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The Bruce Column — Making the long-term work

17 Jul, 2014

The B20 summit is taking place in Sydney. One of the greatest challenges facing the world economy, and one that is on the B20’s agenda, is that of how to enable investment in long-term infrastructure projects. A recent report and roundtable pointed a way. Robert Bruce, our resident, regular columnist, explains.

The really big problem up ahead is how to fund the vast, but essential, infrastructure projects required around the world. Estimates suggest that US$3.2 trillion will be needed each year for the next fifteen years. But they also suggest that there will be a shortfall of US$500 billion every year. The reasons for this are straightforward. Governments, post-financial crisis, have constrained budgets. Banks similarly are under pressure to deleverage. So both of the traditional providers of long-term funding are out of the game, as it were.

Instead the world looks to other traditional long-term investors — pension funds and the insurance industry, for example. But these investors are wary. The information that would provide reassurance is not always available or accessible in a form that would help their decision-making. And this is why the B20 Group, which brings together business leaders from the G20 countries, asked the six largest global accounting networks to provide analysis, insights and recommendations which could promote the necessary infrastructure investment.

It is a huge issue, involving huge numbers, but it also links into much of the current thinking in the world of financial and corporate reporting. Even before the financial crisis, and with significantly greater urgency since then, the focus has shifted to how to encourage the long-term view across business and investment.

And the report from the global accounting networks emphasizes this. And as a recent roundtable on its findings agreed it is not the accounting that is an impediment to investment in infrastructure. In the context of long-term investment it is the political and regulatory risks that are the more relevant. Investing decisions by insurers, for example, ‘are likely to be more heavily influenced by the expected stability of cash flows’. And: ‘Financial statements prepared in accordance with International Financial Reporting Statements also offer the significant advantage of being comparable for investors and potential investors across the globe and are therefore especially relevant in the context of cross-border capital flows’.

That said, as participants at the roundtable were swift to point out, under current regulation corporate reporting can fall short in terms of communicating a company’s long-term value proposition. The narrative reporting which accompanies accounts often provides a review of business performance and, in varying detail, a description of strategy, risks and opportunities.  However, it may stop short of the strategic insight into what really makes the company tick which, in some cases, would account for 80% or so of the company’s market value.  This would include the value not on the balance sheet relating to the company’s order book or ‘pipeline’, or representing the company’s intangibles and risks.

There are also the inherent difficulties in long-term investment. An infrastructure project may represent a 25-year long project to build roads, railways, or airports, for example. As one participant at the roundtable pointed out, 25 years in the US would span ten congressional terms. The political risk and uncertainty over that time would be immense. Investors need extraordinary comfort and contact with the project. Sovereign wealth funds or giant pension funds will gain this by investing directly into the project. Other investors will invest through intermediaries, like fund managers. All investors will have different levels and means of access to information across the project’s term. But they will all require transparency.

So the way forward must be innovation that will unlock an understanding of that critical, and currently unseen project information. And the innovation has to be something that works with the grain rather than against it. So it cannot be direct regulatory action. It has to be something that encourages the innovation that investors in long-term projects need and which allows best practice to emerge rather than be proscribed.

This is not easy. Providing that sort of forward-looking information is not something which CFOs traditionally feel comfortable with; not because they are intrinsically opposed, but because they recognize the dangers for the company, themselves, and the investors. The commercial sensitivity of risk and forward-looking information are difficult. Amongst other things some form of safe harbor provision need to be provided.

Many projects may well be public sector infrastructure looking for private sector investment. And here there will have to be much greater symmetry between the different financial and corporate reporting models for it to work.

But recent developments in corporate reporting have been moving in the right direction to free up the information required to facilitate long-term investment. Internationally the development of integrated reporting is an example. This directly addresses many of the issues of reporting that elusive but vital information. And innovation is also coming into play in other ways. The UK Financial Reporting Council’s financial reporting lab is a good example of how companies and investors can come together and experiment and exchange views as they try to identify best practices. Also, requirements in the UK for a strategic report, and corporate governance “comply or explain” provisions in South Africa for an integrated report, create a good climate for experimentation and innovation in this space.

The answers to the problems are within people’s grasp. It is a question of understanding what is at stake and allowing best practices to emerge. It is all about creating an enabling environment.

