It gives me great pleasure to join you here today at one of the most important forums for our region and I thank the organisers for the opportunity to speak at this session.
The Australian Financial Reporting Council that I chair is the peak body responsible for overseeing the effectiveness of the financial reporting framework in Australia
The recent Global Financial Crisis reminded us of the strong interconnection of capital markets around the world, and the importance of high quality financial reporting. Indeed, the G20 called for renewed efforts to achieve a single global set of high quality standards. This call was accompanied by a strong sense of urgency amongst the global community to increase the pace towards the achievement of global high-quality standards.
Our region is faring comparatively well in the aftermath of the Global Financial Crisis. In this difficult period where other regions are struggling with significant sovereign debt problems, our region has the opportunity to take the lead in progressing the agenda for a global set of high-quality standards.
I travelled to Europe and the US in Oct last year to talk with major organisations involved in financial reporting and was very pleased to find that there is great interest, at a high level, in what we are doing in this region. The views I am expressing in this paper reflect discussions I had with people I met.
IFRS as the global accounting standard
I'll begin with why the global economy today needs IFRS. The arguments for a single set of global accounting standards have been cited many times, so I shall keep it brief.
Australia was one of the early adopters of IFRS in 2005 - and this is because we recognised early on, that with the current pace of globalisation, the movement to a global set of accounting standards is a logical transition. In today's world where businesses and investments operate on a global level - companies, investors and other stakeholders all gain from one set of accounting standards. Companies can prepare reports for subsidiaries located in different countries on the same basis; a lower cost of capital can be accessed by companies because investors can easily understand and compare financial information across jurisdictions; and the long-debated problem of regulatory arbitrage can be minimised. In economic terms, having one set of accounting standards allows the market to operate efficiently - and everyone benefits from an efficient market.
Australia is also very involved with other countries in the Asian-Oceanian region in promoting the adoption of IFRS. One such example is our deep involvement with AOSSG, the Asian-Oceanian Standards Setters group, whose Chairman, Kevin Stevenson, is also Chairman of the Australian Accounting Standards Board as well as being a Member of the Australian Financial Reporting Council and of the New Zealand Accounting Standards Board.
IFRS has made significant progress over the past few decades, in the journey to achieve a single set of standards. Most of the large developed and developing countries have either already adopted, or will begin adopting IFRS. However, the path towards a single set of global accounting standards still faces many obstacles. I will talk about two key challenges.
Challenge 1: Uncertainty with US adoption
The first challenge is uncertainty with US adoption.
The existence of two main sets of financial reporting standards…being US GAAP and IFRS…hinders transparency and comparability of financial statements. The single most important input into any company analysis is the figures presented on financial statements. Investors trying to compare reports prepared using different standards need to put in significant resources to understand both financial reporting frameworks…and even then, it is difficult to make comparisons.
Whilst the capitalisation of stock markets in the Asian Oceanian region has caught up with that of the US, the US still represents about one-third of the world's capitalisation. To not have the US adopt IFRS would significantly impact global comparability of financial performance. Moreover, it would limit to some degree the expertise available to develop IFRS in the future.
Challenge 2: Consistent application and enforcement
The second challenge is how to ensure consistent application of IFRS across jurisdictions. One of the major differences between US GAAP and IFRS is that US GAAP is more rules-based, while IFRS is trying to be more principles-based. While principles-based standards have the advantage of providing flexibility, they are subject to professional judgement and uncertainty - and this raises the risk of inconsistent application.
The IASB is a standard-setter, and does not have an enforcement mechanism. It has not, nor does it have, the ability to enforce application of IFRS, let alone in a consistent manner. This role of encouraging and ensuring consistent application…is largely left up to regulators.
This leads to our main topic of discussion for this session ... the role of international regulators.
Role of international regulators
I'll talk about two main roles for international regulators in "working towards a global set of accounting standards".
Role 1: Participation in the standard-setting process
Firstly, international regulators play a crucial role in the standards-setting process. While the IASB acts as the strategic think-tank in identifying divergences in standards and drafting new IFRS; users, preparers, practitioners and, importantly, regulators provide, from their various perspectives, expertise and practical insights.
