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Good morning Ladies & Gentlemen. It is indicative of the changing landscape of regulation that the programme describes me first as former chairman of CESRfin, and then as CEO of the FSA.
I will focus on two major areas which Commissioner Campos has outlined, and which I see as particularly important at the moment for market confidence: Convergence of accounting standards and audit market concentration. I will also comment on the report published last week, 'Vision from the CEOs of the International Audit Networks'
Convergence
For global convergence of accounting standards, there are three aspects I want to touch on: the IASB/FASB roadmap, and then consistent application and enforcement of IFRS.
IASB/FASB Roadmap
The purpose of the IASB/FASB road map is to provide a process for the convergence of IFRS and US GAAP. As part of this roadmap, the IASB & FASB will work on the amendments to, and new projects in, areas of financial reporting which they consider necessary for convergence.
It is important to focus on the overall objective of the IASB/FASB road map and what is meant by convergence. I welcome Commissioner Campos' view that convergence is not seen as reaching totally identical accounting. Instead it is about the recognition of the equivalence of accounting standards. And here, as we did within CESRFin when undertaking our assessment of equivalence, I take equivalence to mean that an investor, when faced with financial statements prepared under different accounting standards, would take the same investment decision i.e. the focus is on consistency of outcome for the investor.
It is also important to be sensitive to different accounting traditions. We have very different accounting and corporate law traditions in the EU compared with the US. It is important for many markets around the world that converged standards should retain the principles of stewardship as well as providing a basis for investment decisions derived from estimates of future cash flows.
Experience so far
There is of course another roadmap under which the SEC will seek to remove the need for companies to reconcile to US GAAP, and a major part of this roadmap is the effective implementation of IFRS. In considering this we need to reflect that, since January 2005, over 8,000 listed companies in the EU have implemented IFRS for their consolidated financial statements. This has been a massive exercise and the early studies indicate that there have been no major 'hiccups' in the implementation of IFRS. There have certainly been no indications of any upsets to market confidence. However, this is only the first stage of implementation and we now need to build on this as we focus on consistent application and enforcement.
Consistent application
Users of IFRS financial statements will expect a consistent application of IFRS across the EU. However, at the same time there must be realistic expectations about what is possible. Here, we are all on a long and steep learning curve.
Principles-based standards rely on the experience and judgement of preparers, auditors and users to be able to apply them to the particular circumstances. Regulators and other stakeholders must understand that this is a new body of accounting standards for many preparers. It will take time for experiences of applying IFRS in particular circumstances to develop and for preparers to get used to all the disclosures required under IFRS.
As IFRS are principles based standards, the most useful way to assess consistency of application is in terms of the IFRS themselves and the IASB's framework. There may be more than one accounting policy which is consistent with the standard and the key is to disclose fully the policy that has been followed. In other words, we need to understand and accept that consistency does not necessarily mean that every company will have identical accounting policies just because they are using the same standards. However, disclosure is key, and it should be clear why companies have chosen the particular accounting policy.
Consistent enforcement
Consistent enforcement also needs some reflection. Enforcement must be proportionate to the risks involved for investors. It should not be focused on every minor application of IFRS, but should be directed to the larger issues with application of IFRS – in other words those issues that have an overall impact on investor decisions. In addition, companies are human. Regulators should not punish companies for making honest mistakes in applying accounting standards.
If the standards are enforced in a way that is intended to achieve uniformity through application of precedents then we will turn them into rules, stifle innovation, and move inexorably towards a different version of IFRS in each major market. We support the IOSCO initiative to develop a global enforcement database that mirrors the CESRfin work. However, it is important that all enforcement agencies accept that principles- based standards will not always provide identical results.
CESRfin has good links on an international level both through IOSCO and with the SEC. Within the CESR-SEC Regulatory Dialogue, protocols have been established for the exchange of information between the SEC and CESRfin. The aim is to allow CESRfin and the SEC to develop converging solutions which are both effective and timely. As an example, before the SEC takes a position over the application of IFRS to an EU dual listed registrant, it would consult with the relevant CESR Member's staff on that matter.
