Financial Reporting and Financial Stability Dushanbe, June

Transcription

1 Financial Reporting and Financial Stability Dushanbe, June Pascal Frèrejacque World Bank Centre for Financial Reporting Reform

2 Presentation outline» Causes of the crisis» Policy response» International» European» Consequences for financial reporting» Recent developments» Ongoing initiatives

3 The global financial crisis: A loss of trust Credit is trust: the credit crunch is a breakdown of trust» Trust between banks and households: the sub-prime crisis» Trust between banks: the seizing-up of inter-bank markets» Trust between banks and investors: collapse of bank equities» Trust between companies: cut-backs in trade credit» Trust between countries: reversal of cross-border flows» Trust between governments and accounting standard-setters

4 The simple logic No transparency, no trust; no trust, no credit; no credit, no investment; no investment, no growth! So there is a simple logic: financial reporting is an essential building block for financial intermediation, foreign investment, and sustainable economic development. Martin Gruell Raiffeisen International

5 Causes of the global financial crisis At the root of market failure was optimism bred by a long period of high growth, low real interest rates and volatility, and policy failures in:» Financial regulation, which was not equipped to see the risk concentrations and flawed incentives behind the financial innovation boom» Macroeconomic policies, which did not take into account the build-up of systemic risks in the financial system and the housing markets» The global financial architecture, where a fragmented surveillance system compounded the inability to see growing vulnerabilities and links Implications for financial reporting. Not the major cause, but clear room for improvement

6 Financial regulation Similar activities conducted by various types of institutions were regulated differently, even when in a single group and subject to the same regulator. The resulting opportunities for regulatory arbitrage fuelled the growth of the shadow banking system, resulting in excess leverage obscured by complexity.» Information gaps in data and the understanding of underlying risks» Procyclicality (prudential regulation, compensation, fair value accounting, provisioning)» Failures of market discipline, corporate governance, risk screening and due diligence (originate-and-distribute, CRAs, off-balance-sheet vehicles, etc. from an ownership society to a failed agency society)

7 Macroeconomic policies Macroeconomic and financial stability issues were generally treated separately, rather than taking an integrated macro-prudential approach, the former focused on preserving low and stable inflation as well as growth, the latter on firm-level supervision of the formal banking sector. Neither set of policymakers saw the wider implications of rising risks in the shadow financial sector; nor did they appreciate that economy-wide trends in credit growth, leverage and house prices posed systemically costly tail risks.» Central bank reliance on prudential regulation to control build-up of systemic risk» Financial reporting firm-level rather than systemically-focused

8 Global architecture This crisis was a story of fragmented surveillance in silos of expertise; of a policy debate dispersed in numerous fora (BIS, Gs, FSF, IMF); of limited collaboration among national financial regulators; of ad-hoc bilateral, regional, and multilateral facilities to address financing and liquidity needs; and of an overall failure to engage key decision-makers around the world.» Accounting and auditing standard-setters not sufficiently plugged-in

9 Proposed solutions (IMF, February 2009)» Addressing the procyclicality of existing capital requirements and other prudential norms, preferably in a manner that is rules based and counters the cycle» Filling the information gaps, especially with regard to lightly regulated financial institutions and off balance sheet transactions, ensuring that both supervisors and investors are provided more disclosure and a higher level of granularity in information provided

10 London G-20 Declaration (April 2009): Strengthening the Financial System» Accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of high-quality global accounting standards» Take action, once recovery is assured, to improve the quality, quantity, and international consistency of capital in the banking system. In future, regulation must prevent excessive leverage and require buffers of resources to be built up in good times

11 De Larosière Report (EU, February 2009)» A new regulatory agenda Reduce risk and improve risk management Improve systemic shock absorbers Weaken pro-cyclical amplifiers Strengthen transparency Get the incentives in financial markets right» Stronger coordinated supervision Macro-prudential and micro-prudential Build on existing structures Stronger, coordinated supervision for all financial sectors in the EU Equivalent standards for all, to preserve fair competition in the single market» Effective crisis management procedures Build confidence and trust among supervisors Agreed methods and criteria

12 De Larosière Report Recommendations» Reform of accounting rules and standard-setting processes» Fundamental review of Basel 2 rules» Common EU definition of regulatory capital» Develop a truly harmonized set of core rules for financial markets and stability in the EU

13 A new European Framework for Safeguarding Financial Stability» Address weaknesses both at the macro- and micro-prudential supervision levels by creating: a European Systemic Risk Board (ESRB) to monitor and assess risks to the stability of the financial system as a whole ("macro-prudential supervision"). The ESRB will provide early warning of systemic risks that may be building up and, where necessary, recommendations for action to deal with these risks. a European System of Financial Supervisors (ESFS) for the supervision of individual financial institutions ("micro-prudential supervision"), consisting of a network of national financial supervisors working in tandem with new European Supervisory Authorities, created by the transformation of existing Committees for the banking securities and insurance and occupational pensions sectors. There will be a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA), and a European Securities and Markets Authority (ESMA).

