Dispatch (UK/ROW edition)

Fair value under pressure

The International Accounting Standards Board (IASB) has yielded to pressure from European Union governments and US regulators to allow some distressed financial instruments to be reclassified, removing them from the requirement to report at fair value. Many banking and insurance executives have blamed the use of fair value and mark to market valuations for the global financial crisis.

An emergency meeting of the IASB agreed that distressed financial instruments can, exceptionally, be moved from banks' trading books to their banking books, provided there is an intention to hold them to maturity, or for the long term.

This brings practice under International Financial Reporting Standards (IFRS) more closely into line with US Generally Accepted Accounting Practice (GAAP), addressing the concern of many European bankers and insurers who feel disadvantaged compared with their US counterparts.

Assets held on the banking books will be reported at amortised cost, rather than current market value. However, the baseline for the amortised cost will be current market value rather than initial cost. The move will therefore have limited impact on current valuations of banks and insurers, but will mean that future rises and falls in asset values will be reported on a gradualised basis, reducing the future volatility of banks and insurers' share prices and capital requirements.

The IASB is under obligation to agree. IASB chairman Sir David Tweedie said it is better that changes are made by accountants than under the direct control of politicians.

To help investors and other report users understand the impact of the asset reclassifications on individual banks and insurers, new disclosure requirements have been introduced by the IASB, with companies having to report in footnotes which assets have been reclassified. Banks and insurers will be permitted, not required, to reclassify financial instruments. Companies will able to use the IASB's amended versions of IAS 39 and IFRS 7 for reporting from July this year.

Auditors fear the rule change will make it difficult to approve current year accounts. However, Pauline Wallace, a partner at PwC, said: 'I don't believe the process of reclassification will present difficulties for auditors. The challenge will be for companies that choose to reclassify, which will need to ensure they are able to track the reclassified assets in future in order to meet the extensive disclosure requirements in the amendments.'

Mark to market under review

A review of mark to market valuations has been initiated by the US Securities and Exchange Commission (SEC). The move was required under the federal government's emergency legislation, designed to rescue the US banking system.

Under the Emergency Economic Stabilization Act, the SEC must complete its mark to market study by the beginning of January. It must consider the impact of mark to market valuations on financial institutions' balance sheets and their role in bank failures this year; how mark to market affects financial information for investors; the process by which the Federal Accounting Standards Board develops accounting standards; whether accounting standards should be modified; and what alternatives there are to FAS 157, which implements mark to market valuations in the US.

The study will be led by James Kroeker, deputy chief accountant for accounting at the SEC. Roundtable discussions involving accountants, standard setters, investors and business leaders will feed into the review.

Lord Turner, the recently appointed chair of the UK's Financial Services Authority (FSA), has said he would support a wider review of the use of mark to market valuations. He added that other priorities for the FSA in the wake of the meltdown in financial markets are re-evaluation of banks' capital adequacy requirements, more monitoring of financial institutions' liquidity and the possible systematic assessment of banks' remuneration policies to prevent them being based on short-term profit positions that subsequently turn into losses.

Banking regulation tightens

Leaders of the G7 major industrial nations are set to strengthen global banking regulation in response to the crisis in the financial markets. Moves likely to be adopted include the creation of an international oversight panel that brings together representatives of the main financial regulators.

A report from the Financial Stability Forum (FSF) presented to G7 finance ministers and central bank governors recommends a series of steps to tighten and co-ordinate market regulation. These include strengthened prudential oversight of capital, liquidity and risk management, greater transparency in accounts and in asset valuations, reform of credit ratings agencies, more focus on how regulators respond to emerging risks and more robust arrangements for dealing with stress in the financial system.

The FSF's paper provides additional impetus for reforms being driven by UK Prime Minister Gordon Brown. The position of Brown among international leaders has been significantly strengthened because the UK government's reforms have been widely regarded as a template for action by other major developed nations.

Speaking in Brussels after a meeting of European leaders, Brown said that decisive action is necessary to tackle what he termed the 'irresponsibilities and excesses' of the financial system. He added that it is necessary to have rules that provide 'international global co-operation to deal with the management of the international financial system, a proper early warning system, proper co-ordination in crises and, of course, an agreement that we can work together to keep thorough macro-economic policy, as well as proper supervisory arrangements for the world economy moving forward'.

Brown also called for the reform of the International Monetary Fund (IMF). 'The IMF has got to be rebuilt as fit for purpose for the modern world,' said Brown. 'We need an early warning system for the world economy that can involve the supervisors in different countries.