Takes IOSCO, for example. IOSCO seeks to promote integrity in financial markets, which is achieved only by effective surveillance of international securities transactions, and the enforcement of consistent standards. IOSCO therefore maintains a close interest in the standard-setting process for financial reporting and in the activities of the IASB's interpretations committee. As IOSCO has direct experience with lodged financial reports and with the disputes and uncertainties that arise in relation to such reports, their comments on draft standards are very valuable to the IASB. IOSCO assists the IASB to ensure that standards are of a high-quality…whether a standard would have interpreting and monitoring issues…and in response, make constructive suggestions.
Apart from assisting the IASB through submissions, IOSCO also currently chairs the IFRS Monitoring Board, and is represented on the Advisory Council. The Monitoring Board ensures the independence of the standard-setting process, and gives securities regulators a means of ensuring IFRS are being developed according to procedures and policies that protect investor interests.
Other regulators, who may not have objectives aligned with accounting standard-setters, should also express their views where appropriate on IFRS matters, but at the same time, regulators should respect the purposes of accounting standards.
Role 2: Monitoring and enforcement
The second key role which international regulators can play…as mentioned earlier on, is the role of ensuring consistent application.
A good example of inconsistent application occurred last year in Europe, with the valuation of Greek bonds. Discounts applied to the valuation of Greek bonds amongst the banks in the Eurozone were so significantly different…varying from 21 percent to 50 percent, that they prompted Hans Hoogervorst to write to the Chairman of ESMA, the EU's financial markets regulator, pointing out the issue and requesting action in ensuring that IFRS is applied consistently across the EU. As Hans knows, I was an observer at the IFRS Trustees meeting last October where this issue was discussed.
Just a bit of background…IAS 39 requires financial assets to be written down where there is "objective evidence of impairment", and provides guidelines on how to value the assets. In the case of the Greek bonds, the EU and the International Institute of Finance in July proposed plans which would effectively result in a 21% discount on the bonds and some banks were maintaining this 21% discount in the face of mounting evidence that the discount should be higher. Furthermore, international audit firms were validating different discount rates being used for these bonds in different countries.
There were several judgment calls that banks needed to make in valuing these bonds…whether the bonds were held-to-maturity or available-for-sale, whether the bonds on hand were affected (because the plans did not apply to some maturities, and some financial institutions), whether the bonds had an active market…and so on.
Because of such vast interpretation differences and the significant reliance on professional judgment calls, write-downs recorded by banks ranged between 21 and 50%…and this represents significant value for some banks.
In short, this case study illustrates the fundamental problem…that there is much less use in having global standards if they are interpreted and applied inconsistently. If even across the EU region there could be such vast interpretation differences…imagine this inconsistency magnified on a global scale!
There is a clear role here for regulators such as ESMA (for the EU region) and IOSCO (on a global scale) to coordinate enforcement action between the national regulators. This is certainly not an easy job, but it is an absolutely key element in a single global financial reporting framework.
Let's give some credit to all the hard work the international regulators have put in to date in promoting consistent application.
IOSCO has taken several initiatives to promote consistency in the interpretation of IFRS - one example is a database which allows international regulators to share information on IFRS. The intention is to improve consistency in the assessment of the application of IFRS among members. More than 46 securities regulators have taken part in this database…this database will not only help the regulatory agencies in their decision making…it also helps regulators identify significant inconsistencies in interpretation…which they can then refer to the IASB or the Interpretations Committee. It would be untoward if consistent standards were inconsistently interpreted by the many securities regulators around the world.
Europe has a similar database, coordinated by ESMA. While the existence of such databases should not remove the need for regulators to use their judgments when assessing the application of international accounting standards, they provide a useful source of information for standard-setters.
In addition, ESMA has established European Enforcers Coordination Sessions, which provide a forum for national enforcers to discuss interpretations of IFRS. These forums create opportunities for jurisdictions to identify any issues, which can then be alerted to the IASB Interpretations Committee.