14 Financial reporting: Lessons learned from the crisis (1/2)» Market discipline didn t work» Serious questions about the agency model. Need to move to a fiduciary society?» Efficient market hypothesis -v- behavioral economics» Prudential supervision (micro and macro) has an indispensible role» Why should markets and regulators want different information? Who knows best?» Even if it didn t cause it, financial reporting facilitated procyclicality» Financial reporting is not neutral hard-wired into regulatory systems, contracts, incentives» Accounting and auditing are designed for stable systems - need to take better account of the business cycle, and to have circuit-breakers in times of severe stress» The current mixed-attribute model is not functional.» Risks not understood or reflected

15 Financial reporting: Lessons learned from the crisis (2/2)» Standard-setters underestimated their systemic role» Political frustration with the IASB» IAASB and IESBA not central» Where were the auditors?» Why did the audit function as designed make so little difference? Where s the value-added?» Can audit reporting be expanded beyond the micro only?» Should the profession not have spoken out more and earlier about the weaknesses in the accounting and auditing model?

16 Possible impacts on financial reporting (1/2)» Rebalancing the priorities of financial reporting» Treating financial institutions differently who are the real bearers of residual risk?» Are sector-specific issues for the banking sector adequately covered in general purpose standards?» Less emphasis on market discipline and neutrality more on prudential stability concerns and on the role of financial reporting in shaping behaviors (de jure and de facto)» Continuing the push to go beyond the single earnings figure things are more complicated» Consolidation, fair value, reserves and provisions, risk disclosures, goodwill, deferred tax, taking account of the macro

17 Possible impacts on financial reporting (2/2)» Continuing pressure for further reforms of the IASB» Greater integration with, and accountability to, the broader global system of financial regulation: traditional independence an unhelpful concept» Recognition of the prudential and other impacts of financial reporting» Where do we stand on convergence? Will the US proceed urgently with the SEC roadmap?» Trying to work out how the audit function fits in the new landscape» Beyond the pure financial statement audit» Can audit reporting be expanded beyond the micro only?» Expanded links between the auditor and prudential regulators» Better integration of the IFAC PIACs with, and accountability to, the broader global system of financial regulation building on the earlier IFAC reforms, Monitoring Group assessment

18 IASB challenges» SEC Roadmap and Convergence Project uncertain. IFRS and US GAAP to co-exist indefinitely?» Governance reforms ongoing. More fundamental changes may be needed» Changes to fair value standards under severe political pressure and abbreviated due process» Further work underway to revamp approach to fair value, with very tight deadlines» New balance between fair value and amortized cost? Treatment of unrealized fair value gains?» Expected losses across the business cycle?» Is there sufficient time to resolve divergences between different stakeholders? What about the FASB?» How far can one go in aligning prudential considerations with the market discipline role of general purpose financial reporting?» Will the EU be satisfied? Risk of further carve-outs/ins? IFRS 9» IFRS for SMEs just issued, but likely take-up uncertain» Traditional IFRS for only non-financial PIEs?

19 IAASB challenges» ISA Clarity Project completed» EU endorsement likely. Consultations underway» Future focus on implementation» But does the audit model need to change? Scope of audit; audit reporting and communications?» Significant reduction in scope of application of statutory audit under consideration for the EU

20 Basel Committee Guiding Principles (August 2009) How to implement the G20 recommendations» Reflect the need for earlier recognition of loan losses to ensure robust provisions» Recognise that fair value is not effective when markets become dislocated or are illiquid» Permit reclassifications from the fair value to the amortised cost category; which should be allowed in rare circumstances following the occurrence of events having clearly led to a change in the business model» Promote a level playing field across jurisdictions

21 FSB Report to G-20: Policy measures for improving financial regulation (Sept. 2009) 33. We strongly encourage the IASB and FASB to agree on improved converged standards that will: incorporate a broader range of available credit information than existing provisioning requirements, so as to recognise credit losses in loan portfolios at an earlier stage as part of an effort to mitigate procyclicality. We are particularly supportive of continued work on impairment standards based on an expected loss model; and simplify and improve the accounting principles for financial instruments and their valuation. We are particularly supportive of continued work in a manner that does not expand the use of fair value in relation to the lending activities (involving loans and investments in debt instruments) of financial intermediaries. 34. While respecting the independence of accounting standard setters, the FSB is urging renewed efforts by the IASB and FASB to achieve these objectives, working with supervisors, regulators and other constituents. The Basel Committee has issued for consideration by accounting standard setters principles for the revision of accounting standards for financial instruments, agreed by all G20 banking supervisors, that address issues related to provisioning, fair value measurement and related disclosures.

