Globalisation, Investments and International Accounting Standards
- Extra Reading
Professor Sir David Tweedie
Chairman, International Accounting Standards Board
Introduction by Lord Sutherland of Houndwood KT FBA
Provost of Gresham College
This is the 2005 Sir Thomas Gresham Docklands Lecture.
Other Sir Thomas Gresham Docklands Lectures can be accessed here:
2015 - Mark Hoban
2014 - Verena Ross
2013 - David Weaver
2012 - Charles Taylor
2011 - Andy Haldane
2010 - Anne Craine
2009 - Charles McCreevy
2008 - Bill Emmott
2007 - David Blood
2006 - Professor Werner G Seifert
2004 - Callum McCarthy
GLOBALIZATION, INVESTMENTS AND INTERNATIONAL ACCOUNTING STANDARDS
Professor Sir David Tweedie
Lord Sutherland of Houndwood KT FBA, Provost of GreshamCollege:
Welcome to the Sir Thomas Gresham in the Docklands lecture. This is the second of what is now an annual series, where Gresham College links up with the Financial Services Authority to provide a platform to bring distinguished speakers on matters of common concern to talk, to provoke, to make us all think.
Gresham College was founded through the will of Sir Thomas Gresham, who was Lord Mayor of London and who, according to last year’s lecturer, Sir Callum McCarthy, raised money in all sorts of interesting ways, but I don’t think we’ll talk about that! Sir Thomas Gresham, in his will, specified that money should be set aside to provide professors for a college in the City of London for the people who live and work there. The College has been around now for more than 400 years, trying to do just that. As things in the world round about change, so the College adapts. One of the changes is that much of what went on in the City of London in Sir Thomas Gresham’s life-time now happens here in the Docklands area, and we thought it right that we should come and speak to those who do live and work here, who represent what the City of London has done so well for centuries.
The link with the FSA was something that arose from a combination between myself and Professor Avinash Persaud, who is on the platform with us, and we thought this was one of the ways in which Gresham College could remain true to its origins of providing for the City of London and the link with the FSA – love them or not, they do much to influence how many of you live and how all of us in the end find pensions and other financial services.
The lecture tonight, I’m very pleased to say, is to be given by Professor Sir David Tweedie. The fact that he is a friend and, as a Scot, a fellow compatriot is purely coincidental! It’s a great delight to welcome you, David, to a platform sponsored by Gresham College. My job is now to tell you what’s happening for the next 50 minutes or so. I will leave the stage in one moment, and Profesor Avinash Persaud will take over and introduce the topic. Then we’ll have the lecture, and then Clive Briault of the FSA will respond to the lecture. Thereafter Avinash will wind the proceedings up, and you’re invited to join us for some refreshment at the back of the hall.
Welcome, thank you for coming, and now over to Professor Persaud.
Professor Avinash Persaud:
Thank you very much, Provost. Let me extend my warm welcome to you all, to this the second annual Sir Thomas Gresham Docklands Lecture.
As the Provost said, when we were thinking about establishing this new lecture, our concern was that you often read about the main financial regulators when they’re fining somebody, when they are punishing some company for transgressing some rule. You seldom have the opportunity to listen to someone setting out their vision for regulation – what is the regulation all about, what are we trying to achieve, how would we know whether we have succeeded or failed unless we have an idea of what the regulation is about? And so, we decided to provide a platform for the global leaders in financial regulation, and as the Provost said, the inaugural lecture was held here with Sir Callum McCarthy presenting, and the second lecture is being presented by Sir David Tweedie, another global leader in financial regulation.
Sir David’s principal focus these days is on the accounting side. Some may think that is somewhat separate from some of the financial regulation issues we’ve talked a lot about at Gresham College, but of course today accounting standards are integral to the financial system, its stability and financial regulation. I was, when I met Sir David, trying to measure how broad his shoulders are, because they need to be very broad to cope with the wide range of issues that accounting standards are trying to cover, and to deal with some of the tensions of these accounting standards. As I’m sure Sir David will talk about in greater length, much regulation comes about as a result of some kind of crisis. When one thinks of accounting, one thinks of the Asian financial crisis in the late 1990s and, more recently, some of the corporate governance and accounting crises in the United States – WorldCom, Enron – and also in Europe here with Parmalat, etc. You can see the desire for our regulators to establish some common standards, some way of making sure that these numbers that we read are more robust.
But of course there’s another tension, which we’ve talked a lot about at Gresham College, which is that companies are different, companies have different intentions, and therefore one can’t use perhaps the same regulatory standards and financial standards for all companies. A good example is that a long term investor, an insurance company, a pension fund, someone with a long term horizon might look at an equity as a long term investment – want to earn the liquidity premium – and it would be right for them to do so. But if we were to insist that they were to account for that investment in terms of marking to market on a regular basis, then we make it very hard for them to earn that liquidity premium, as they appear to be forced to respond to short term developments.
