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39 Steps: Behind the Curtain Bankers recently criticised accounting rules, blaming them for deepening the financial crisis. Can an accounting standard be responsible for a credit crisis? How can the IASB respond to this situation? The CESR has its own view on these IFRS issues based on research amongst top European companies.

39 Steps: Behind the Curtain

by Francois Masquelier, Head of Treasury, Corporate Finance and ERM, RTL Group, and Honorary Chairman, EACT

Bankers recently criticised accounting rules, blaming them for deepening the financial crisis. Can an accounting standard be responsible for a credit crisis? How can the IASB respond to this situation? The CESR has its own view on these IFRS issues based on research amongst top European companies.

Bankers call for review of financial rules

In January 2009, the Chairman of HSBC, Stephen Green said that the current financial rules must be “fundamentally revised”, as they had deepened the financial crisis. He continues that the capital adequacy regulations and fair value accounting were “well intentioned” but had proved to be inadequate. Some even said that these rules encourage banks to build up their capital instead of lending money to their customers. He thinks, as many fellow bankers do, that “Fair value accounting has added considerable volatility to results, only part of which is economic…” Many bankers have said that that financial rules have worsened the crisis by using fair value accounting to determine the value of assets whose market price cannot be determined.

Logically, the accounting translation of a financial instrument should not be responsible for its quality and current valuation.

Although this position is understandable, it is too easy to blame an accounting rule when bankers may also have manipulated instruments they did not understand, and did not fully assess risks and potential volatility.

Christopher Cox, Chairman of the SEC at the time, (Dec 2008), said accounting rules must be neutral. He explained, “Accounting rules should not be bent to help soothe the battered US economy. Accounting rules must be neutral and aren’t just another financial rudder to be pulled when the economy ship drifts in the wrong direction”. He added that they are “the rivets in the hull and you risk the integrity of the entire economy by removing them”. Mr. Cox indicated that constructive revisions could be made to improve a rule that the banking industry had been pressing to be suspended in the crisis. An SEC study has found that most investors agree the rules provide a meaningful way to measure assets. He concluded by saying that, the more serious the stresses on the market, the more important it is to maintain investor confidence with neutral, independent accounting standards”. The standard setters must endeavour to continue developing robust best practice guidance for auditors and preparers – particularly for fair value measurements of securities traded in inactive markets.

How could an accounting standard setter respond to a credit crisis?

This is a very complex question. Accounting rules are formal ways to translate financial operations. It is a sort of blood test. However, although a blood test is not the cause of a disease, some consider that IAS rules were somehow responsible for the crisis, or at least have not helped to maintain financial stability. Following these criticisms, demands from the European Union (EU) and stakeholder pressures, the IASB decided to react.

A the end of 2008, the IASB decided to provide the EU with an update of its response to the credit crisis, and how they planned to address the various issues raised. The IASB wanted to take a number of significant steps to improve accounting guidance based on the FSF (Financial Stability Forum). One of the main issues was the fair value measurement when markets are no longer active. Logically, the accounting translation of a financial instrument should not be responsible for its quality and current valuation. However, during an economic crisis, people feared it could drive further market deterioration. The first answer from the IASB was to organise roundtables with experts to address the issues which had arisen (1)1. Both international accounting boards (IASB & FASB) were committed to urgently respond to this unprecedented situation facing financial markets.

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