Let me now turn to audit market concentration.
Audit market concentration
As Commissioner Campos has outlined, the market for audit services is highly concentrated among the Big Four audit firms. An audit market where there are only four major audit firms is just about tenable. Some companies in some sectors might argue, quite reasonably, that even the current situation is not tenable, as these companies may have no effective choice of auditor. The Big Four accountancy firms have shown some ingenuity, indeed some creativity, by presenting themselves as the Big 6 (4+2).
I was surprised that in their recent report, 'Vision from the CEOs of the International Audit Networks' the Big 4 (+2) audit firms underplayed the concerns about audit market concentration. I quote, 'Concerns are expressed about auditor concentration, but there is no doubt among us that at the same time there is vigorous competition in our profession.' From my perspective as a European securities regulator there is a great concern about audit market concentration. And re-badging the Big 4 as the 'Big 6' for the presentation of this report is not enough to assuage those concerns. For example, as European securities regulators we have concerns over the impact on market confidence. What would happen if one of the Big Four firms was forced to withdraw from the market? There could be a short-term issue. Some major listed companies would have to delay publishing their statutory accounts while new auditors were selected. Of greater concern would be the potential loss of market confidence as market participants react to the reduction from Big Four to Three. How would market participants regard the reputation of those audit firms left? How would they value the audit generally? It is difficult to foresee what would happen – it would depend on the particular circumstances – but some disruption to market confidence is likely.
So what can be done? Various ideas have been presented such as audit liability caps and /or more regulatory oversight. Personally, I am not in favour of caps. I welcome the approach that is being taken in the UK to deal with audit liability through enabling auditors to take advantage of proportionate liability. Proportionate liability has at least two advantages over liability caps. It avoids the possibility that auditors would suffer unlimited claims in a disproportionate manner for events which were not totally in their control. Yet at the same time, auditors are still liable for any claims arising from their negligence. This seems pretty fair to me.
Within the UK, we welcome the way the FRC has been leading a public debate on audit market concentration. Participants in the debate are well aware that, as a global issue, if there was a failure of a Big Four audit firm, there need to be co-ordinated plans amongst regulators on a global basis to ensure there was not a disorderly withdrawal of that firm from the audit market. I welcome IOSCO’s proposal to address this area, and we will play our part. However, such a failure is not inevitable. I would like to suggest some other areas where the audit firms themselves could ensure they are taking sufficient action to mitigate the risks of such a failure occurring. These areas were in the submission the FSA made to the FRC as part of the UK debate
The FSA suggested three areas where the Big Four themselves could do more: audit quality, audit firm operating structures and governance of the audit firm.
- On a global basis the audit firms need to review and continually assess their internal processes for ensuring that the quality of audit work meets both regulatory and firm's internal standards. Recent events indicate this has not always been the case.
- the global internal operating and reporting structures of the audit firms are often relatively loosely-linked member firm partnerships centred on individual jurisdictions, and this is a potential source of risk, enhanced public disclosure in this area and an active dialogue with relevant regulators about these risks, would be beneficial.
- The audit firms need to have in place effective governance and oversight of their global business activities thus enabling them to review their internal controls over risks more generally and to ensure that they are managing them properly.
Global Capital Markets and the Global Economy: A Vision from the CEOs of the International Audit Networks
And finally, to the paper which was presented last week by the Big 4 +2. Two points:
- I do not support the proposition that a 'brave new world' of real-time reporting will be the answer to all investor needs. How will the market cope with the proposed explosion of information from companies? There is already a perception that quarterly earnings announcements drive excessive earnings management. How would companies' behaviour change if they had to deliver real-time reporting? And in any case daily or even monthly swings in sales in a traditionally volatile business should not be cause for concern for investors.
- We are already undergoing radical change in financial reporting with the implementation of IFRS across the EU. Let us all focus on bedding in IFRS over the next few years. Rather than looking for new ways of delivering assurance products, the audit firms should focus on their core service of delivering a quality audit that adds credibility to financial statements. The 'brave new world' can wait.
Ladies and Gentleman, I welcome your comments.