So in our attempt to standardise things, we sometimes have a perverse consequence of making it hard for the natural diversity of the financial system to prosper, and without diversity, we get financial fragility. That’s why dealing with these issues, accounting standards, becomes very complex. Complexity itself is a problem. It’s often the avenue of capture. Of course at the end of the day, we want standards in financial reporting that everyone can understand. If you need to have an accountant next to you as you read the Financial Times, we’d be failing. We would not have a financial system that’s inclusive, would not have a financial system that works for as many people as it should do.
Sir David Tweedie has a towering stature in the space of accounting standards. He is not blind to the issues we’ve just touched on. He is not shy to consult with those different and disparate forces in the financial space in discussing these many tensions. It’s not clear to me that he is winning the battle of dealing with all of these issues, but he’s certainly the person you’d want to have on your side batting for you. So I’d like to invite Sir David to come and talk to us about his key concerns, his key priorities, and his perspective on the future financial reporting and accounting standards – Sir David.
Professor Sir David Tweedie, Chairman, International Accounting Standards Board
There was a huge fight between the European Commission and the Securities & Exchange Commission. Europe wanted a part-time board, probably somewhere in the region of 27, nine from Europe, nine from America, nine from the rest of the world. The US wanted 7 full-timers, regardless of where they came from. Eventually, there was a compromise, and the trustees, led by Paul Volcker, Alan Greenspan’s predecessor, opted for six from Europe, six from North America, seven from the rest of the world. The board is 14, 12 of us full-time, from nine different countries, as it happens, and two part-timers, and we link in with the National Standards setters.
Then Europe, suddenly, just after we’d started in 2001, decided that from this year, 2005, all listed companies in Europe, and almost half of them are in the UK, would have to use International Standards in their consolidated accounts. That put us under terrific pressure, because we had to decide what we were going to do with the 34 standards that we inherited. But what it did do, it made sense for Europe. How can you have a single market where you have 25 countries with 26 different ways of accounting? Britain and Ireland do it the same, and the rest all had their own methods, and some allowed International Standards as well, and some allowed American Standards. You can’t have cross-border transactions easily when you have 26 different ways of dealing with them.
Where do the National Standards setters fit in, the UK Accounting Standards Board? Well, it fits in basically by looking at where they deal with the standards. What are they going to do? Their role is now to tell us what is happening, what is going on in their country, deal with national issues that we’re not interested in (if they’re not international, we don’t care), but basically they have to try and look and see where they can comment on our standards and help us. They do research work for us. They help with subjects that are going to arise in the future.
This has all led to the spread of International Standards. I prepared a graph for tonight but it is already out of date and I only did it two weeks ago. There are now now 100 countries which will be using these standards next year, gradually spreading around the world that International Standards are coming.
The National Standards setters are actually behind us. We’ve just come from a meeting with world standard setters, 61 of them, all of whom are trying to help to move their countries on to International Standards, if they’re not there.
Now, what was our agenda to be? Well, we’ve published it, but I expect you’ve forgotten it. I find as you get older, you do forget things. I was in a pub in Edinburgh not so long ago, chatting to this old couple opposite me, and the old boy commented that he’d been in a very nice pub in Rose Street, had a superb lunch, and I asked him the name of it, and he said, “Oh goodness, I can’t remember. Give me the name of a flower.”
“That’s it,” he said, and turned to his wife, and said, “Lily, what was the name of that pub that we were in?”!
Well, our agenda basically was we were faced with these standards we had inherited, the 30 that they’d tried to do, which were criticised, and we had to amend 17 of them. The choice was did we do it before 2005 or did we just do it gradually? We decided to blitz it. That really created an awful lot of work for the beginning, when we started.
We had to produce a standard, our first one, International Financial Reporting Standard 1, which said what do you do when you switch from British Standards to International, from any country to International, and that was to show how you had to transition one to the other. We couldn’t deal with certain areas, like insurance, and mining, oil and gas. We had to say, look, deal with this the way you used to do it, and we’ll come to you in due course, but if we hadn’t done something like that, there would have been massive changes which would then change again in a few years’ time.
We looked at share options. Even in 2001, we could see that was going to be a cancer that would be spreading the accounting for these, which wasn’t accounted for, frankly. This went down like a rat sandwich, especially in California, and we got lots of answers about why we should not extend share options. Firstly, the company was not a party to the transaction, which was news to us. “The employees do not provide a service.” Well, in which case why are you giving them share options? “It doesn’t cost the company anything.” Well, give us all some and we’ll all get rich! “Earnings per share is hit twice: it affects the numerator when you put expense through, but actually it’s only the dilution effect to the number of shares.” No, it isn’t! Even George W. Bush argued this one against us. Basically, that argument was defeated by the fact that if you issue shares and get cash, you pay somebody to do something for you and hand in the money for extra shares, you’ve got to charge the expense. If you simply give him the share to sell himself, you’ve given the same value away, and an option is only a variant of that. And the final answer that we had got against this was, “Well, if you do this, we might not be able to issue share options.” Bingo! That’s the best reason for doing it. If they are scared of the values that are going to be shown, then that is exactly the reason.
