Taken from RSM Reporting - November 2016

by Marco Mongiello

Developments in international accounting and reporting are driven by changes in business models and technological innovations, as well as being influenced by macro-economic events and political decisions. This is what keeps our profession relevant and effective at fulfilling its purpose of providing decision makers with reliable information, on which they may base their decision-making processes.

It is therefore important that we endeavour to obtain an insight into the effects of major political decisions, such as Brexit, which may change the regulatory and economic landscapes of large jurisdictions as we know them.
We are interested in understanding if and how Brexit may affect the way accounting and reporting are regulated, endorsed and developed in Europe. For this reason, I approached the person who occupies the most advantaged observation point with regard to accounting and reporting in Europe: Mark Vaessen, EFRAG board member and chairman of the Corporate Reporting Policy Group at the Federation of European Accountants (FEE). FEE, by its own account, represents 50 institutes of professional accountants and auditors from 37 European countries, including all of the 28 EU Member States. 

With regard to the possible effects of Brexit on international accounting and reporting, Mark Vaessen explains that “it is very early days”.

MV: There is still a lot of uncertainty about what relationship the UK will have with the EU once it leaves, and if it leaves. However, assuming that the UK will leave the EU, the IAS regulation will continue to be applicable to the UK for quite a while, as during the time when the negotiations will take place, the UK will still be a member of the EU. Therefore, nothing will happen for probably three years, allowing for two years to negotiate the exit as the maximum upon triggering Article 50(1), which could happen in 2017 or later(2).

The date for official notification by the UK of triggering Article 50 may be impacted by the timing of the general elections in France and Germany.For the longer term scenarios, one possibility is that the UK will still be part of the EU market, hence continuing to adopt the IAS regulation, including the endorsement process. This scenario is what I would call the Norwegian model(3).

However, from my perspective, the more likely scenario is that the UK will no longer be under the IAS regulation and will have to determine for itself what it wants to do with the IFRS. When considering this scenario, you should look at the investment that the UK has made with respect to IFRS over several decades. The UK was quite instrumental in getting the IASB acknowledged and was also strongly supportive in making sure that we, in Europe, got IFRS at a time when the risk was emerging of many companies moving over to US GAAP.

In Europe, we had to come up with a plan to have standards that reflected the European tradition, and still would be harmonised and serve the international capital market. The UK, at that time, was a big supporter of IFRS. The UK had valuable standard-setting experience at the time in developing UK GAAP but it realised that ultimately its principles-based approach to standards would have lost out to US GAAP if it did not put its weight fully behind the International Accounting Standards. With that history in mind, I would say that, even if the UK will no longer be bound by the IAS regulation, it will continue to be a strong supporter of the global standards, as it has always been. In addition, it will want to keep the UK markets attractive for global companies. Therefore, I have no reason to believe that the support will diminish. Rather, for the foreseeable future, accountants need more and more high-order skills in data-mining and analyses and in making judgements and estimates.

MM: Might EFRAG, FEE and the EU’s clout in the global accounting scene be weakened as a consequence of representing a smaller economy?

MV: Personally, I think that the change [brought by Brexit] will be neutral. You raise a legitimate question, though, because the UK provides large parts of the capital market and liquidity in Europe, so taking that out of the endorsement could make Europe have a weaker negotiating position. On the other hand, the market in the rest of Europe will still be large, and efforts are being made to stimulate the capital markets in the EU outside of London. On balance, I do not think that the impact and the power that Europe has on the IASB will diminish. I also do not think that the UK’s impact on the IASB will be diminished by stepping out of bodies like EFRAG. There is an argument that because the UK will be able to speak directly to the IASB, its voice will be less filtered; having the direct contact with the IASB may actually increase the UK’s voice. My opinion, though, is that the effect will overall be neutral.

MM: This applies to IFRS, but what about IFRS for SMEs? Their adoption seems to be getting some momentum around the world, but not in Europe. Will Brexit give their adoption a boost?

MV: If you look at the status now, IFRS for SMEs are not widely used in Europe. They have influenced national standards of a few EU countries, the UK included, but no country has taken the IFRS for SMEs as they are. The European Commission is currently looking at whether we need separate standards for companies that are listed on smaller markets. There is a question as to whether IFRS for SMEs are the right standards for this purpose, because they are not written for publicly owned companies; they are written for privately owned companies. The [European] Commission is liaising with the IASB to see whether there are alternatives to IFRS for SME for smaller listed companies, for example [to apply IFRS with reduced] disclosure requirements for those companies. In the meantime, the IASB is also working more generally on the Disclosure Initiative and it is looking at what it calls ‘Principles of Disclosure’. This may be promising, because I believe that if you define the right principles, you will end up with less complex accounting and reporting, and in that way, smaller listed companies could still use full IFRS, but then with reduced disclosures.

So, IFRS for SMEs is still a discussion to be had in Europe and I cannot see that Brexit changes the dynamics of that discussion. The reason why countries have not adopted IFRS for SMEs is because they have their own GAAPs, which often are very closely linked with national taxation, capital maintenance and distribution requirements. If you take countries like France or Germany, these are issues that are so close to the national interest that these countries are reluctant to hand them over to an international standard setter independently of Brexit or not.

The UK has a successful AIM(4), where a lot of smaller companies are seeking equity funding, listing on the basis of IFRS. Most of the other countries in Europe do not have an equivalent of the AIM, but the capital markets in the EU are trying to promote the establishment of similar stock exchanges. Therefore, I think that the discussion on IFRS for SMEs will focus, for the first instance, on that part of the SMEs market.

