IFRS Foundation Trustees evening event 23 January 2013 Keynote speech by Arthur Yuen, Deputy Chief Executive of Hong Kong Monetary Authority The importance of international financial reporting standards in promoting a healthy economic environment Overview As an international financial centre, Hong Kong is supportive of a common financial reporting framework at the global level that sets minimum standards for the quality of information provided in a financial report by a company. High quality or true and fair financial information and risk disclosure are essential for a market-based economy, as investors rely on such information as the basis for making decisions about providing resources to a company. As part of the lessons learned from the global financial crisis, transparent, unbiased and relevant financial reporting can help promote financial market stability. While international financial reporting standards (IFRSs) are indeed an essential tool for promoting market transparency and stability, efforts beyond that of accounting standardsetters such as those of the accounting profession, listed corporations and financial reporting/audit regulators, are needed to continuously implement and enforce these standards so as to achieve the overall objective of promoting a healthy economic environment in a sustainable manner. Tonight we have representatives from various organisations and regulatory bodies, including financial institutions and listed corporations as reporting entities, accountants and auditors who prepare and audit financial statements respectively, accounting standardsetters from the IASB and HKICPA, the financial reporting regulator from the Hong Kong FRC, and financial regulators from the HKMA, SFC as well as representatives from the HKEx. I hope my thoughts on this topic will help provoke a robust panel discussion. Benefits of a global financial reporting framework The need for a single set of global financial reporting/accounting standards is driven by various factors. First, investors seek diversification and investment opportunities on a global basis nowadays. Standardising financial reporting standards at the global level can help provide investors with more comparable financial information across institutions and jurisdictions. Second, multinational corporations favour using the same set of accounting rules to account for their international activities to reduce the costs of preparing financial statements. Third, with increasing globalisation of financial markets, prudential regulators are supportive of a single set of high quality global accounting standards to allow for a level playing field of financial reporting by financial institutions operating in different jurisdictions. Following the global financial crisis, the G20 has repeatedly called for a joint effort from the IASB and FASB to develop improved and converged accounting standards. In a nutshell, a single set of global financial reporting standards allows a common language to be used for financial reporting and hence allows users of financial statements to make comparisons across institutions and entities operating in multiple jurisdictions. 1
Hong Kong as an international financial centre sees the benefits of using a single financial reporting language. Like many countries in Europe, Hong Kong Financial Reporting Standards (HKFRSs) have been fully converged with IFRSs from as early as 1 January 2005. To date, over 100 countries have adopted IFRSs. Companies incorporated in Hong Kong are currently required under the Companies Ordinance to comply with HKFRSs in preparing their financial statements. Given the objective of financial reporting is to provide financial information about a particular reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity, IFRSs as an essential tool for achieving this objective have an important role to play in this regard. Ongoing enhancement and review of IFRSs is needed to ensure financial information and risk disclosures presented in financial reports remain of high quality or true and fair as the information needs of financial markets evolve over time. Recent examples of this work include enhancing: i) Fair value measurement by providing additional guidance on the accounting treatment of financial instruments traded in inactive/illiquid markets, including better disclosure about measurement uncertainty for instruments measured at fair value, and by improving the accounting treatment of own debt when there is a downgrade in own credit ratings so that no gain in earnings is recognised. All these improvements to the implementation of fair value accounting will bring about greater transparency and help prevent artificial accounting volatility in an entity s profit or loss account, notably in the case of financial institutions; and ii) Transparency about risks and leverage such as tightening up of conditions for offbalance sheet financing so that reporting entities are unable to mask the true extent of their leverage. These include improving consolidation requirements to prevent undesirable offbalance sheet financing, and bringing certain off-balance sheet transactions back onto the balance sheet (e.g. leases) in order to show the true leverage of a reporting entity. These were all lessons learned from the global financial crisis in respect of financial reporting. Other similar work in train includes enhancing loan loss provisioning by moving to a more forward-looking expected loss approach from the existing incurred loss model. Accounting for impairment of financial assets is a topic of significant importance for the global financial markets at large and for banks and banking regulators in particular. The Basel Committee has a strong interest in this topic and has been actively providing direct inputs to the accounting standard-setters. Further, given IFRSs are principles-based standards that allow for flexibility in applying the standards to reporting entities with different business models, this means that accountants and auditors need to exercise professional judgment in implementing the standards. We consider consistent application of IFRSs is important to facilitate international comparisons of financial information. Accordingly, we appreciate the IFRS Interpretation Committee's continuing efforts in reviewing issues where diverging interpretations have developed with a view to reaching a consensus on the appropriate treatment. 2
In this context, high quality IFRSs can help enhance financial reporting and risk disclosure practices by financial firms and other companies, which in turn can lead to greater transparency and help promote financial market stability. Efforts required beyond accounting standard-setters While IFRSs can help raise the financial reporting bar internationally, the efforts of other parties beyond those of the accounting standard-setters are needed in order to ensure that the standards are implemented to their fullest extent as intended. These include: a) Accountants and auditors The accounting profession most obviously has a key role to play in financial reporting. As preparers of financial statements, the professional competency of accountants is of utmost importance in respect of financial reporting. Auditors need to assess whether the financial information and risk disclosures presented in financial reports represent a true and fair view. The key challenge is what degree of assurance auditors should provide about the quality of risk disclosures, including those in the financial statements, and management s discussion and analysis sections of financial reports. To what extent, and in