This is going to take American profits down by about 8%. In the high tech sector, 88%, and that’s why Congress is being fed money by California. In Europe, the effect is about a third. They say it doesn’t cost them anything, but when you looked a few years back, at the time of the various crises in America, on average, each of the top 500 companies in America spent £500 million buying back shares to stop the dilution effect. And another interesting statistic: 75% of the share options went to the top 5 executives. So if you like to divide 500 million, take three-quarters of that and divide by 5, you can see why you had all the American scandals. If you can ramp the share price for a while, it’s well worth it, because you don’t have to work ever again, and probably several generations down the line too.
Well, that showed us the fact that we had to get together and bring our standards together with those of the United States, and that really is now our major objective. We’ve got the standards ready for 2005. Now we’ve got to make sure that these two international sets of standards come together.
Why is everybody trying to come together? Well, most countries want a strong, stable and liquid capital market to fuel economic growth. A common set of accounting standards enables trade between countries, removing the accounting risk. Unfamiliar standards lead to a risk premium. That’s why China has asked us to come out and help them use our standards. Of course people often walk away. If they don’t understand, why take the risk? Just walk. Widely differing information of course, even between ourselves and the American standards, makes investors say, well, what is the right answer? What exactly is happening?
Enron helped in all this. It’s quite interesting, watching or looking at the accounts of Enron. I don’t know if you’ve ever looked at them, but if you look at the operating revenues of Enron in 1998, there were $31 billion, a huge company. The next year, however, they were $40 billion. They had increased by 33% - staggering! In 2000, it had gone up to $101 billion – too good to be true…and it was of course. If they’d kept going, operating revenues would equal the US Gross National Product in a matter of only a few years.
So, who failed? Well, the executives failed; the non-executives; the Audit Committee, the auditors; the analysts, who were sound asleep; the regulators, who didn’t look at them; the standard setters, in part, but mostly, they broke the rules; investment bankers, who created the schemes to allow them to show what are in fact loans as sales; and the lawyers, who said it was legitimate. The whole system collapsed in America, and that’s why the issue was not so much an accounting crisis as a corporate governance crisis. But it helped us, because the Americans were saying any help we can get, we’ll take it, and they suddenly opened their arms to receive ideas from outside. We made an agreement with the American standard setters: we would remove the differences between our standards, we’d align our agendas, and we’d interpret the standards the same way.
We’ve already done quite a lot of that. The business combination standard is the same. Merger accounting is banned. Goodwill, brands, we impair them, we don’t write them off over a fixed lifetime, as the Americans used to do, and we’ve done that. Remember when we brought this in, the then-Chief Accountant of the Securities & Exchange Commission was horrified. He said the United States had found the answer to accounting for goodwill and brands over 30 years ago, and that was to write them off equally over 40 years. As I pointed out to the gentleman, in the United Kingdom, we have brands, such as Gordon’s Gin and Johnny Walker, that are actually older than the United States, and, in my humble opinion, have done more for the sum of human happiness than the United States, and personally, I’d write off America before I’d ever write off Johnny Walker Black Label!
The other ones, we’re taking the American standards because we felt they were better than ours, and the Americans moved in too, and then started taking some of our standards and changing theirs, including the share option one.
We also decided that we needed a conceptual framework. Now, accountants aren’t great consumers of conceptual products. When I was a partner at KPMG, I used always to show my partners a picture of one…(displays picture of traditional building in London) and there you are, a logical structure of one thing built on top of the other, and accounting I’m afraid is a bit more like this. Those of you who know London will recognise the headquarters of the Institute of Chartered Accountants in England and Wales – I keep forgetting the Welsh, but then so do they!
One of their Council Members was heading towards Wales on the motorway when he was stopped for speeding, and apologised to the policeman, said he was very sorry, it was because he was going to Wales, hated Wales, hated the Welsh, and everyone he met in Wales, he said, was either a prostitute or a rugby football player.
”Oh, that’s interesting,” said the policeman, taking his notebook back out again, “My wife’s Welsh.”
“Really?” he said. “What position does she play?”!
Well, we have to set out, if you like, the basic tenets of accounting. What’s the objective? It’s information for decision making. What are the qualities and characteristics? Well, you want information that’s relevant, timely, comparable, reliable. Can’t give you all those. I can give you a very reliable cost of this building, and a more relevant but more subjective valuation, and you have to have a trade-off. On balance, we’ll go for relevance.
