASB/Danjou: 'Financial Reporting and Financial Markets'

What are the mega-trends that are shaping the IASB’s technical work and that probably feature prominently on investors’ radar screens?

Globalisation: Financial markets are increasingly global, and investing is no longer restricted to safe, well-known, national or regional markets. Investment opportunities abound in emerging economies, growth is stronger in the BRIC countries and financial markets in those economies are booming. But with higher returns come higher risks. Accounting scandals are too frequent in some emerging markets. High quality financial reporting is one tool for reducing investment risk. Furthermore, the optimisation of capital allocation is made easier if the financial information is directly comparable.

Currency changes: Investing internationally, or investing in entities that are active on foreign markets, means that one takes on an exposure to Forex risks, which can be significant when currency exchange rates are as volatile as they are today. Investors need to better understand the currency risks that affect companies and how they are managed and hedged. Hedge accounting needs to depict accurately those risk reduction activities. The same is true of the volatility in commodities, energy prices and interest rates.

High leverage and asset valuation problems: Today’s economy is marked by highly leveraged financial strategies, not only in the banking industry. Easy monetary policies and historically low borrowing costs are pushing up asset prices. Multi-billion dollar mergers and acquisitions deals are the norm. Such deals are based on assumptions about underlying asset values, which in turn rely heavily on forecasts—sometimes on dreams—about growth in markets. However, the modern economy is also quite cyclical, and prone to high volatility. Hence, the repeated creation of bubbles and impairments of assets and goodwill are likely to be seen in the periods that follow an investment in excess capacity or a large business combination. The strictness of accounting standards, and the quality of their enforcement, is very important to investors.

Low interest rates: The current environment, characterised by very low or even negative rates on high quality bonds, creates new financial and accounting challenges. The impact on balance sheets of the reduction in discounting rates can be very material and one can ask how it should be reflected in the performance of companies. It also puts the spotlight on the pension obligations of many entities: how can they face up to their defined benefits plans? The same applies to life insurance companies.

Diversification: Many entities want to mitigate these risks by engaging in diversified activities or operating in different geographical zones. Their consolidated financial statements give an aggregated view but cannot, by themselves, allow investors to understand in sufficient detail the risks and returns of those different activities and markets. Segment reporting (IFRS 8) is of the utmost importance, as are the recently improved disclosures of key figures for entities that comprise a consolidated group (refer to IFRS 12).

Key performance indicators, non-GAAP figures and disclosure overload: The management of companies wants to communicate to investors the way they see their performance, and investors need quantified information about key performance indicators (KPIs). IFRS currently does not cover this form of financial reporting, and the reliability of published non-GAAP information, which is frequently not audited, is questionable.

Full speech

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