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IFRS Advisory Council’s terms of reference amended

17 Jul, 2014

During its July 2014 meeting, the IFRS Foundation Trustees approved an amendment to the secondary objective of the IFRS Advisory Council’s terms of reference in order to address a shift in focus from promotion and adoption of IFRS to one that encourages board participation in IFRS development.

Previously, the terms of reference were discussed during the IFRS Advisory Council meeting held on 9-10 June 2014, where the council members recommended a change to the secondary objective to clear any misconceptions regarding its independence and objectivity.

For more information, see the press release on the IASB’s website.

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IFRS conference in Mexico City announced

17 Jul, 2014

The IFRS Foundation has announced that an upcoming conference will be held in Mexico City on 6-7 October 2014. The English and Spanish-language conference will include discussions on the latest IASB updates on the major IFRSs and its future plans. In addition, the conference will focus on innovations in IFRS disclosures and the support for consistent implementation of new IFRSs.

The conference will feature presentations by IASB Chairman Hans Hoogervorst, Vice-Chairman Ian Mackintosh, and IASB members (Amaro Gomes, Darrel Scott, and Mary Tokar).

Some of the topics to be covered at the conference include:

  • IASB update: progress and plans
  • Panel discussions on:
  • Advice on implementing new IFRSs:
    • IFRS 9 Financial Instruments
    • IFRS 15 Revenue from Contracts with Customers

The conference will also have a special-interest session on fair value measurement and other cross-cutting measurement issues, as well as break-out sessions led by IASB members and senior staff on the following topics:

  • Macro hedge accounting
  • Leases
  • Insurance contracts
  • Business combinations under common control
  • IFRS 9 implementation for financial institutions
  • IFRS 9 implementation for nonfinancial institutions
  • IFRS 15 implementation
  • Conceptual framework

More details, including registration information, are available on the IIR & IBC Finance website.

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We comment on the new draft SORP for financial reports of pension schemes

17 Jul, 2014

We have published our comment letter on the Pension Research Accountants Group (PRAG) and its SORP Working Party Exposure Draft (ED) setting out revised proposals for financial reporting by pension schemes in the UK. Overall the SORP provides some useful guidance, however we have some concerns in relation to some of the proposals in the ED.

The ED sets out proposals for accounting and reporting by pension schemes in the context of the new accounting framework introduced by Financial Reporting Standard (FRS) 102 applicable in the UK and Republic of Ireland for financial years beginning on or after 1 January 2015.  The ED also updates the 2007 SORP to include the requirements of new regulations and changes in the pension industry since the 2007 SORP.  

Our key concerns are that:  

  • the requirements for some of the additional disclosures and measurement information specified in the ED may add significant cost in terms of obtaining information, preparing disclosures and engaging actuaries, investment managers and auditors as necessary, particularly for smaller pension schemes; and
  • the costs of the additional complexity and length of pension scheme accounts resulting from these proposals will outweigh the benefits to the key stakeholders (the members of the scheme) in areas such as requiring actuaries to value annuities and the requirement for much more detailed investment risk disclosures.

Further comments and a full response to all questions raised in the invitation to comment are contained within the full comment letter.

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FRC publishes annual report 2013/14

16 Jul, 2014

The Financial Reporting Council (FRC) has today published its 2013/14 annual report (“the annual report”). The annual report reviews the activity of the FRC over the last year, highlights the achievements of the FRC in 2013/14 and also identifies areas that it will address in 2014/15.

The annual report provides an assessment of the progress that the FRC has made against its three year strategy, set in 2013.  The strategy, focusing on five areas, seeks to promote:

  • High quality corporate governance and investor stewardship which foster trust in the way companies are run.
  • High quality corporate reporting that is fair, balanced and understandable.
  • High quality audit and confidence in the value of audit.
  • Actuarial oversight and standards which underpin high quality actuarial practice, and integrity, competence and transparency of the actuarial profession.
  • Effective, proportionate and independent investigative, monitoring and disciplinary procedures.

