Will IFRS ever succeed in becoming the dominant world accounting standard? Gerald Santing the Managing Director of Markets at DFSA, asks

Gerald Santing, Managing Director, Markets - Dubai Financial.

Gerald Santing, Managing Director, Markets – Dubai Financial.

BEING A market regulator, I like to use this opportunity to share with you some thoughts. Maybe I am getting too old and cynical but I am beginning to despair.

When I was a younger man I anticipated with enthusiasm the heralding of International Financial Reporting Standards (IFRS) as the world accounting standard and all other accounting standards known as the country GAAPs (standards for Generally Accepted Accounting Principles) would eventually be assimilated by IFRS.

The most anticipated and celebrated assimilation was the convergence of US GAAP with IFRS. However as the years have rolled on my enthusiasm has turned to apathy. It reminds me of a young couple getting engaged to be married and are looking forward to a bright future together but then they keep on delaying their wedding date. Over time, both become disenchanted and their love for each other fades.

Much of my enthusiasm for convergence has also faded because of the protracted negotiations between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) on convergence, similar to the young couple, not agreeing on where and when the reception should be held and who to invite.

But what went wrong? To answer that, one must first understand the history, the emergence and the changing roles of the IASB and the FASB.

History of convergence
The concept of convergence of accounting standards can be traced back to 1904. Yes 1904! The idea of “International Accounting Standards” was first enunciated at the first International Congress of Accountants held at St Louis in 1904, according to a paper published in the International Journal of Business and Management.

However, it was the Dutch who should be called the “fathers of convergence” when in 1957, Jacob Kraayenhof, one of the founding fathers of KPMG, spoke on the need of international accounting co-operation and standardisation at the 7th International Congress of Accountants held in Amsterdam.

International Accounting Standards Committee (IASC) the predecessor of the IASB was founded in June 1973, in London, and replaced by the IASB in 2001. It was responsible for developing the International Accounting Standards and promoting the use and application of these standards.

It was created by the professional accounting bodies of Australia, Canada, Netherlands, Germany, UK, Ireland, France, Japan, Mexico and the US. The IASB is controlled by the IFRS Foundation which is an independent organisation having two main bodies, the Trustees and the IASB, as well as an IFRS Advisory Council and the IFRS Interpretations Committee.

The IASC Foundation Trustees appoint the IASB members, exercise oversight and raise the funds needed, but the IASB has responsibility for setting International Financial Reporting Standards (international accounting standards) and is independent from professional bodies and governments.

In the 1995, IASC entered into an agreement with International Organisation of Securities Commissions (IOSCO) to complete “comprehensive core set of Standards” that could be used for cross-border and national listings.

In May 2000, IOSCO adopted 30 core International Accounting Standards (IASs) that led to the acceptance and recognition of the International Accounting Standards Committee (IASC) as a worldwide standard-setter. With the formation of the IASB in 2001, it took over the work of the IASC.

The IASs were renamed the IFRS. More importantly in the same year, the US Securities and Exchange Commission (SEC) suggested the acceptance of IAS for use in cross-border listings in the US, without reconciliation to results under the USGAAP. Things were looking up.

The fore-runner of the FASB was the Accounting Principles Board (APB) which was established in 1959 by the American Institute of Certified Public Accountants (AICPA). Up until the 1970s, the APB had a virtual monopoly on setting the US GAAP when the FASB took over this task.

Then there was a divergence, as the IASB was taken over by a foundation independent of the profession and government influence but the same cannot be said for the FASB. While it was an independent body it was heavily influenced by government through the influence of corporate lobbying and the SEC.

For example, from1972 to 1976, the SEC issued 70 Accounting Series Releases (more than a third of which dealt with financial reporting). This influence played heavily on how accounting standards developed. The FASB standards are very much more prescriptive whereas the IASB’s standards (IFRS) are more principles-based.

In October 2002, a Memorandum of Understanding (MoU) was signed between the IASB and the FASB, the two major players in the accounting standards arena, which is better known as the Norwalk agreement. Things were looking up.

However, the next 10 years were what I would call the “lost years” in contrast to Hans Hoogervorst, current chairman of the IASB and a Dutchman who describes the same period as “ten years of remarkable progress … with more than 100 countries using IFRS including more than two-thirds of the G20”, in his recent speech at the London School of Economics.
The reason for my view is that the US and the FASB have differing agendas. What went wrong?

