09 September 2013

IASB/Hoogervorst: Europe and the path towards global standards

EU Commissioner Michel Barnier has asked Philippe Maystadt, former President of the European Investment Bank, to develop proposals to reinforce the EU’s contribution to IFRSs. The IASB is grateful to Mr Maystadt for having had the opportunity to contribute to his research.

The EU has retained the prerogative to adopt IFRSs Standard-by-Standard and it takes its endorsement procedures very seriously. In fact, it can be argued that Europe has by far the most stringent endorsement process of all jurisdictions that have adopted IFRS. A myriad of European organisations are involved in the adoption of IFRS: EFRAG, national standard-setters, the Accounting Regulatory Committee, the European Commission, the EU member states and finally the European Parliament.

Some big economies have not yet fully adopted IFRS. However, most of them have made a great deal of progress towards IFRS adoption and progress continues to be made, often behind the scenes. In Japan, for example, in the near future a sizeable number of companies representing around 20 per cent of the total market capitalisation of the Tokyo Stock Exchange is expected to be using IFRS. Although the American SEC still has to make up its mind about the use of IFRS for domestic firms, it is important to note that over 450 foreign issuers, representing trillions of dollars in market capitalisation, are using IFRS in the domestic markets. This makes the US a very significant stakeholder in IFRS.

Finally, the European Union plays a very proactive role in the standard-setting process of the IASB. In fact, there is probably no other jurisdiction in the world that devotes so many resources to outreach, fieldwork and input to the standard-setting process as the EU does, through EFRAG and national accounting standard-setters such as the DRSC here in Germany.

Mr Hoogervorst believes that the relationship between the European Union, the IASB and its Standards is overall well balanced and constructive.

Mr Hoogervorst informed about IASB´s major projects: revenue recognition convergence with the FASB, lease accounting, impairment and insurance contracts.

In relation to lease accounting, he mentioned that currently, the vast majority of lease contracts are not recorded on the balance sheet, despite the fact that they usually contain a heavy element of financing. For many companies, such as airlines and railway companies, the off balance sheet financing numbers can be quite substantial. It has been estimated that the hidden leverage in leases leads to an underestimation of long-term debt by some 20 per cent. Right now, most analysts take an educated guess on what the hidden leverage of leasing is. Some underestimate and some exaggerate the true level of leverage implicit in the leases.

He is also convinced that bringing leases to the balance sheet will have benefits to preparers themselves.

He would not be surprised if many CEOs are only vaguely aware of the full extent of the hidden debt in their leasing contracts. By making this hidden debt clearly visible, companies might be able to make more rational decisions on capital allocation. Leasing will certainly not disappear. But companies will be able to make better-reasoned decisions between purchasing and leasing.

On impairment, IASB and FASB both agree that the current incurred loss models gives too much leeway for banks to postpone the recognition of inevitable loan losses for too long. It is a question of too little, too late. The IASB therefore agrees that the incurred loss model needs to be replaced by an expected loss model that is more forward-looking.

However the IASB has found it difficult to agree on the mechanics of the expected loss model. The FASB want all possible loan losses to be recognised on Day 1; the IASB thinks the bulk of the losses can only be identified and recognised once a significant increase in credit risk has taken place.

EIOPA, the European Insurance regulator, recently raised the alarm bell about the effects of persistent low interest rates on the industry. EIOPA is concerned that some insurance companies will not be able to meet their capital requirements. EIOPA refers to Japan, where persistent low interest rates caused some insurers to fail, while others had to lower the returns they had promised to their customers.

If the insurance industry is a victim of the crisis, it has been a rather silent victim thus far. Part of the reason why it has not made more headlines is that the problems cannot be fully seen, for lack of a proper accounting Standard.

Fortunately, the end to this unacceptable situation is in sight. Recently, the IASB released its second and final Exposure Draft for a new insurance Standard. In its proposals, the IASB require measurement of liability using current interest rates. This will allow investors to gain a much more realistic view on the true performance of the industry. Markets will gain much more insight into how effective insurers are in matching their liabilities with assets. Where IASB´s proposals lead to more volatility, it is probably a reflection of real economic risks.

At the same time, the IASB has worked very hard to ensure that the new Standard minimises, to the extent possible, non-economic, accounting-related volatility. IASB´s revised proposals go a long way towards addressing concerns in this respect about our first Exposure Draft. The IASB does acknowledge, however, that there has been a trade-off of increased complexity. The IASB thinks that it has got the balance about right, but it is keen to hear views before moving to finalise the Standard during 2014.

Full speech

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