What’s an asset? What’s a liability? Everybody knows what these are. That’s why they keep missing them off their balance sheets. An asset is the right to a stream of benefits in the future. It’s not just these things. A liability is an obligation from which you cannot escape and leads to resources leaving the organisation. When do we recognise them? When we can measure them reliably, we get roughly the same answer. How do we measure them? Value or cost. We’re going to have to move to value one day, but accountants are very reluctant to do that. They like cost. You can audit cost easier. But value will come, and how do we present it?
That might not sound controversial, but it was massively controversial. Let me just give you an example. I’m about to lose all the accountants in the room, but basically, in accounting, every debit has a credit. A debit, you spend money, and it’s either an asset or an expense. That’s why I didn’t define expense, I just defined what an asset was – everything else is an expense. Well, in accounting, we have another one. A ‘what’s-it’. A what’s-it is an expense that you don’t want to put through the income statement, so you stick it on the balance sheet and pretend it’s something else. A classic was the sort of thing like hotels starting up, and making a loss in the first year. Well, they’ll claim that’s a cost of starting a new hotel, so they just add it to the cost of the building, and write that off over 50 years. Well, think of the Euro Tunnel. What did it lose? Two billion or something? You can imagine the CEO coming back to his wife and saying what a dreadful year we’ve had, but look how strong this balance sheet is getting – and that’s what it’s all about: a loss is a loss, and we have to safeguard the income statement by refusing to allow what’s-its to creep on to the balance sheet.
But getting together with the Americans is going to take too long. We’ve got so many differences, it’s going to take years to get through them all, and the speed is pedestrian. There are only two types of pedestrian, the quick and the dead, and we basically decided we had to accelerate this. So we made an agreement with the FASB, which is at present with the European Commission, and with the Securities & Exchange Commission in America, how we can get through this in three years, so we can do enough to get rid of this reconciliation. Basically, we’re going to look where we have options and decide shouldn’t we get rid of the option and the standard and just do the American Standard. They’re going to do the same, where they think we’ve probably got the better answer, and see if they can quickly get rid of some of the differences. The standards won’t be identical, but they’ll be very close.
And then we move on, because that’s just dealing with differences, but we all have standards we don’t think are particularly good – they’re old fashioned, they’ve been there 15, 20 years, they’re not very helpful – and we have to try and change them. These are the sort of standards we’re looking at: Special Purpose Vehicles – well, Enron hid most of its losses. We’ve got to make sure these are reflected properly in accounts. Consolidations – I remember when I was Chairman of the UK Standards Board, the Government was terrified this was where creative accounting really existed, and this was the introduction of it they thought.
I first met creative accounting at the age of 11, when I visited my uncle’s smallholding just as the auditor was leaving, and he commented he hadn’t seen my uncle’s horse.
“No, you wouldn’t,” said my uncle, “I sold it.”
“Well, that’s strange,” said the auditor. “I didn’t see the cash coming through the cash book.”
“Of course you didn’t,” said my uncle, “I spent it.”
“Well, that won’t do,” said the auditor. “Give me £2.” So he took £2 off my uncle, picked up the cash book and wrote “Payment to man for burying dead horse: £2”. Now those of you who are worried, let me assure you, no Scottish auditor would ever do a thing like that these days – not for £2 he wouldn’t!
Financial Instruments – the most complicated standard we inherited, full of rules, exceptions, exceptions to exceptions, a real nightmare of a thing! Some things are shown at cost, some things are shown at value. Anyone who claims they understand that standard hasn’t read it properly – it is impossible to go through. We have to change it; it’s based on the American one, and we have to get rid of it.
Leasing - One of my ambitions before I die is to fly in an aircraft that’s on an airline’s balance sheet. None of them is! Why not? Well, the good news is we have Leasing standards worldwide that are perfectly harmonised – they’re all absolutely useless! The reason they’re useless is if you lease something, they divide it into one of two categories. Are you still renting the thing, in which you just charge each year what you pay, or have you really borrowed to buy it, a long term lease? Typically, as they did in those days, they put a bright line in, which says, “Look, if this – the payments you make under this lease, the present value is 90% of the value of the asset when you start, it’s on balance sheet.” Well, they all come in at 89%! If you dropped it to 80, they’d come in at 79% - they’re designed that way. Airlines are nothing like that anyway, because they only lease aircraft for about seven years, with a penalty clause if they don’t do another seven years and so on. So all they’ve committed to is seven years and a penalty clause – nowhere near 90%. But back to our definition of a liability – “an obligation you can’t get out of”. Can the airlines get out of these leases? No. Do we know how much the lease is worth, how much you’re going to have to pay? Yes. That’s a liability, and on the other side, the right to a 747 for seven years. Well, we’ve told the airlines this, and the banks that finance these leases. They think this is the end of Western civilisation as we know it, but that’s where this is heading.