I think two important factors played a major role: the Global Financial Crisis and the US’ inability to finally let go of their position as number one (this is evident in the recent SEC announcement in June 2012 and referred to Hans’ speech wherein he said “The SEC has intended to make a decision on IFRS during 2011, but announced in July that it would postpone this decision.”

I can’t help but interpret Hans’ comments of “For the call of the G20 for a single set of global accounting standards to remain credible, it is important that progress is made soon” as a wake up and smell the coffee defining moment for the Americans. I think it is already too late.

Global financial crisis
The crisis brought home that accounting standards will never be left alone to the accounting intellectual elite. Politicians will always play an important role in what is acceptable.

One major example during the crisis that brought much pressure to bear on the standard-setters (including the IASB and the FASB) was the mark to market issue.

In dysfunctional markets, fair value accounting comes under extreme pressure and there was an argument put forward that fair value accounting should take a holiday in such situations. The accounting elite eventually won over but not without much hand-wringing and explanation.

The US position
It is fair to say that the FASB has worked tirelessly with the IASB in trying to bring about convergence but they were never really in charge and I refer you to my comments about politicians and the SEC above.

This is clearly evident from the work on particular standards. Fundamentally, it was always going to be difficult to merge a principal-based set of standards with a rules-based one. I believe the recent announcement from the SEC has sent a clear signal that convergence is no longer a priority.

In July 2012, a staff report of the SEC stated “it became apparent to the staff that pursuing the designation of the standards of the IASB as authoritative was, among other things, not supported by the vast majority of participants in the US capital markets.”

G20 deadline for convergence projects
The final communique from the G20’s Washington DC meeting on April 19, 2012 urges the IASB and the FASB to meet their target of issuing standards on key convergence projects by mid-2013 (at the latest). Hans referred to it in his speech on November 6 of this year.

I agree that it is important that both the IASB and the FASB continue to work together towards the goals of the G20, it is equally important that a robust due process (free from influence) is followed.

The Middle East region
Let me now turn to the Middle East and try to summarise the state of play here in this region. In my view the Middle East, with the exception of Saudi Arabia, has been fairly compliant with the use of the IFRSs since inception.

This is evident when one sees how the accounts are being published. This has come about more so from legislative decree rather than exertion from the accounting profession or from global financial markets.

For instance the Dubai International Financial Centre (DIFC) since its formation in 2004, has always required IFRS as the de-facto standard. With respect to the Dubai Financial Services Authority (DFSA) Authorised Firms, all are required to present their financial statements in accordance with IFRS except for 26 branches which have received a waiver and can produce their accounts in their home state GAAP.

These waivers are issued in favour of 9 jurisdictions. However, before a waiver is granted, the DFSA conducts a thorough analysis to identify and measure the differences to ensure that those differences are understood.

Waivers by Country

  • Canada
  • Hong Kong
  • Switzerland
  • India
  • Japan
  • UK
  • US
  • Singapore
  • Italy

Saudi Arabia has its own accounting standards, known as Saudi GAAP. While similar to IFRS, it does have a number of differences. Most notably is the inability to re-value assets. Although I understand that banks in Saudi Arabia do apply IFRS.

The case with China and India
So what is their position on IFRS?

China is more favourable in accepting IFRS than India, in my opinion. It is important for emerging economies like China to converge to IFRS, thus, allowing the market participants to look at useful financial information in a universal way. This is particularly important as China has a precedent of localising global practices.

I suspect that same will apply with IFRS. In May 2012, China amended its regulation requiring the “Big 4” audit firms to hire local Chinese citizens to manage the firms by 2017. Further, and most recently, a Hong Kong-based regulator fined a Big 4 firm over failure to produce audit working papers from its Chinese affiliate.

The IASB also sees the importance of the East with China providing the IASB’s secretariat for the Emerging Economies Group and the IASB’s first regional office being opened this month in Tokyo.

India is equally important, with a population of over 1.2 billion people and a GDP of over $1.8 trillion and more than 6,000 listings on its major exchanges. It is important that India converges to a unified set of financial reporting standards.

In February 2011, India issued a set of standards called Ind-AS. The implementation of these new standards also requires changes to the Companies Act. The Ind-AS standards are yet to be notified and the modification to the Companies Act is awaited.

Stakeholders, including industry and tax authorities, have raised arguments against Ind-AS and its implementation roadmap. At present, India’s move to IFRS has moved into a more silence zone.