22 G-20 Summit Pittsburgh (September 2009) Strengthening the International Financial Regulatory System 14. We call on our international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process, and complete their convergence project by June The International Accounting Standards Board s (IASB) institutional framework should further enhance the involvement of various stakeholders.

23 IASB (November 2009) IFRS 9: Financial Instruments (Phase 1: Classification and measurement)» European Commission will not proceed to EU endorsement at this time» Phase 2: Impairment methodology ED published in November 2009» Phase 3: Hedge accounting ED expected in first quarter of 2010

24 Financial Stability Board (January 2010) Strengthening accounting standards As requested by the G20 Leaders, the FSB continues to monitor progress in implementing G20 and FSB recommendations for improved, converged accounting standards. FSB members welcomed the IASB s plan to continue its enhanced technical dialogue with prudential authorities and market regulators on financial institution reporting issues, and to conclude its full review of the financial instruments standard by the end of this year.

25 Central Bank Governors / Heads of Supervision (January 2010) Provisioning It is essential that accounting standards setters and supervisors develop a truly robust provisioning approach based on expected losses (EL)» Address the deficiencies of the incurred loss approach without introducing an expansion of fair value accounting» Promote adequate and more forward looking provisioning through early identification and recognition of credit losses in a consistent and robust manner» Address concerns about procyclicality under the current incurred loss provisioning model» Incorporate a broader range of credit information, both quantitative and qualitative» Draw from banks' risk management and capital adequacy systems» Be transparent and subject to appropriate internal and external validation by auditors, supervisors and other constituents So-called "through-the-cycle" approaches that are consistent with these principles and which promote the build up of provisions when credit exposures are taken on in good times that can be used in a downturn would be recognised. The Basel Committee should translate these principles into a practical proposal by its March 2010 meeting for subsequent consideration by both supervisors and accounting standards setters.

26 Adair Turner (UK FSA) - London (January 2010) Banks are different: should accounting reflect that fact? Banks are different because they matter more, because they can do more harm. That s why we regulate and supervise their businesses but don t regulate the businesses of retailers or hoteliers or manufacturers. That s why there is a special relationship with central banks as lender of last resort. That s why we worry a lot about banks which are too-big-to-fail. And that s why prudential regulators, central banks and economic policymakers have a vital interest in the decisions of accounting standard setters in relation to bank accounting standards, which does not apply between regulators and accounting bodies in any other sector of the economy.

27 President Sarkozy Davos (January 2010) The G20 foreshadows the planetary governance of the 21st century. It symbolises the return of politics whose legitimacy was denied by unregulated globalisation. Without the G20, it would not have been possible to envisage regulating bonuses, closing down tax havens and changing the rules of accounting and prudential standards. And how can we hope that people will continue to trust the word of States if the commitments made are not kept? If the absolutely crucial debate on accounting standards gets bogged down, if the private agencies to which we have delegated regulatory power deliberately flout the mandate given them by Heads of State and government, and we let them get away with it, what will be left of the credibility of the G20 and the prospect of world governance?

28 Unresolved issues» Extent of convergence with regulatory concerns» Scope of application of fair value» Treatment of fair value adjustments» Implementation details of a more prudent approach to loan loss provisioning» From incurred loss to expected loss, but» Through the cycle how long is the cycle?» Impairment calculation on a loan-by-loan or (sub)portfolio basis?» Macro-economic outlook to be based on management assumptions or informed by regulators?» Challenges for multi-country financial institutions» Regulatory statement as a new component of financial statements» Role of the auditor

29 The simple logic No transparency, no trust; no trust, no credit; no credit, no investment; no investment, no growth! So there is a simple logic: financial reporting is an essential building block for financial intermediation, foreign investment, and sustainable economic development. Martin Gruell Raiffeisen International

30 Financial reporting A fundamental foundation Tax Administration Corporate Governance Banking Supervision Insurance Supervision Securities Regulation Accounting & Auditing

31 Importance of high quality financial reporting ECONOMIC GROWTH Job Creation Development of Capital Markets Improved Access to Credit Private Sector Growth Accounting and Auditing Financial Sector Development Financial Stability Financial Information

32 Importance of the financial reporting infrastructure, not just accounting and auditing standards Accounting Standards Statutory & Governance Framework Monitoring & Enforcement Education & Training Accounting Profession & Ethics Auditing Standards

33 All supporting pillars need to be strengthened Accounting Standards Statutory & Governance Framework Monitoring & Enforcement Education & Training Accounting Profession & Ethics Auditing Standards

34 Concluding Remarks

35