'Where international or multinational companies work in a whole series of different countries, they themselves are agreeing that instead of having 15 different supervisors meeting separately, you need a college of supervisors to deal with these issues.'

What is needed, added Brown, is nothing less than a 'rebuilding of the financial international architecture' akin to the creation of the IMF, the World Bank and the United Nations after the second world war. It is an 'immediate task' to create modern institutions that are 'relevant' today, he said.

Reporting to become clearer

Financial statements will have more coherence and greater disaggregation of figures, under proposals jointly made by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB).

The two standards boards said that the global financial crisis underlined the need for financial reports to be transparent and intelligible - a test that many reports currently fail. Financial statements should be cohesive, in the sense that a reader can follow a flow of information through a succession of different statements.

But figures would be disaggregated, so that it could clearly be seen which activities of an entity generated a profit or a loss. Financial information would be brought together in 'reasonably homogeneous groups of items' that would also enable investors to predict future cash flows.

Together, the new reporting structure would provide a clearer picture of an entity's liquidity and financial flexibility, say the standards boards, enabling report users to understand the entity's capacity to exploit future opportunities, make investments and respond to unexpected events.

Robert Herz, chairman of the FASB, said: 'Providing investors with the most transparent, consistent financial reporting possible is more critical than ever to the efficiency and soundness of our capital markets. By working together to create one common, high-quality global standard for financial statement presentation, the boards are aiming to increase the usefulness of financial reports, while enhancing their comparability across international capital markets.'

Sir David Tweedie, chairman of the IASB, said that the two boards had opted to build on established practice, rejecting the option of eliminating the net income line.

In another initiative - one of a sequence in response to the financial crisis - the IASB has published for comment proposals to improve the information available to investors on the fair value measurements used for financial instruments. The proposals build on suggestions from the Financial Stability Forum, backed by the finance ministers of the G7 group of countries, on how to measure fair values when markets are not active and on the impact on liquidity risk.

FDs expect credit to stay tight

Chief financial officers of UK listed companies are feeling increasingly gloomy about the financial outlook, according to the findings of a Deloitte survey. Most CFOs reported that their companies intend to cut staff and capital expenditure.

The impact of the global financial market turmoil is already felt across companies, said the CFOs. Most, even in the non-financial sector, are engaged in reducing debt and restructuring their balance sheets. Nearly all said that credit had become more expensive and harder to obtain. There has been a big increase in the number of companies that are likely to reduce dividends and an even greater interest in moving capacity offshore.

Margaret Ewing, a Deloitte partner and vice chairman, commented: 'CFOs are preparing for a more prolonged period of distress in credit markets than they had expected initially, with cost cutting and cash preservation coming to the fore. There is also a growing readiness to contemplate more radical options, such as offshoring and dividend cuts - a reflection of the growing intensity of the slowdown. Non-financial corporates appear to be following banks in cutting expenditure and strengthening their balance sheets.'

Deloitte reports that while credit availability has fallen, so has demand. It found that more companies intend to reduce gearing than increase it, contrary to all recent experience. It said this is consistent with the results of the most recent Bank for England Credit Conditions Survey, which found that the only source of strong demand for credit came from corporates seeking to restructure their balance sheets.

However, there is a marked increase in interest in mergers and acquisitions, with a recognition that equity prices have become cheap. Almost half the CFOs who participated in the survey expect merger and acquisition activity to increase in the near future.

FRC stresses support for accountants

There will be no knee-jerk reaction to the global financial crisis through the introduction of new governance standards in the UK, the Financial Reporting Council's (FRC's) chief executive, Paul Boyle, has pledged. In fact, according to Boyle, problems do not lie with either corporate governance or accountancy standards. Rather, he argued, the focus needs to be on the way in which standards have been used by companies.

Boyle was addressing an accountancy profession delegation in London. He said he continues to be proud of being an accountant and believes accountants and auditors have nothing to apologise for. 'So far, at least, auditing has had a good crisis,' asserted Boyle.

While some observers had criticised auditors for either being 'too lax' or 'too strict', the reality is that the role of auditor is often misunderstood.

'Suggestions, for example, that auditors should have intervened to encourage their financial services clients to constrain the role of innovation and expansion of their businesses seem based on a fundamental misunderstanding of the relative roles of auditing on the one hand, and on the other hand corporate governance and financial services supervision,' said Boyle.