Performance reporting – the obsession with the bottom line. As a Scot, I’ve always likened the bottom line to a haggis. If you knew what was in it, you wouldn’t touch it with a barge pole! We get things like EBITDA, Earnings Before Interest, Taxation, Depreciation and Amortisation – or earnings before bad stuff, if you like – absolutely ridiculous! It’s like the girl writing home from boarding school, and she writes to her mother: “There’s been a terrible fire in the dormitory. At the last minute, I was rescued by the school handyman. As there’s no dormitory now and I’ve fallen madly in love with him, I’ve been living with him in his one-room flat for the last three weeks.” At the bottom of this letter to her Mum, there’s a little postscript, which says, “There hasn’t been a fire. I’m not in love with a handyman, and I’m most certainly not living with him, but I failed my history exam, and I wanted you to get it into perspective”! Well, the same goes for performance reporting, and really, we need to break down the various aspects of a company’s performance – what is its trading profit, what’s its treasury activities, and so on – and then you can see exactly where these things fit together.
Pensions. The British companies have real problems with pension deficits. Why? Not just the bear market, and not just the Chancellor removing their tax benefits, it’s the fact that people live longer – dreadful habit, and it’s got to stop! And interest rates have gone down. That’s normally a good thing, but think about it when we’re talking about annuities. If you promise someone a pension of £10,000, and interest rates are at 10%, you need a capital sum of £100,000 to finance that. If they’re 5%, interest rates, you need £200,000. That was the Equitable Life problem. That’s why they didn’t have the liabilities showing correctly, and that was the problem, and that’s why they’ve gone into deficit. So the assets have gone down, and the liabilities have gone up. And then you look at the accounting for it. Only the UK has a system that actually shows you what happens. If you had a scheme that had, say, 40 million assets, 40 million liabilities, and then the stock market fell 10 million, in the UK, you would show that – 10 million would be shown in the accounts. Internationally, in America, it doesn’t happen that way. They say, well, some of that’s market noise, so we’ll measure that by saying 10% of whatever’s the higher, assets or liabilities. Well, liabilities are still at 40, so that’s 4. Knock that off the 10 million. Down to 6. Now, spread that over the working life of the employees, let’s say 10 years, and they show a figure in the accounts of 600,000. Now, you explain that number to your Granny! You may as well take the 10 million and divide it by the cube root of the number of miles to the Moon and multiply it by your shoe size – it doesn’t mean a thing! That’s really the sort of thing we’ve got to drive out of accounting and get proper answers.
We haven’t actually got the answers right yet, in pensions – it was as far as we dared go in the UK – because in profit is a number which is the estimated future return from the pension assets. You get a company like General Motors. They had a 19 billion deficit in their pension fund. They raised corporate bonds when interest rates were low of 14.5 billion, they sold a subsidiary to make up the rest, they invested in junk bonds, hedge funds, and emerging market funds, and estimated the return on these assets would increase their profits by 550 million a year, without doing anything. You can’t have that. We don’t bring future profits into the profit and loss account. We have to strip all that out.
The other thing that’s in there is retirement benefits – not just pensions, but what else have you promised them, because these people aren’t going to work for you any more? And in America, they promised them healthcare till death, and BUPA – whatever it is in America – type of payments. Well, the trouble was, as you get older, bits fall off, and medical costs inflation is higher than normal inflation. So we insisted it costed what they’d actually promised these people, and the American Standards setters did it first. Well, for General Motors, the cost, the liability they were committed to, was 32 billion – 78% of their equity. They hadn’t a clue that was the figure. That’s why General Motors is in trouble. It’s got a massive pension deficit, or at least it had, and it’s got these massive healthcare liabilities. Not the only one – Ford has a 12 billion liability too. These are the areas we have to tidy up.
So these are the fights that are going to go on with Europe and America. Companies don’t want to show these numbers, for obvious reasons, though in the UK, it’s interesting, the attitude towards it, we’re actually for the first time discussing pensions in the board room. We know the problem. We’ve got to fix it.
Our convergence project with the United States is to set milestones for these areas that I’ve looked at. We’re not going to finish them all, but what the SEC wants to see is progress. Some will be finished, some will be almost finished, others will be just started. As long as they see, with all these 11 issues I’ve showed, that we’re making progress, the SEC says if that’s happening, if they’re audited properly, and enforced, they will accept International Standards on to the New York Exchange as equivalent. So they won’t be the same at that stage, they will be becoming the same, because we’re writing these together with the Americans, they’ll be in close alignment, they’ll be generally comparable, and in a few years time, they will be the same.