Europe as a region has in place some good initiatives that we in the Asia-Pacific region should consider. AOSSG was created as a platform for jurisdictions within our region to discuss issues such as IFRS, as well as forums such as today's. AOSSG regularly shares issues among its members and communicates them to the IASB and the Interpretations Committee. It would arguably also be beneficial for our region to have our regulators establish a database, or contribute to that of IOSCO, in a way that member countries can share the experiences of IFRS…in particular to share cases where judgment calls have to be made for interpretation of IFRS. That way, we can ensure that we, as a region, are consistently applying IFRS, and that any inconsistencies are immediately detectable and can be raised as an issue to the IASB. Our region has some of the fastest growing countries in the world, and it is important that we work together in tackling future global challenges.
I'll leave you to consider the suggestion of a regional database or section of a global database, and I shall move on.
As the global economy becomes more and more intertwined, there has been an important change in the regulatory landscape…a shift in the focus from domestic governance to international governance…one of these bodies is the G20.
The G20 has played a key role in responding to the economic problems, including some international accounting standards issues, raised by the Global Financial Crisis. The G20 provides a forum where the major economies of the world, including developing countries from Asia-Pacific, as well as Australia, can work to coordinate global economic responses to global problems. As such it is a forum on which Australia places great value, and we are keen to see it continue to play a leading role in providing the kind of coordination that cannot be provided by bodies such as the G7 or G8 which do not include such diverse membership.
The focus of the G20 regarding international accounting standards issues was on finding out where components of the existing system might have created an opportunity to exacerbate the fundamental economic problems that created the crisis. It was agreed that accounting standards themselves had not caused the crisis. That said, it was clear that having multiple inconsistent accounting standards did not foster the transparency needed in a crisis, and at worst created the opportunity for regulatory arbitrage. Therefore the G20 urged accounting standards setters, most notably the IASB and US FASB, to hasten their pre-existing convergence project so that we would move closer to a world with a single set of high-quality global accounting standards. This has long been Australia's goal, and so we enthusiastically support this project.
The G20 also urged the accounting standards setters to work faster to improve the complex aspects of the financial instruments standard, which had been under repair for a long time, basically since the IASB had adopted it. Many aspects of this project have been completed, although there remain a few bones of contention between the IASB and US FASB on how to finalise the remaining issues.
Finally, the G20 recommended that the IASB enhance its outreach and stakeholder engagement activities, especially to emerging economies. Again this is something that Australia strongly supports, not least because many of our major trading partners in our region are emerging economies. The IASB has already begun addressing this recommendation, with the establishment of the Emerging Economies Group last year. Australia, through AOSSG members, actively participates in that forum.
Australia sees the relationship between the G20 and the IASB now as a very positive one, that allows both sides to understand their respective issues, and adds a degree of public accountability to the IASB that was needed.
I'll now like to spend time talking about Australia's approach to IFRS and how countries can assist international regulators and the G20 at the domestic level.
The Australian Financial Reporting Council recognises that it is our responsibility, along with the Government, domestic standard-setters and regulators, to alert the international regulators and the IASB of any issues which come to our attention which may require interpretation, and which may be inconsistently applied between jurisdictions.
With regulators taking a top-down approach from the international level, it becomes the responsibility of domestic Governments to ensure our views and circumstances are heard and properly considered in the decision-making process. Representations on international institutions have become a crucial way for countries to ensure that each country's individual circumstances are considered.
Because Australia understands this, we encourage our representation on international financial reporting boards and committees…and we strongly encourage other countries in the region to do the same.
Since adopting IFRS in 2005 we have been very active in the development of international standards. For example, Australia has provided support to the IASB in the form of financial assistance, secondment of staff, and provision of technical input. We recognise the benefits of adopting a global set of accounting standards,
Our region has survived the Global Financial Crisis relatively well, and this resilience is due to our efforts over the past few decades in managing our own individual economies and at the same time ensuring we are all more transparent in our dealings as well as accountable for outcomes,
The key to avoiding another financial crisis, and to continue along the path to one global economy with one single set of standards…is effective communication…communication between countries, between regions, and on the global scale, between standard setters, preparers, users of financial reporting and regulators..
Again, I urge that we, in our region, take the lead, based on our relative current economic strengths, in progressing the agenda for a global set of accounting standards-our shared vision. We can take the lead by developing even more effective ways of communication between us.. We each can contribute to this process by working collaboratively so that the best ideas are encouraged. In so doing, I believe we will be working in the public interest - for everyone in the region as well as internationally, now and into the future.