More than three years after I posted ‘Fair value accounting in retreat?’ on this blog, it seems appropriate to take stock of the results of reform initiatives undertaken after the financial crisis. Just as a brief reminder: In the course of the financial crisis, International Financial Reporting Standards were suspected to have exacerbated the collapse of financial markets. Particularly the use of “fair value accounting” for banks’ financial assets was scrutinized for its contribution to downwards spirals between devaluated market assets and banks’ rising capital requirements. Previously considered as a purely technical matter, accounting principles suddenly became a matter of international politics. The G20, the Financial Stability Board, IOSCO and the two leading standard setters, IASB and the US-American FASB, all got involved in what appeared a busy beehive of reform debates. Three-and-a-half years later, with the financial crisis followed and superseded by the European sovereign debt crisis, accounting principles seem to have returned to their status of “sleeping beauty”. Yet, this impression is misleading. Accounting principles continue to be a crucial link between the reporting of financial institutions and financial market regulation. All the more a reason for reviewing two recent publications which analyse international accounting standards reform and harmonisation.
Did accounting standards exacerbate the financial crisis because accounting of assets by their “fair value” in inactive and collapsing markets forced banks to unnecessarily increase their capital base? Were better buffers against market fluctuations necessary for a more robust accounting that would provide financial market regulators more fair and just figures on what was really happening in the banks? Was the “creative” use of accounting standards an enabling factor fore the growth of the shadow banking sector? Debates about such issues perked up in the immediate months after the financial crisis. There was a lot of pressure from politicians, international regulatory bodies and the general public to investigate the role of accounting standards, and to possibly to revise them. As is common with complex policy matters, publicity-seeking statements by politicians were soon replaced with less-visible committee work, where a variety of different parties fought over gradual and incremental changes.
Problem-solving without a common problem-definition
In a paper (PDF) that Paul Lagneau-Ymonet and I recently published in Renate Mayntz’ edited volume on ‘Crisis and Control’, we trace policy debates across a range of international and European arenas during the period from November 2007 to November 2011. While theories of the policy cycle typically assume agreement among actors on a common problem definition to start with, debates on accounting standard reform interestingly enough did not converge towards such an agreement. Reforms actually unfolded in a context in which controversial debates over competing problem diagnoses – arising from a transparency and prudential approach to accounting – continued. Problem definition changed over time but remained unsettled. Hand-in-hand went shifting and sometimes fairly counter-intuitive coalitions between actors which ran across typical industry-regulator and private-public divides. While securities regulators tended to side with investment banks and the IASB’s accountants in a plea for “fair value” and market transparency, banking regulators and business banks were more likely to support accounting reforms which should render accounting figures more robust against crisis-driven market fluctuations.
In sum, however, unsettled debates did not prevent reform altogether. Faced with pressure from politicians, international organisations and banking regulators, the IASB – in loose cooperation with its US-American counterpart FASB – started a review process of its international financial reporting standards in the light of the financial crisis. As a result the IASB has undergone reforms at the organizational level and some IFRS have been modified. By November 2011, the most important changes were:
- Improved accountability: A Monitoring Board und Financial Crisis Advisory Group (FCAG) have been established including representatives of public authorities. Overall, this has made the governance structure of the IASB more publicly accountable. However, while prudential regulators, demanding for a stronger consideration of the stability of the financial system in designing accounting standards, have played some role in the FCAG, the Monitoring Board includes only representatives from security markets regulators who (like the members of the IASB themselves) lean more towards market efficiency and transparency as the prior goal of accounting standards. The only exception is the European Commission whose role in the Monitoring Board still needs to be seen.
- More robust accounting standards: The standards provide now clearer guidance on Fair Value measurement and a simplified classification of financial instruments (IFRS 9). The notion of “control” as the basis for consolidation of entities (dealing with the problems arising from special purpose entities during the crisis) has been much more broadly defined than for example by the US-American standard setter FASB (see also blog post by Mathias Thiemann).