Given the growing power of these two (China and India), I doubt that they are willing to accept a western-centric view of accounting again for the same reasons why the US’ has prevented the FASB from converging with the IASB. It is a question of sovereignty and whoever has the power will want to retain it.

Wait and watch
Here, I would like you to take a pause and think. Why are countries like the US, India, China, Japan and Saudi Arabia on a wait and watch approach for convergence with IFRS? When IFRS was initially introduced a decade ago, around the world, the Board made a commitment to provide a “stable platform.” Companies adopting IFRS had the comfort that the standards would not change in the near term, easing their transition. That is no longer true.

The Board has been working on a slew of measures to change several standards including those for revenue recognition, leases, financial instruments and presentation of financial statements. Has the IASB become too engrossed in trying to please the FASB and lost sight of the main goal?

Regional groups
It is time that regional standard-setting bodies take part in the IASB’s standard-setting process. They are a valuable source of information and can assist the IASB to ensure that IFRSs are appropriate for regional and country-specific financial reporting needs.

Over the past years, many regions decided to create regional representative bodies to discuss regional accounting standards issues, share experiences on the adoption of IFRSs and provide input to the IASB’s standard-setting process. To name a few:
• Asian-Oceania Standard-Setters Group (AOSSG)
• European Financial Reporting Group (EFRAG)
• Group of Latin-American Standards-Setters (GLASS)
The DFSA is a member of AOSSG and we have seen the value of such a regional body in voicing our opinion individually and collectively to the IASB.

Besides the DFSA, Saudi Arabia is also a member of AOSSG. I would like to ask if this region needs its own regional standard-setting body.

Care should be given in not replicating the efforts already undertaken by other existing bodies, however, I would encourage the national standard-setters from the Middle East region to join hands at one of the already existent regional bodies. This will give the Middle East a stronger voice in the setting of IFRS.

IASB work plan
The Board’s work plan has been overloaded in the last couple of years resulting in the Board changing plans quite frequently. Although an ambitious timetable sometimes serves as a catalyst to maintain momentum, it might strain the IASB’s ability to cope with important issues.

Considering the rapidly changing environments (such as a seemingly never-ending global financial crisis), the IASB should keep a sufficient ‘buffer’ to deal with unanticipated issues by sketching out a realistic workplan to demonstrate the Board’s responsiveness to its stakeholders worldwide.

The IASB should also consider the relevance to this region. There are significant issues relating to Islamic finance transactions, since IFRSs requirements, and the basis of Islamic finance transactions, are not necessarily consistent. The IASB should, at least, examine issues by undertaking studies in the area and via outreach activities with major stakeholders.

Users of the financial reporting
I would like to stress that the most important user of the financial reporting, is the investor. Getting everyone on board with IFRS provides the baseline, but it is not the end of the story. Standards must also be endorsed, implemented and enforced on a consistent basis, by regulators. Feedback from investors is very important.

We now have a truly inter-connected world economy and cannot rely on national standards, we need a truly global set of accounting standards. IFRS is the obvious answer.

As Hans Hoogervorst said; “Capital no longer respects national borders. Investors seek diversification and investment opportunities on a global basis. In such a globalised environment it makes no sense to maintain national accounting standards.”

I am aware that the IASB, has managed to attract the attention of the investor community but are we successful enough to keep them engaged? If you look at the volume of comments received from this very important stakeholder, it is evident that the majority are still silent.

We need to identify ways to engage them in a more meaningful way.

The Future

So where does this all lead to?

The IASB should look to the East and engage the emerging Asian powerhouses. That is where IFRS is going to take its direction. As the markets of the East grow in stature so will the need for a unified set of accounting standards. This will become paramount. The IFRS is best placed to fulfil this role, however, it needs to engage more.

Will the IASB be able to achieve this? Would we witness the fall of another Berlin Wall?

I am confident that the IASB, under the current leadership of Hans Hoogervorst, will break this barrier and the world will witness a unified set of financial reporting standards. It will no longer be an issue of convergence with US GAAP alone but being accommodative enough to assimilate all of the Eastern GAAPs into IFRS. The US will have no choice but to assimilate as well.

Any opinions, statements or other information or content expressed or made in this article are those of the author and not the Dubai Financial Services Authority, and the author’s opinions, statements or other information or content expressed in this article should not be viewed as any indication of the opinion, view or policy of the Dubai Financial Services Authority.