what ways, should auditors review or audit the accuracy and reliability of the financial reports that they examine, and how do they report on their assessments and findings to users of financial reports? Many of these assessments will inevitably require exercise of professional judgement and, in some cases, information included in financial reports may not be auditable at all. It is therefore essential that auditors exercise sufficient professional scepticism in auditing financial statements and other relevant information contained in financial reports. b) Reporting entities For reporting entities, corporate governance and management mentality in financial reporting is of significant relevance. The management of reporting entities has primary responsibility for formulating appropriate accounting/financial reporting policies for their entities and ensuring that the financial information presented in the financial statements is true and fair. Neither accountants nor auditors can relieve management of their responsibilities in financial reporting. Audit committees also have a key role to play in financial reporting in the case of listed companies. As banks play a central role in providing financial resources to the economy, prudential regulators are primarily concerned with maintaining the stability of the banking system and fostering the safety and soundness of individual banks so as to maintain market confidence and protect depositors interests. Financial reporting and risk disclosures therefore are of particular relevance to banks. One of the Basel Core Principles for Effective Banking Supervision addresses the particular aspect of financial reporting and external audit for banks. Principle 27 requires banks and banking groups to maintain adequate and reliable records, prepare financial statements in accordance with internationally-accepted accounting standards and practices, and annually publish information that fairly reflects their financial condition and 3
performance and bears an independent external auditor s opinion. It also requires banks and parent companies of banking groups to have adequate governance and oversight of the external audit function. In its October 2010 Principles for Enhancing Corporate Governance, the Basel Committee recommends that large and internationally active banks should have an audit committee and outlines the overall responsibilities of the audit committee. Among its other responsibilities, a bank s audit committee is charged with an oversight responsibility of the effectiveness of the bank s external audit process and in this regard, plays a key role in ensuring a high quality audit of the bank s financial statements. To improve the quality, comparability and timeliness of risk disclosures by banks, a private sector Enhanced Disclosure Task Force (EDTF) was formed in May last year at the initiative of the Financial Stability Board (FSB), bringing together senior officials from the banking sector, investors, analysts, rating agencies and audit firms, to develop principles and recommendations for enhancing ongoing risk disclosure practices by major banks, in consultation with international standard-setting bodies and prudential regulators. The EDTF s principles and recommendations for improved bank risk disclosures practices, as set out in its October 2012 report on Enhancing the Risk Disclosures of Banks, are designed to provide timely and useful information for investors and other users about the banks risk exposures and risk management practices as market conditions and risk profiles change. These measures to strengthen the transparency of financial institutions will contribute to improved market confidence in financial institutions and financial market functioning over time. Nonetheless, the key challenge of banks risk disclosures is to keep risk information up-to-date and relevant, given market conditions are changing rapidly and the financial system is always evolving. c) Investors As primary users of financial statements, investors can help provide useful feedback on whether the financial and risk information presented in financial reports meets their information needs. As demonstrated in the global financial crisis and the European sovereign debt crisis, due to the lack of sufficient information to inform their risk assessments, funds providers have pulled back from the financial markets, leading to a withdrawal of market liquidity, increased funding pressures and falling asset prices. This has the effect of putting greater pressure on financial institutions to be as accurate and transparent as possible about the nature and extent of the risk exposures they face. In this context, this suggests that investors have a key role to play in reinforcing market discipline. This check and balance performed by investors is an important complement to the financial reporting and risk disclosure regulations. d) Financial reporting/audit regulator Financial reporting/audit regulator performs a key role in reviewing whether listed companies and their accountants and auditors comply with relevant financial reporting/accounting standards in producing their financial reports. In Hong Kong, the Financial Reporting Council (FRC) currently performs this role though it is not an audit regulator per se compared to its overseas counterparts such as the UK FRC. The role of the FRC is to conduct independent investigations into possible auditing and reporting irregularities in relation to listed entities and to enquire into possible instances of non- 4
compliance with accounting requirements on the part of listed entities. Any auditing or reporting irregularities identified by the FRC will be referred to the HKICPA for follow-up action. Any non-compliance relevant to the Listing Rules will be referred to the SFC or HKEx for follow-up action. e) Accounting profession regulator To ensure HKFRSs are properly implemented, the HKICPA performs two key roles in this respect by: (1) putting in place an effective licensing regime to ensure competency of accountants and auditors in performing their respective tasks in financial reporting; and (2) undertaking disciplinary actions for non-compliance with HKFRSs and professional misconduct. f) Financial regulators Last but not least, as mentioned earlier the regulatory community has a direct interest in promoting financial stability through increased transparency. This includes the Basel Committee s work on Pillar 3 disclosures for banks. Following the global financial crisis, the Basel Committee has introduced new Basel III disclosure requirements for banks on regulatory capital to help promote greater transparency and enhance comparability of disclosure between banks and across jurisdictions. Aside from promoting market discipline, financial regulators may also need to step in and take appropriate action as required if regulated entities are not in compliance with relevant financial reporting and risk disclosure requirements. Conclusion As an international financial centre, we are supportive of a single financial reporting framework at the global level for the various reasons and benefits mentioned earlier. I hope IASB and FASB can continue their joint efforts to converge their financial reporting/accounting standards as far as possible. Nonetheless, it should be noted that IFRSs alone cannot achieve the objective of promoting a healthy economic environment in a sustainable way in the absence of ongoing efforts required of other relevant parties to enhance, implement and enforce these standards. Sure we will have a robust discussion on this topic tonight. Thank you. 5