Thanks to Dr Kamal and Mr Stolojan for arranging this meeting, and for giving me the chance to represent the views of investors. I am somewhat overawed by the experience and skills of my fellow panellists.
My background is that I am a member of the FCA, a former auditor, now working with UK Shareholders’ Association.
UKSA represents its members who are private shareholders in quoted companies, who directly own around 12% of the UK market. That was worth about 220bn euros recently. I have been working with and am today representing a group of major UK investment institutions who jointly manage something over 250bn Euros of investments.
As well as the Swedish equivalent of UK shareholders, the European grouping of such bodies – called Eurofinuse- has also now expressed support. Brief summaries of the views of both our UK coalition and of Eurofinuse are available for you if required.
We all support the idea of international accounting standards so long as they produce the right answer but we are worried. We think accounts should
- show a true and fair view
- be drawn up on a prudent basis
- report on the stewardship, by the directors, of the shareholders’ money
When accounts are drawn up this way they can
- improve economic stability
- underpin responsible corporate governance
- help to rein in excessive pay and incentivise the longer term view from management.
We think those advantages are clearly in the public interest.
The G20 group of nations in 2009 endorsed the aim of establishing a single set of high –quality global accounting standards. They believe that such standards will strengthen the financial system and reduce the prospect of similar crises occurring in future.
[ICAEW Paper “The future of iFRS” Nov 2012]
True and fair
The 4th Directive says ” ….. annual accounts must give a true and fair view of a company's assets and liabilities, financial position and profit or loss “. A concept, which from a UK viewpoint, started as long ago as the 1940s. It has never been precisely defined in English law as that law has recognised that how true and fair is arrived at may change. But it is in EU law and is supported by a number of cases, some of which are referred to below. It includes the idea of maintaining the capital of the company and ensuring that dividends are only paid out of “profits made”.[4th Directive].
IFRS, on the other hand, include unrealised profits- and these can be calculated on assumptions only- Mark to model- and this has required the UK ICAEW to issue guidance involving over 140 pages attempting to reconcile IFRS to the law, both UK and EU. IFRS accounts, on the other hand, are not required to show the distributable profits.
Does this fit with the law?
Prudence
Accounts did not give any warning of the financial crisis. One example was raised by the UK banking commission. The accounts of a bank called HBOS showed provisions of circa 300 mn euros for the year to 31 Dec 2007 …. . Around 28bn euros were written off in the next 4 years. I am sure there were some clues as to what was coming. But the accounts didn’t reflect those clues.
Why was this?
At least in part because accounting standards have progressively reduced the importance of the concept of prudence and eventually in the 2010 conceptual framework the IASB removed it completely. They said the concept- the Americans call it conservatism – was biased.
But is it?
I think we have become intellectually arrogant. We think we can measure risk. We allow banks to have “risk adjusted capital”, but the evidence shows that we cannot measure risk. Virtually no-one foresaw the crisis; no-one foresaw the interbank market coming to a halt. Lord Stevenson, chair of HBOS said it was unforeseeable. But it happened and demonstrates that we can never know what the future will bring.
Another example. The London Times newspaper recently commented that the statistical odds of gold dropping in price as steeply as it did were a once in 4700 plus years.
But it happened last month.
So, if realistically we cannot truly measure risk, what are we to do?
We need to return to the concept of prudence. I could argue that not having prudence was in itself a bias- a bias to optimism and a bias to the view that we are able to really measure risk.
Apart from the need to be prudent if we cannot measure risk, there is also the legal requirement to account on a prudent basis. …valuation must be made on a prudent basis, and in particular: (aa) only profits made at the balance sheet date may be included,” (4th Directive). These requirements have been reinforced by several court cases such as Tomberger [1996] DE+ES Bauunternehmung[1999[ and Banque Internationale pour l’Afrique Orientale [2003] . Unfortunately the Conceptual Framework of the IASB has dropped this concept. The IASB has said, through its chairman Hans Hoogervorst in a speech to the London School of Economics last November that “The Conceptual Framework is the foundation of our standards.” So how can Standards which do not include prudence comply with EU law?
Stewardship
The IASB defines the objective of its standards as being to produce “information useful to existing and potential investors, lenders and other creditors…”. (IASB Conceptual Framework para OB1). There is no reference to a true and fair view nor to the idea of stewardship. As largely long term investors- there can be few investors with a longer term view than those managing pension savings for example-we want accounts to demonstrate how our money had been used. We call that stewardship.
This view has been supported recently by Standard Life, a large UK investment manager, in a letter to the Financial Times. Guy Jubb, the signatory is, I think, here today.
So what is to be done?
We need in the EU to consider whether the current IFRS
- help or hinder economic stability
- now comply with EU requirements as to the showing of a true and fair view
and to
- ensure that the standards which are endorsed for EU use produce the prudent view that the Directives require.
We can then hope that the next financial crisis will be flagged up sooner giving chance for action to be taken to minimise or even avoid some of the enormous financial and social consequences of the present crisis which we have seen, and still see across Europe, today.
Roger A Collinge
At the European Parliament on 8th May 2013