The problem of course is going to be how we write the standards. The Americans like rules, because they’re terrified of litigation. We tend to like principles. Can we get away with writing just principles? The Leasing Standard, for example, the main principle is show the liability you’ve incurred by signing the lease contract and the right to the assets obtained thereby. That’s the standard. It’s six inches thick in America, and doesn’t work, and that’s really what we’ve got to get down to. But if we do that, no exceptions, no scope exclusions, no bright lines, and they’ll be very tough standards, but they’ll also require judgement, and that’s what scares the Americans. We’re quite used to that in the UK, but can the auditors do it? Are they scared of litigation? I think we’ve a better chance of getting away with it – if they document what they’ve done, their judgement, how they deferred to the rules, what they tried to do. If it turns out they were wrong, and you’ve done it carefully and documented it, you’ll almost certainly get off in a UK court. If you’ve missed a rule, you’re dead, and that’s why I think it’s probably safer to do this way.
But don’t ask us to answer a lot of questions, because that’s a rule every time we answer one, so you’re on your own. People like principles – they just want you to answer the 400 questions on how to apply them, and that’s what we can’t do. The signs aren’t good. I don’t know if you’ve noticed, but the Lord’s Prayer has 57 words, the Ten Commandments 297, the American Declaration of Independence (big mistake that was!) 300 words, and the European Directive on the import of caramel products, 26,911 words!
Then we’ve got the European Union. They have to endorse our standards, so, not surprisingly, the pressure comes on them – turn it down, don’t like it, don’t like the answer. Europe hasn’t quite got used to the idea we’re not consensual. We actually try and do what we think is right, and that doesn’t mean trading bits of the standard for other bits. We obviously know the political realities sometimes and feel, well, we had better do it in two steps rather than one, but nonetheless, the idea is to get the right answer, and certainly not put something in a standard we think is just plain wrong. Europe then has this endorsement mechanism to see our standards.
I’m often asked if I’d give them advice on what they should do. I’m always reluctant to give advice. I remember when I moved into our present home in North Berwick many years ago, in the front garden was a rather unusual plant which I thought was overgrown parsley, but the neighbours, who didn’t like the lifestyle of the previous occupants, thought it was cannabis. I was a bit concerned about that, so I went to see a horticulturalist, and he didn’t know what it was either, but he gave me advice I never forgot. He said, “Look, if you’re worried about this plant,” he said, “pick it, dry it and then smoke it, and if you’re still worried about it, then it’s parsley”!
Europe has also got to enforce the standards. Europe, being Europe, has different rules in different countries. They’ve got to pull them all together to make sure that not only are the auditors auditing properly, but when the auditors find problems, the regulators force through change. That’s very good in the UK, but in other parts of Europe, it’s only just starting, and that’s something they’re going to have to deal with.
We have other projects. We’re going to work on a new Insurance Standard. Insurance is one of the big black holes in accounting. There’s various ways around the world, none of them particularly good. We’ve got to deal with small, medium enterprises – they can’t deal with these complex standards that we have – and we’ll certainly touch that.
But overall, what’s our aim? It’s what I said at the beginning. We’re out to try and reduce costs, costs of dealing with multiple accounting systems. We’re also trying to encourage inward investment. We’re trying to encourage growth, because of that investment, and employment. And a final thing we’re trying to do, by showing pension deficits and things like that, we’re trying to encourage management to manage better. If you look at some of our major companies, they’ll say things now in their operating and financial review – “We have a pension deficit of £50 million. We think the assets in the fund will rise at 4% per annum over the next few years. We’re going to put an extra 5 million a year. We think we’ll have the deficit cleared by 2008 – the effect on profits, 1.3%.” That’s the way they manage it, and that’s what people want to know – how are you going to solve this problem - and that’s actually what British companies are doing, and that’s how you manage better.
Well, I’m aware this has sounded a bit like a sermon and sermons can go on for ever. I remember being in the kirk not so long ago listening to the minister bang on, and the old lady in front of me turned to her neighbour and said, “Is the meenister no feenished yet?” Back came the answer, “Aye, he’s feenished. He just cannae stop!” Well, let me assure you I can!
I’m often asked, will we win? I never used to liken standards setting to winning. I used to liken us to the cross-eyed Olympic javelin thrower – he didn’t win any medals, but by God, he kept the crowd on the edge of their seats! But the situation we are in just now is more like the time when I was playing in goal for my primary school football team. We were in a cup semi-final, winning 1-0, and in the last few minutes, one of the opposing forwards broke through and he hit the ball so hard, it went past me before I could move, but fortunately, it came back off a goalpost. He hit it again, but this time I threw myself to the left and touched it round the post. My team mates were ecstatic. What they didn’t realise was I was trying to save his first shot!
We won’t get a second chance at this. This is probably our best chance in a lifetime to try and get standards round the world as part of the globalisation of regulation and accounting. The Chairman of the American Board, Bob Hurst, was one of our board members. He was chosen deliberately by the Americans so that we would work together well. He was educated at the University of Manchester – if you can be educated at the University of Manchester ! He’s married to an English woman, so he knows all about international disputes. That’s why I do think we have a chance. We’ve got internationalists in America, we’ve got people round the world, in China, Japan, Canada, in Europe, who want these standards, and that’s why I think it’s going to happen. Sooner or later, there will be one set worldwide, and the mission will be accomplished.
