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The Bruce Column — Hoogervorst makes his case for leasing reform

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Nov 13, 2012

At a speech to an audience at the London School of Economics IASB Chairman Hans Hoogervorst made his resolve for further reform plain. Robert Bruce, our regular columnist, was there to listen to the arguments.

There was a sense of great anticipation at the London School of Economics. The audience was the broadest of groupings. There was a large number of young students and a wide range of academics and practitioners, right down to Ian Hay Davison, Arthur Andersen’s UK managing partner from the days when they first set up in the country.

They had gathered to hear Hans Hoogervorst, Chairman of the IASB, set the current thinking on IFRS into context. The day before he had been before the European Parliament where an aside about how waiting for the US to decide whether or not it was going to join the IFRS family was now resembling the Samuel Beckett play ‘Waiting for Godot’ had charmed his audience.

At the LSE there was no talk of playwrights or delays. Hoogervorst wanted to emphasise the IASB’s firmness of purpose and its determination. He recalled the past. He talked of the time when the IASB and the FASB ‘had the mother of all battles against vested interests to record the granting of stock options as an expense’. He recalled the pressure brought to bear. He talked of the ‘huge lobbying campaign led in part by the technology sector’. He talked about the legendary investor Warren Buffett’s 1998 criticism of widespread opposition to ‘FASB’s attempts to replace option fiction with truth’ with virtually none having spoken out in support of FASB. Its opponents, Buffett had complained, ‘even enlisted Congress in the fight, pushing the case that inflated figures were in the national interest’. Back then, Hoogervorst pointed out, lobbyists spent $70m in their efforts to stop the standard-setters’ efforts. And ultimately the standard-setters had won. ‘It was the IASB, and I am really proud of that’, he said, ‘that led the way, paving the way for the FASB to follow suit’.

This was the heart of Hoogervorst’s thesis. There was a pattern. Enormous amounts of money and lobbying were brought to bear. The standard-setters, more concerned with recording economic realities, finally won. And now, years later, no one can understand what all the fuss had been about. ‘Almost ten years on’, he said of the stock option fracas, ‘and very few people question the logic of recording stock options as an expense. It is simply regarded as a good business practice’.

The same, he argued, had been true of the battle to bring pensions and other post-employment benefits onto the balance sheet. ‘Many years ago’, as Hoogervorst pointed out, ‘companies were able to keep the information related to these liabilities off the balance sheet’. And without their clear and visible presence strategies, unsurprisingly, could go disastrously awry. ‘As a result’, said Hoogervorst, ‘the management of some companies were able to literally give away the value of the company without shareholders knowing anything about it’.

Reform was, understandably, painful to companies. ‘At the time’, he said, ‘bringing pension liabilities on balance sheet was hugely controversial. And to some degree it still is. However such liabilities are now routinely discussed in the boardroom and with investors. This is especially true as many pension schemes are in trouble and the company is on the hook if things go wrong’.

This brought Hoogervorst to the third of his examples. And this one is still playing in realtime. ‘Today we have a similar battle with leasing’, he said. And the ingredients are the same.

‘The vast majority of lease contracts are not recorded on the balance sheet’ said Hoogervorst, ‘even though 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. What’s more, the companies providing the financing are more often than not banks or subsidiaries of banks. If this financing were in the form of a loan to purchase an asset, then it would be recorded. Call it a lease and miraculously it does not show up in your books’.

And this, he argued, caused real problems for users of financial reporting. ‘Right now’, he said, ‘most analysts take an educated guess on what the real but hidden leverage of leasing is by using the basic information that is disclosed and by applying a rule-of-thumb multiple. It seems odd to expect an analyst to guess the liabilities associated with leases when management already has this information at its fingertips. That is why it is urgent the IASB creates a new standard on leasing and that is exactly what we are doing, in close cooperation with the FASB’.

And the lobbyists are again arguing that the standard-setters’ proposals, like stock options and pensions before them, will in Hoogervorst’s words, mean ‘that the end of the world is nigh’. ‘I seem to remember similar claims being made when the IASB and the FASB required stock options to be expensed’, he said. And it is not as though regulators have not provided the same warnings. Hoogervorst quoted from what the staff of the US regulator, the SEC, had to say on the leasing issue back in 2005. “The fact that lease structuring based on the accounting guidance has become so prevalent will likely mean that there will be strong resistance to significant changes to the leasing guidance, both from preparers who have become accustomed to designing leases that achieve various reporting goals, and from other parties that assist those preparers”, it said.

But Hoogervorst is making a wider point. We have all learned, very painfully, what the effect of hiding debt has upon the global economy. ‘As the financial crisis was caused by excessive leverage’, he said, ‘our efforts to shed light on hidden leverage should be warmly welcomed around the world. The fact is that we are still facing an uphill battle. We will need all of the help we can get, to ensure that we do not get lobbied off course. We need national accounting standard-setters, regulators such as the SEC, investors and others to stand by their beliefs and help us to bring much-needed transparency to this important area’.

Click for our previous story on Chairman Hoogervorst's speech to the London School of Economics.

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