Boyle explained that, in the opinion of the FRC, the standards set out in the Combined Code on Corporate Governance remain comprehensive and appropriately principles-based. It places responsibility where it should lie, suggested Boyle. 'The Code states that the role of a company's board is “to provide entrepreneurial leadership of the company within a framework of prudent and effective controls that enable risk to be assessed and managed”. We expect that directors of banks and other financial institutions are already reviewing their governance and risk management practices. We therefore believe that the recent difficulties in the financial sector do not require a generalised tightening of governance standards across the UK corporate sector. The focus should be on whether the existing standards have been observed in practice.'

But there is a need to further consider whether standards are sufficiently consistent internationally, added Boyle. 'There has also been a great deal of heat generated by the debate on the appropriateness of fair value accounting. Notwithstanding the recent efforts of the IASB and FASB, questions remain about differences between various IFRS and US GAAP requirements relating to fair value accounting.' The FRC continued its support for the IASB, he said.

Boyle also suggested that complaints against fair value made by companies in the last year or so now need to be viewed in a different light. 'I note that some of the organisations that were most critical of accounting standards earlier in the year have turned out to be in need of substantial public sector financial support,' he said. 'Perhaps we have discovered a new regulatory risk indicator.'

In brief

UK is tax competitive, says OECD
The UK charges less tax than many of its major competitor nations, including France and Germany, according to a survey by the Organisation for Economic Co-operation and Development (OECD). Total tax revenue in the UK as a percentage of national income is 36.6%, against 43% in France and 43.6% in Germany. But the US charges much less, at 28.3% of GDP. Personal income tax and labour taxes tend to be lower in the UK than competitor nations, but taxes on corporations are higher.

More small firms excused audit
European Union member states will be permitted to excuse micro-businesses from the European Union's Accounting Directives, internal market commissioner Charlie McCreevy has announced. A report prepared for the Commission found that savings of €5.7bn could be achieved if micro-entities were exempt from the accounting framework and did not have to prepare annual accounts. Member states are already permitted to exempt some types of small businesses from the requirements of the Accounting Directives. The EU defines micro-businesses as employing less than 10 staff, with a turnover or balance sheet value of less than €2m.

HMRC buy-to-let crackdown
HMRC is clamping down on buy-to-let landlords, checking whether they have fully declared rental income. From next April, tax officers will have new powers to visit landlords' homes and inspect records. According to accountancy firm Target, HMRC is preparing to use its additional powers by collecting information on landlords with property in the UK or overseas. The firm warns that many landlords who believe they do not need to include information because they are making a loss on the rental of their homes could be affected.

Accounts 'must show liquidity risks'
The FRC has warned companies they must disclose any risk of having insufficient working capital, even if their profitability is not in doubt. It says that companies must be honest about liquidity risks in the current market conditions.

Balfour Beatty settles Bibliotheca case
Balfour Beatty has settled a Serious Fraud Office (SFO) investigation by agreeing to pay £2.25m against a civil recovery order, plus a costs contribution. Action was initiated over a subsidiary company's failure to keep accurate records on the Bibliotheca Alexandrina construction project in Egypt. Balfour Beatty says there is no suggestion of any improper commercial advantage accruing to the company, or any individual associated with the company. The SFO decided that no criminal proceedings should be instigated against Balfour Beatty and that the matter could be settled by civil resolution.

Pre-death gift rules set to tighten
HM Revenue & Customs is to investigate inheritance tax liability more thoroughly, collecting evidence from a variety of sources and for much longer periods, with the tax office claiming it will challenge estates much longer after death. HMRC aims to stop estates excluding assets that were given away less than seven years prior to death. Helen Clark, partner at chartered accountants Dixon Wilson, said: 'By looking at returns of capital gains and other sources of information, it will be much easier for the taxman to identify if cash and assets have been gifted away prior to the taxpayers' deaths.'

HMRC complaints rise
Complaints against HM Revenue & Customs' criminal law enforcement operations have increased by 21% in the past year, according to analysis by chartered accountants Wilkins Kennedy. Peter Goodman, a tax partner at the firm, said: 'There has been a lot of pressure on HMRC from the Treasury to improve the amount of money it takes in from its compliance work. As part of that, HMRC has been granted tough new criminal investigation powers. So, it is not really surprising that we are now seeing an increase in complaints from taxpayers subject to these new powers.'

Banks' remuneration controls strengthen
The Financial Services Authority (FSA) is clamping down on banks' remuneration policies, alleging that they 'may have been inconsistent with sound risk management'. It has written to regulated financial services firms saying that while the FSA will not become involved in setting remuneration levels, it wants evidence that boards have policies in place that ensure remuneration policies do not encourage risk taking.