Problem-solving driving standard-setters apart rather than toward convergence?
Following the financial crisis, one key goal of politicians and regulators was to achieve greater harmonisation of accounting standards across the world. Yet, the results are paradoxical. While policy-makers and international financial regulatory organizations have pushed for increased collaboration between the IASB and the US-American standard-setter FASB, this cooperation has only taken the form of a loose cooperation. As a result, both standard-setters have been pursuing similar topics with different time horizons and deadlines, engaging in exchanges with different stakeholder groups. By the end of 2011, the reform initiatives had produced a variety of different opinions and solutions in fields such as measurement of financial instruments, impairment and consolidation. Part of the reform outputs, thus, seems to run counter to the goal of unified standards envisaged at the beginning of the process. This view is further supported by the content of the IASB-FASB Update Report from April this year.
Standard-setting: Harmonisation at the cost of financial stability?
Attempts of the IASB and FASB to achieve more convergence have been accompanied by the articulation of substantial differences in ‘legacies’, interests and responses of stakeholders between the two standard-setters and their constituencies. Progress on issues which were still open in November 2011 has been very slow and cumbersome. The Boards of the two standard-setters are still working on solutions for issues such as numbers of classifications for measuring financial instruments, assets to be measured at fair value, recognition of fair value, impairment, hedge accounting, consolidation of entities, accounting of netting – to name the most important ones. In some areas standard-setters are struggling to agree on one version (classifications), in other areas they are defining meta-solutions (impairment). The developments since November 2011 support the argument that the overall global governance architecture has not been effective in initiating a convergence process, mainly because there has not been a clear enough mandate, goals of convergence remained too ambiguous and deadlines were not sufficiently coordinated.
Furthermore, these developments reinforce the impression that the IASB had been undertaking more substantive realignments of its standards in response to calls from prudential banking regulators and politicians (predominantly from Europe and international organisations such as the FSB and the Basel Committee) than the FASB has done or is willing to do. This is evidenced by the FASB’s more gradual revisions in the framework of a narrow legalistic notion of control in the case of consolidation (as compared to the broad substantial definition of control introduced by the IASB) and its reluctance to account for long-held loans on the basis of amortised, rather than fair, value. Apart from historical legacies of accounting (increasingly highlighted by both standard-setters in recent publications) this outcomes can be also traced to the different institutional environment that the FASB faces. In the US, the Securities and Exchange Commission, in charge of overlooking the American accounting standard setter, by definition of its institutional tasks focuses more strongly on capital market efficiency (and hence a transparency approach in accounting) than the Financial Stability Board and European prudential regulatory authorities have done after the crisis (leaning towards a more prudential approach).
Overall, problems of harmonisation thereby have delayed the reforms of IFRS. In December 2011, the IASB announced that the mandatory date for implementation of IFRS 9 has been deferred from 2013 to 2015 (voluntary adoption being possible before that date). This also implies that the EU, which has declared not to be willing to endorse the standards before the whole package is completed, will postpone formal adoption. De facto, thus, reforms are still waiting for implementation on the ground in one of the largest jurisdictions of IFRS adoption.
Governance reforms: Informal deliberation with regulators more effective than formal oversight?
In terms of governance reforms the IFRS Foundation’s Strategy Review of April 2012 and the Monitoring Board Governance Review of February 2012 are of interest. The reports of both bodies provide evidence for strategies of justification and institutionalisation of a “moderately revised transparency approach” as compared to a “prudential approach”. This can be illustrated by the self-definitions, claims and justifications presented for changes and continuities in governance, including those referring to the inclusion or exclusion of specific actors at different levels of decision-making and consultation.
The most significant changes are:
- While transparency continues to be highlighted as the first priority, “sensitivity towards needs of others with responsibility for financial stability” is mentioned as well.