Response by Mr Clive Briault, Financial Services Authority:
I am nevertheless delighted to have been asked to thank Sir David on behalf of Gresham College, the FSA and most of all, I hope, for the audience, for his incisive, insightful and entertaining explanation of the work of the International Accounting Standards Board in creating international accounting standards.
When Sir Thomas Gresham endowed his college, he stipulated that the seven professors should be paid £50 a year so that each of them could give a lecture once a week. In those days, accounting was regrettably not regarded as a core subject, but I’m sure you will agree that Sir David is a worthy successor of Sir Thomas’ original idea and will well deserve his £50 once he’s given his lecture every Tuesday for the next 51 weeks!
It should also be noted that Sir Thomas Gresham was himself no stranger to the fine arts of international accounting standards, and indeed even to some of the more archaic aspects of fair value and foreign exchange accounting. He spent much of his working life in Antwerp, which was then a major European centre of trading and finance – these things can change… He served no fewer than three English monarchs – I’ll leave that as a pub quiz question, if you can name all three – by arranging loans, by smuggling money and arms into the UK, by manipulating the Sterling exchange rate in Antwerp to reduce the cost of servicing the Crown’s debt, by suggesting that the owners of private UK merchant fleets should lend to the Crown at one rate of exchange in Antwerp and be repaid in London at a lower rate, and also by taking an imaginative approach to the representation of his own personal accounts. So when they audited his accounts in 1574, no fewer than 11 years after the previous audit, Sir Thomas managed to turn accounts showing net receipts of £18 and a debt to the Crown of £100,000 into a claim on the Crown of £11,000. The Crown Commissioners, the precursors obviously of the International Accounting Standards Board, disputed this claim, but Sir Thomas dashed off to see Queen Elizabeth to sanction it, and promptly told the Commissioners where to go!
Much of what Sir David has covered this evening strikes a chord with us at the Financial Services Authority. Let me just mention briefly three aspects of this. First, our own statutory objectives at the FSA include consumer protection, where consumers include investors, and maintaining market confidence. The International Accounting Standards we regard as being clearly important to both of these objectives. There is, as Sir David has said, now a real opportunity to take a major step forward towards global financial reporting standards that are consistently interpreted, applied and enforced across all major capital markets, and as economies and markets around the world continue to become increasingly integrated, it is incumbent on both regulators and accounting standards setters to facilitate the flow of capital around the world and to facilitate access to new and wider markets. Convergence of accounting standards between the three major capital markets of the world – the EU, US and Japan – is heading in the right direction, and should facilitate companies in one marketplace being able to access investors in other marketplaces, without having to undergo the costly exercise of restating their accounts. In this way, companies will have access to a wider pool of capital without incurring the substantial additional costs, while investors will benefit from the wider pool of equivalent financial reporting information.
Second, we are also very familiar with the trade-off between principles and rules. We at the FSA are trying to be more principles-based, but many of our stakeholders exhibit a remarkable affection for all 8,000 pages of our handbook of rules and guidance. To give but one example, our recent modest proposal for removing a swathe of detailed rules relating to training and competence requirements for wholesale market participants has led to howls of protest in response.
Third, just as we the FSA look in Europe, and globally, for consistency in the application, interpretation and enforcement of regulatory standards, so it is clearly important to do so in the context of international accounting standards. This requires a considerable degree of co-operation in order to achieve convergence, and this is never an easy task, but the ultimate gains, what I referred to a moment ago, make it important to pursue this with the vigour that Sir David has demonstrated over many years, and also, because it is not easy to achieve such convergence, it is again important to focus on those areas that matter most to the end users of international accounting standards.
So to conclude, I would suggest that in the absence of international accounting standards we run the risk of seeing a variance of Gresham’s law at work, his law being that bad money drives out good, but in this case in the sense of the best investment opportunities not being funded in international capital markets because those markets, or investors in them, cannot distinguish good from less good opportunities. I would therefore ask you to join me in thanking Sir David for his massive contribution to creating a world in which the best and most profitable investment opportunities for investors can indeed clearly reveal themselves as such, rather than leaving investors to deal in the fog created by the wide variety of different national approaches to accounting standards.
Thank you, Sir David.
Professor Avinash Persaud
Thank you very much. In a moment, I’m going to invite you to join Sir David and Clive for a drink at the end of the hall there and where we can continue our discussion, but may be to help start that discussion, let me leave you with this thought. I’m gravely against racial stereotyping, but it probably makes sense that the world’s accounting standards are set by a Scot. Now, given that large numbers of people in this world won’t understand them, we would probably need to have some tests we should establish as to whether these accounting standards are working. What should those tests be? I’d like to start off by coming up with maybe three tests.