The annual report highlights:

  • That “the quality of governance amongst larger listed UK companies is generally sound” as indicated by the high levels of compliance with the UK Corporate Governance Code (“the Code”) found in the annual review of the Code and Stewardship Code published in December 2013.  However the FRC comment that many companies “still struggle to articulate clearly why they have chosen not to comply with the Code”.  The FRC also indicate that it has “concerns about whether companies, markets and policymakers take a sufficiently long-term view” and that, going forward, it will be looking to provide thought leadership in the EU on the developing role of risk capital.
  • That corporate reporting has generally been “good” but notes that improvements could be made in the reporting by smaller listed and AIM companies.  The annual report highlights the initiatives, such as the publication of the Guidance on the Strategic Report that the FRC is undertaking to improve the overall quality of corporate reporting in order to address the needs of investors. 
  • That the quality of auditing in the UK is “generally good” most notably in relation to the largest listed companies.  The FRC highlight that “there is scope for improvement in the banking sector in particular, including a concern about the lack of sufficient challenge when testing key assumptions underpinning loan loss provisions”.  This was highlighted in the 2013/14 Audit Quality Inspections Annual Report.  The FRC also highlight that there has been a “positive response” to their efforts to promote audit re-tendering and that its work, alongside UK stakeholders, on the new EU audit Regulation and Directive will “ensure that UK audit regulation can remain effective and proportionate”.

Looking ahead, key priorities for the FRC include:

  • Undertaking a project to evaluate and plan how it might assist smaller listed and AIM companies to address the quality of their reporting so as to improve confidence in the integrity of their financial statements and of the markets as a whole.  The project will aim to achieve a step change in the quality of financial reporting of smaller listed and AIM companies over a three year period. 
  • Undertaking a thematic review of UK bank audits, focusing on how these are conducted, identifying why improving their quality has been slow and seeking to understand what needs to be done to improve them.
  • Developing further guidance for audit committees focusing how audit quality and effectiveness might best be assessed by audit committees.
  • Implementation of aspects of the EU Audit Regulation including reviewing auditor independence requirements.
  • Reviewing audit firm governance.
  • Supporting the application of the new UK GAAP standards.
  • Implementation of Lord Sharman’s recommendations on going concern. reporting.
  • Promoting Clear and Concise reporting in annual reports.

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New SORPs issued for charity accounting and reporting

16 Jul, 2014

The Charity Commission for England and Wales (Charity Commission) and the Office of the Scottish Charity Regulator (OSCR) have today published two new Statements of Recommended Practice (SORPs) setting out a new framework for charity accounting and reporting.

SORPs issued by the Charity Commission and OSCR apply to charities preparing accounts under UK GAAP to present a ‘true and fair view’ and are intended to supplement accounting standards and other legal and regulatory requirements to reflect transactions or circumstances that are unique within the charities sector. 

The SORPs set out the required accounting and reporting by charities in the context of the new accounting framework introduced by Financial Reporting Standard (FRS) 102 applicable in the UK and Republic of Ireland for financial years beginning on or after 1 January 2015.  One SORP is targeted at those charities that adopt FRS 102 (“the FRS 102 SORP”) and the other is targeted at those charities that, depending on their size, can choose to adopt the Financial Reporting Standard for Smaller Entities (FRSSE) (“the FRSSE SORP”).  Each SORP reflects the different accounting treatments under the two standards.  Both SORPS are effective from financial years beginning on or after 1 January 2015 and have been developed after reflecting on feedback received on the original Exposure Draft issued in July 2013.

The SORPs have been created in a modular format containing a set of core ‘modules’ which apply to all charities and also a number of additional modules which will only apply to specific charities.  The Charity Commission and the OSCR have highlighted that charities will be able to customise the SORP according to their specific circumstances through an interactive website.  It is hoped that this modular format will help to better meet the needs of the preparers of charity accounts especially for smaller charities. 

Alongside the publication of the SORPs the Charity Commission and the OSCR have published guidance to help charities choose the right SORP to adopt.  Help sheets have been created that explain the main differences between the FRS 102 SORP and the FRSSE SORP and the criteria that must be met to be able to adopt the FRSSE SORP.  An indication is provided that the FRSSE standard is due to be reviewed in 2016 in light of the new EU Accounting Directive and this may mean that charities adopting the FRSSE now will have to change their accounting policies twice in succession due to the amendments. 

The Charity Commission and the OSCR emphasise that “it is important to make the right choice” of accounting framework to adopt and advise that charities speak to their auditor, independent examiner or advising accounting to assist in choosing the standard that is best.  They comment that “although the two SORPS have the same structure and order of modules, the requirements differ significantly due to underlying differences in terminology, accounting policies and disclosures required by the FRSSE and FRS 102”.