In summary, I would be really surprised if Brexit caused a lot of changes in the developments of accounting and reporting. I predict that there will be some continued discussions in Europe on whether we should bring on European standards, but I would say that if you look at the consultation on the IAS regulation that the [European] Commission carried out in 2014, there was a groundswell support for global standards – people say that it has achieved great benefits – and generally, there was no support for European standards. After Brexit, the voice supporting European standards may be a bit louder, but generally the mood is that this is not in the interest of the many European companies acting on the global stage, and therefore is unlikely to prevail.

MM: On the other hand, change in accounting and reporting is on the horizon, as acknowledged in the Future of Corporate Reporting Cogito Paper, which FEE published in 2015. Can we expect IFRS to evolve in the direction of allowing for more effective metrics to evaluate companies’ performance, particularly in situations where profit and cash flows seem to fail to capture the companies’ value and value creation? How will these developments pan out in a post-Brexit context?

MV: This is an excellent point. We [at FEE] have some work to do as a follow-up on the paper on the future of corporate reporting. We have to make clear that when we talk about non-financial information, we are not talking only about ESG(5). ESG are important, and there are elements of ESG that are more important for some companies than others, e.g. environmental indicators are more important for an oil company than for a professional service company, because environmental performance is not value driving in a service company, but clearly it is in an oil company. However, performance is broader than ESG. We have to take into account operating performance metrics, which are leading indicators for future value creation. They may be customer satisfaction scores, employee loyalty, creation of intellectual capital, the number of trademarks registered, or whatever the measure is that ultimately reflects the company’s longer term success.

At the moment, for reporting these aspects of a company’s performance, we rely very much on the front end of the annual report, where we have a lot of liberty but not a lot of discipline. Most KPIs are not comparable and, although analysts will try all sorts of ways to bring in comparability, there is no real structure. You need to have a framework that instils a certain level of quality and discipline in reporting these KPIs; this is the direction we ought to go. For example, the economic performance of Tesla(6) is determined by the success of whatever engine, battery or technology is Tesla’s long-term value driver. However, a lot of the information about these value drivers is in the front end of the company’s corporate report and comes from systems that are not at the same level in terms of quality as the systems that produce financial information. The internal control over those systems are nowhere near to what companies have in place for financial reporting. We [at FEE] are looking at making them more ‘investment grade’, by bringing more discipline around them. Part of this is in the discussion of the ‘Core&More’ in the FEE report.

Integrated Reporting (<IR>) is consistent with this view(7); its principles recommend to report what is really crucial to your value creation, what the company’s management board monitors very closely in order to know if the business is doing well or not. You then have to take those metrics and report on those consistently, and not change the metrics when they would show you in a negative light, providing more consistency and comparability over time. I think, in the same way, you have to report on what is really crucial for your company and hold yourself accountable against those KPIs.

On this topic, the discussion we are having with the IASB includes the question of whether we should take on a project on intangibles. The reason for questioning this is that we will never be able to remove the difference between market capitalisation and book value of assets on the balance sheet, because they are influenced by so many other factors. So, we just need to be better at reporting those other factors that make up the difference.

If I look around the world, I see that in many ways the UK has taken a leading role in trying to make improvements to reporting after the financial crisis, by recognising and addressing a number of weaknesses. The UK is not there either, but I think that it has taken important steps making some corporate governance changes, e.g. the work on the strategic report, requiring boards to declare that this report is ‘fair, balanced and understandable’, and also the focus on  ‘clear and concise’ reporting. These initiatives together have already moved the pendulum quite a bit. 

We should now be looking at an international level and consider what we can learn from the UK experience and whether we can replicate it. I think that the UK will continue to be an important player in the discussion around reporting, in being at the forefront of those developments. The UK is an environment where people are open to change and to development in corporate governance and reporting. For example, the Financial Reporting Lab(8); can we replicate it internationally? What are the means needed to be able to do the same at an international level? These are follow-up discussions that we are going to have on the FEE paper.

Moving the corporate reporting agenda forward at international level needs cooperation, and ownership of this ‘agenda for change’, including by the IASB and security regulators. [Brexit or not], the UK will have an important role in this process.

MM: I am grateful, on behalf of our readers, that Mark Vaessen agreed to share his views with us as there is nothing more valuable than a reassuring expert voice in periods of rapid change and uncertainty.

(1)  Editor’s note: Article 50 of the Lisbon Treaty (www.lisbon-treaty.org) stipulates that any Member State of the European Union may decide to withdraw from the Union by providing formal notification of its intention. It also stipulates that the Treaty will cease to apply to that Member State within two years of the notification.
(2) Editor’s note: since the interview took place, the UK prime minister indicated that the UK will trigger Article 50, i.e. will give notification of its intention to withdraw from the European Union, in the first quarter of 2017.
(3) Editor’s note: Mark Vaessen refers to the bundle of bilateral agreements that define the economic and political relationship between Norway and the European Union, whereby Norway, albeit not a Member State of the European Union, enjoys a status that is in many respects similar to that of a Member State.
(4) Editor’s note: AIM, or Alternative Investment Market, is the London Stock Exchange’s international market for smaller growing companies.
(5) Editor’s note: ESG stands for Environmental, Social and Governance key performance indicators. The CFA Institute provides an effective overview of this concept here.
(6) Editor’s note: Tesla is a highly innovative car manufacturer which has introduced significant technological advancements in electric cars.
(7)See this newsletter Issue 27 – May 2016 and Issue 23 – May 2015
(8) See issue 12 – June 2012