The first would be that there are fewer occasions where we discover that a company did not have as much revenues and as few costs as it had previously claimed. The second test would be that good companies are able to attract investors from around the world, a wide variety of different investors, because those investors can easily understand what that company is up to because of the international accounting standards. The final test, I would say, is that we have a set of standards that allows companies and institutions to do the right thing, to do what’s sensible, and to account for the right costs, for insurance companies and pension funds to be insurance companies and pension funds, for long term investors to invest in long term assets, and that our accounting standards don’t in some perverse way get in the way of companies doing what actually makes economic sense. When I think about those three tests, I suspect it’s still too early to tell whether we’ve passed them.
Response to Sir David Tweedie
Clive Briault, Managing Director, Retail Markets, Financial Services Authority
I am delighted to have been asked to thank Sir David on behalf of Gresham College, the FSA and you the audience for his incisive, insightful and entertaining explanation of the work of his International Accounting Standards Board in creating international accounting standards. When Sir Thomas Gresham endowed his college he stipulated that each of the seven professors should be paid fifty pounds a year so that each of them could give a lecture once a week. In those days accounting was not regarded as a core subject but I am sure that you will all agree that Sir David is a worthy successor of Sir Thomas' original idea and will well deserve his fifty pounds once he has given a lecture every Tuesday for the next fifty one weeks.
It should also be noted that Sir Thomas Gresham was himself no stranger to international accounting standards, and even to some of the more archaic aspects of fair value and foreign exchange accounting. Sir Thomas spent much of his working life in Antwerp, which was then a major European centre of trading and finance [these things can change!]. He served no fewer than three English monarchs [Edward VI, Mary and Elizabeth] by arranging loans, by smuggling money and arms into the UK, by manipulating the sterling exchange rate in Antwerp to reduce the cost of servicing the Crown's debt, by suggesting that owners of private merchant fleets should lend to the Crown at one rate of exchange in Antwerp and be repaid in London at a lower rate, and by taking an imaginative approach to the representation of his own accounts. So, in the audit of his accounts in 1574 – 11 years after the previous audit – Sir Thomas managed to turn accounts showing net receipts of £18k and a debt to the Crown of £100k, into a claim on the Crown of £11k. The Crown Commissioners disputed this claim, but Sir Thomas dashed off to see Queen Elizabeth to sanction his claim and then promptly told the Commissioners where to go.
Much of what Sir David has covered this evening strikes a chord with us at the Financial Services Authority. Let me mention three aspects of this.
First, our statutory objectives include consumer protection (where consumers include investors) and maintaining market confidence. International accounting standards are clearly important to both of these objectives. There is now a real opportunity to take a major step towards global financial reporting standards that are consistently interpreted, applied and enforced across all the major capital markets. As economies and markets around the world continue to become increasingly inter-related, it is incumbent on both regulators and accounting standard setters to facilitate the flow of capital around the world and to facilitate access to new and wider investors' markets.
Convergence of accounting standards between the three major capital markets of the world in the EU, US and Japan is clearly heading in the right direction and this should facilitate companies in one marketplace being able to access investors in other markets without having to undergo the costly exercise of restating their accounts. In this way companies will have access to a wider pool of capital, without incurring substantial additional costs, while investors will benefit from a wider pool of equivalent financial reporting information. Together, this will help to ensure that financial resources flow to those investment opportunities that are most deserving of capital market financing, and everyone should gain from a lower overall cost of capital.
Second, we are very familiar with the trade-off between principles and rules. We at the FSA are trying to be more principles based, but many of our stakeholders exhibit a remarkable affection for all 8000 pages of our Handbook of rules and guidance. To give but one example, our recent modest proposal for removing a swathe of detailed rules relating to training and competence requirements for wholesale market participants has led to howls of protest.
Third, just as we, the FSA, look in Europe (through CESR, CEBS and CEIOPS) and globally (through IOSCO, Basel and the IAIS) for consistency in the application, interpretation and enforcement of regulatory standards, so it is important to do so in the context of international accounting standards. This requires a considerable degree of co-operation in order to achieve convergence, and this is never an easy task. But the ultimate gains that I referred to a moment ago make it important to pursue this with the vigour that Sir David has demonstrated over many years. And also, because it is not easy to achieve such convergence, it is again important to focus on those areas that matter most to the end-users of international accounting standards.
So to conclude, I would suggest that in the absence of international accounting standards we run the risk of seeing a variant of Gresham's Law at work, namely that bad money drives out the good, in this case in the sense of the best investment opportunities not being funded in international capital markets because they cannot distinguish themselves from less good opportunities.
I therefore ask you to join me in thanking Sir David for his massive contribution over many years to creating a world in which the best and most profitable investment opportunities for investors can clearly reveal themselves as such, rather than leaving investors to deal with the fog caused by the variety of different national approaches to accounting standards.
© Professor Sir David Tweedie and Clive Briault, Gresham College, 27 September 2005
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