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CFA Institute issues study on financial crisis insights on bank performance reporting

16 Jul, 2014

The CFA Institute, a global association of investment professionals, has published a report entitled 'Financial Crisis Insights on Bank Performance Reporting (Part 1): Assessing the Key Factors Influencing Price-to-Book Ratios', suggesting that better reporting of risk, timely loan write-downs on balance sheets, and investor access to comparable reporting of information across jurisdictions, will improve transparency and reduce investor risk aversion towards the banking sector.

The study focusses on price-to-book ratios (P/Bs) as one metric investors monitor when valuing banks and as a metric widely referenced by policymakers as a yardstick for the financial health of banks. It is based on a sample of 51 banks (31 from the European Union and 20 from Australia, Canada, Japan, and the United States). The sample includes large, complex banking groups and the analysis period is 2003–2013, i.e. it covers the periods before, during, and after the financial crisis.

A key analytical angle in the study concerns the relationship between loan impairments and P/Bs as loans are a key element of a bank's financial assets, and their impairments affect both the market value of equity (stock price) and the equity. The survey coincides with a (not yet published) survey by the CFA Institute identifying improved requirements in the accounting for impairments as the second-most important required regulatory reform to avert future financial crises and the current initiatives from IASB (the final version of IFRS 9 Financial Instruments is expected to be issued later this month), the FASB, and other regulatory bodies aimed at improving the accounting for financial instruments and the overall transparency of banking financial institutions.

The study shows that during the financial crisis, the representation of loan impairments on balance sheet and non-performing loans lagged the capital markets' economic writedown of these loans and this lagging trend was particularly evident for the EU banks. In addition, comparing the pre-provision income and net income for the sample banks showed that loan impairments significantly contributed to reduced overall net income at different junctures during the financial crisis. The authors of the study also found an incremental risk aversion toward the bank sector, translating to relatively higher risk premiums, lower stock prices, and lower P/Bs.

Based on these findings, the report contains two major policy recommendations:

  • In addition to amortised cost carrying values, fair value measurement of loans should be recognised on the face of the balance sheet as a means of avoiding "too little, too late" recognition of loan losses and providing decision-useful information.
  • Bank risk disclosures should be enhanced as a better understanding of bank business models reduces the risk premium that investors assign owing to limited transparency of bank financial statements.

The report is available for download on the CFA Institute website. The CFA Institute has announced that part 2 of the report, Relationship between Disclosed Loan Fair Values, Impairments and the Risk Profile of Banks, will be released in August 2014.

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FEE factsheet on the EU Directive on disclosure of non-financial and diversity information

16 Jul, 2014

The Federation of European Accountants (Fédération des Experts-comptables Européens, FEE) has published a factsheet on the EU Directive that will require certain large companies to provide additional information on social and environmental matters.

The amendments to European accounting legislation had been proposed by the European Commission in April 2013 and adopted by Parliament in April 2014. They currently await adoption by the Council and publication in the Official Journal of the European Union after which they will become law. Current expected transposition date for EU Member States is autumn 2016.

The FEE factsheet outlines key aspects of the new legislation. Please click to download it from the FEE website.

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Call for applications as EFRAG TEG member

16 Jul, 2014

The European Financial Reporting Advisory Group (EFRAG) has issued a call for applications regarding membership in its Technical Expert Group (TEG).

EFRAG is calling for candidates in view of the current preparer vacancies and the fact that the present mandate period of three EFRAG TEG members expires on 31 March 2015 and in anticipation of vacancies that might result from the new EFRAG governance structure. It is expected that some reappointments will take place.

Applications must be submitted by 1 October 2014. More information is available through the press release on the EFRAG website.

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Additional public consultation on lessee accounting

16 Jul, 2014

The European Financial Reporting Advisory Group (EFRAG) and the major European standard-setters (ANC, ASCG, FRC and OIC) have launched an additional public consultation on the two different approaches for lessees proposed by the IASB and FASB. This consultation is focused on users' views.

This new consultation complements the consultation on preparers' views launched on 30 June 2014.

Again, the objective of the consultation is to obtain examples where contracts or transactions could qualify as leases under a single-model approach (IASB) or a dual-model approach (FASB), but are viewed by constituents as in-substance services. In addition, the EFRAG and European standard-setters are seeking input on which of the two alternative approaches is preferred.

Users interested in participating can either do so through an interview of no more than 30 minutes or through filling in and submitting a questionnaire. Questionnaires must be submitted by 29 August 2014.

Further information, contact details for the interview, and a link to the questionnaire are available through the press release on the EFRAG website.

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