- Further “enhanced technical dialogue” with prudential supervisors and international organizations like IOSCO, the Basel Committee, FSB and IMF is considered necessary
- Closer formal cooperation with national standard-setters and securities regulators is seen as urgent for providing a solid factual and legitimacy basis for the implementation of IFRS.
- An Emerging Economies Group is being established to enhance participation from emerging countries in the development of IFRS.
- Changes in the Due Process Handbook will incorporate practices which developed in response to dealing with the crisis, such as regular meetings with prudential regulators. For example, the revision of the Due Process Handbook forthcoming in the second half of 2012 is going to include an acknowledgement of the responsibility of the IASB to communicate with securities and prudential regulators. There will be recognition of formal meetings as well.
- The IFRS Foundation is establishing a Working Group from the “international community” to discuss methodologies for field work and effect analyses (something requested for a long time by critics and practitioners).
- For the first time, the IASB will also specify protocols for how to deal with complaints about possible breaches of its Due Process. It needs to be seen to what extent these protocols will involve binding rights and duties (as in the case of Due Process in US administrative law).
The most significant continuities are:
- The so-called “independence” of the standard-setter from any vested interest – private or public – is recognised by both the Monitoring Board and the Board of Trustees (and also not questioned in more general policy discourses, as far I can see). The notion “independence of the IASB as standard-setter within a framework of public accountability” seems to represent the new policy consensus – without detailed specification of what “public accountability” actually means (which would require more in-depth tracing of other documents to establish how widely it is shared).
- After the introduction of the Monitoring Board and high level advisory groups (like the Financial Crisis Advisory Group, FCAG), this independence has been institutionalised (and further steps in this direction are recommended by the review reports) by means of a Memorandum of Understanding which clarifies the division of rights and responsibilities between the Board of Trustees, Monitoring Board and the IASB as standard-setter.
- As part of this institutionalisation, the Monitoring Board is clearly defined as “Monitoring Board for Oversight – not Operation”. The rights of the Monitoring Board to influence broader directions of standard setting are very narrowly defined – at least on paper.
- It is significant that both reports come to the conclusion that the Monitoring Board should be confined to representation of those authorities which are in charge of financial reporting standards and oversight of capital markets – not mentioning banking and prudential regulators or other stakeholders like investors. Actually, the reports explicitly rejects suggestions for broader representation during the consultation phase on the grounds that they represent “a misunderstanding” of the function of the Monitoring Board. Thus, we see a new insider elite (consisting predominantly of capital market regulators who during the crisis have predominantly have taken a capital market efficiency and transparency stance) claiming to be in the position to define the function of the oversight board.
- It stands also in continuity with the IASB’s expert model of standard-setting and output-based claims for legitimacy that both the Monitoring and Trustee Board see the consultation procedure as the arena for broader participation other stakeholders.
My overall assessment of changes and continuities in the governance of the IASB is that this organization is developing into an international regulatory body, woven into intergovernmental agency networks in a similar way to IOSCO, and integrating public regulators of securities markets at the international and national level for both legitimacy and implementation purposes. Yet, the core of the standard-setting process is dominated by accountants – now under the supervision of branches of securities regulators often also staffed with accountants – whose continued claims to have the monopoly of technical expertise to produce high quality standards serve the exclusion of other types of technical expertise (like from prudential banking regulators) from the formal decision-making process. It is interesting, however, that communication channels with prudential regulators are now recognized and formalised as “enhanced technical dialogue”. Based on the evidence presented in the article on the influence of the FCAG in pushing problems of pro-cyclicality on the IASB’s reform agenda (under the pressure of the crisis) it seems worthwhile keeping an eye on these interactions in the future. This is because (in the best-case scenario) they might turn out to be more effective at opening the IASB’s accounting standard-setting to broader policy concerns through recurrent technical deliberation among experts rather than through the oversight of a Monitoring Board alone.
For articles on reforms in other policy fields after the financial crisis compare:
Renate Mayntz (ed) (2012): Crisis and Control. Campus/Frankfurt am Main.