Another step closer

A landmark decision by the Securities and Exchange Commission could mean IFRS convergence may happen much sooner than originally thought, reports Holly Yeager

The US Securities and Exchange Commission (SEC) in 2005 announced what it called a ‘road map’ – an ambitious plan to move towards one set of high-quality accounting standards that would be accepted around the world.

The market regulator is now poised to take an important step in that direction, with a proposal to allow non-US private issuers that file financial statements with the SEC to use International Financial Reporting Standards (IFRS), rather than reconciling them with US GAAP, as is now required. At a time of tough competition in capital markets, many in the US are cheering the move as a tool to boost the appeal of the US to foreign issuers – and as a broader sign of commitment to moving towards an international standard.

‘I think this is a watershed event,’ says Barry Epstein, a Chicago-based consultant who advises accountants and corporations on the application of US and IFRS. ‘I think it is going to change the landscape.’

Epstein has an unusual way to measure interest in IFRS. Ten years ago he published a reference book about the international framework, as a companion to a text he had written about GAAP. The IFRS book did not move much in the early going, but in the last few years it has sold out its press run, he says.

The SEC announced the proposed rules change in late June and is accepting public comments on the move until 24 September. But recent official statements reiterating the commission’s support for the road map, as well as other regulatory shifts on the treatment of non-US companies and broad support from market participants, make most observers confident the change will go through, taking effect with 2008 annual reports, submitted early in 2009.

When the proposal was unveiled this summer, Roel Campos, an SEC commissioner, said the changes ‘demonstrate that the SEC is committed to facilitating the raising of capital in the US by foreign issuers’.

Other market participants agree. In a SEC-sponsored discussion of the proposal, Catherine Kinney, President and co-chief operating officer of what is now NYSE Euronext, said: ‘The assumption that there would be a larger pipeline of listings or issuers coming to the US markets is a fairly reasonable and sound assumption to make.’ (Kinney also noted the New York Stock Exchange’s recent merger, and the required reconciliation of Euronext’s financial statements to US GAAP, as evidence that reconciliation is not essential, citing the ‘very small differences’ that emerged in that process.)

In a July letter to the SEC about the proposal, top executives from Citigroup and British Airways who lead the Transatlantic Business Dialogue applauded the move. ‘Stimulating open and competitive financial markets is one of the TABD’s central concerns, and we strongly support the creation of a seamless transatlantic capital market,’ they wrote. ‘We believe this early agreement by the SEC will benefit transatlantic companies, the investing public and the competitiveness of both US and EU markets.’

Another recent step by the US regulator is also seen as making US markets more accessible to non-US companies. In the spring, the SEC made it easier for foreign private issuers to deregister and delist from the US. That simplified departure lowers the bar companies face when contemplating whether to list in the US, because they know it will not be too difficult to leave the market, should they choose to do so. ‘I believe that all of these rules – separately, but especially together – maintain our US market’s friendliness to foreign issuers who wish to raise capital in the US,’ Campos says.

Epstein says underwriters may be the happiest about the rules change, and those most concerned about it include some US companies who worry that the new entrants into the US markets may crowd them out. The companies most likely to come to the US after the rules change are what he calls ‘second tier’ public companies eager to tap the US market. ‘There are lots of institutional and individual investors that are uncomfortable investing in foreign companies that are not listed in the US. They would be very happy to invest, but they want to see companies that are listed here and have no red flags,’ he says. ‘I think that will be a great comfort to US investors.’

But David Schmid, a partner at PwC who spent the last decade helping UK and Europe companies raise capital in the US, is more cautious about the potential impact of the change. ‘Based on my discussions with many of my clients, they don’t see a flood back to the US, at least currently.’

Litigation

There are several factors that influence a company’s decision on listing in the US, he says, including the costs of complying with Sarbanes-Oxley, the regulatory crackdown enacted in the wake of the accounting scandals at Enron and WorldCom. Another stumbling block for those considering US offerings is the litigious environment in the US, including the use of class-action lawsuits, which far outpaces its European counterparts. ‘Opening themselves up to that sort of exposure certainly gives them major pause in the go, no-go decision,’ he says.

Reconciliation to US GAAP – which he ‘guesstimates’ could take anywhere from five to 30 ‘man weeks’, depending on the complexities of accounting, the size of companies, their level of centralisation and decentralisation, among other factors – is also an issue. ‘It costs money to do, and it’s hard to get that sort of knowledge embedded into a non-US company,’ he says.

‘Many of our clients have indicated that, of those three things, they certainly view the cost of Sarbanes-Oxley and the potential cost of the litigious environment to be more of a factor than the cost of the reconciliation itself,’ says Schmid.

Schmid, who now leads his firm’s IFRS consulting group within the US, said the globalisation of capital markets is making it easier and easier for someone sitting at a computer screen in the US – or another country – to buy shares outside their own country. ‘That would be another reason why non-US companies are not necessarily scrambling to get into the US – that they can attract the amount of US investment they are aiming to attract, without that NYSE or NASDAQ listing.’

Ultimately, he says, the ability to file with IFRS to the SEC ‘may encourage a few more [US listings], but it’s not necessarily going to be a tidal wave’.

Schmid and Epstein agree that the proposed rules change marks an important step towards the convergence of international accounting standards. Perhaps more importantly from that perspective, the SEC is also considering whether to allow US companies to file their financial statements under IFRS – a logical next step in some minds, once foreign issuers are permitted to use that standard.

The proposal to allow foreign issuers to use IFRS has not been universally welcomed.

John Rader, an independent investor in Peachtree City, Georgia, voiced his disapproval in a comment letter to the SEC. ‘As an independent investor, it is difficult enough identifying and analysing current and relevant information to evaluate potential and existing investments. I envision the degree of difficulty will be increased considerably by not knowing if the fundamentals of two companies, one US and the other foreign, are in fact equal comparisons if a foreign firm is allowed to follow non-US financial and reporting practices.’

But most observers expect the change to go through. Says Epstein: ‘Having made the proposal, the SEC has already announced that they think it’s good enough.’

Holly Yeager is a freelance writer based in Washington DC.