ASEM IFRS Seminar Implementation of IFRS A World

ASEM IFRS Seminar Implementation of IFRS – A World Bank Perspective Shanghai, 25 -26 March 2006 John Hegarty Manager, Financial Management Europe and Central Asia Region THE WORLD BANK

Introduction The World Bank – Our Role Making the link between financial reporting and poverty reduction Advocate for improved standards and compliance Contributor to the policy formulation process Assessor Advisor Financier Fiduciary reliance on external audit / use of accountants and auditors to support Bank operations …but not a standard-setter or regulator

Background: The Need for a Strengthened International Financial Architecture 1990 s – Emerging Market Crises and contagion effects Philippines Malaysia East Asia (Thailand) Hong Kong Indonesia Taiwan South Korea

Background: The Need for a Strengthened International Financial Architecture Shift from ex-post crisis resolution Ex-ante crisis prevention

Background: Origins of the ROSC program The G-22 Reports: focus on crisis prevention - Transparency and Accountability (Led to ROSC program) - Strengthening National Financial Systems - Government guarantees to the private sector

Introduction Accounting and Auditing: A fundamental pillar Insolvency & Creditor Rights Corporate Governance Insurance Supervision Banking Supervision Securities Regulation Accounting & Auditing

Introduction Importance of High Quality Accounting and Auditing ECONOMIC GROWTH Job Creation Private Sector Growth Development of Capital Markets Accounting and Auditing Improved Access to Credit Financial Sector Development Financial Information Financial Stability

Introduction Economic Goals Promote: - Development of capital markets - Access to credit, particularly for SMEs - Development of the private sector - Evaluate corporate prospects, make informed investment and voting decisions - Assess management performance, thus influencing its behavior Avoid:

Accounting and Auditing ROSC Program Economic Context Legal & Institutional Framework Accounting in Practice Auditing in Practice FINDINGS Perceptions Factual Assessment A&A ROSC: Assessing the Quality of the A&A Framework Recommendations

A&A ROSC: Global Coverage

A&A ROSC: Europe and Central Asia

Accounting and Auditing ROSC Program A&A ROSC: Assessing the Quality of the A&A Framework Benchmarks: International Financial Reporting Standards Acquis communautaire International Standards on Auditing Good international practice

The Lessons Learned What does it mean to “adopt international standards”? Introduction of “modern” accounting and auditing practices One-off “transformations” of financial statements prepared using national standards Development of national standards “based on” (a selected subset of) IFRS/IAS and ISA One-time-only adoption of international standards with no, or poor, subsequent updating Program of “convergence” between national and international standards over time Underestimation of practical implementation challenges IASB and IFAC promotional material not always helpful Doesn’t compliance mean “all or nothing”?

The Lessons Learned Mechanisms to grant national authority to international standards Without force of law/regulation, “international” standards become “offshore” standards Constraints on granting national public authority to international private standards Backing for the standard-setting process or for individual standards, keeping up to date Translation, copyright/royalties, gazetting Role of legislation -v- standards Company law or securities regulation as the legal basis for accounting and auditing requirements Example of EU IAS Regulation / endorsement mechanism

The Lessons Learned Linkages between general purpose and regulatory reporting Policy objectives of international standards and national regulatory reporting regimes not always aligned Regulatory reporting includes that for taxation and company law purposes Risk of conflicts when international standards adopted through regulatory reporting mechanisms However, specialist regulatory bodies can play a major and positive role in oversight/monitoring/enforcement Avoid completely parallel systems, encourage adoption of a common general purpose reporting platform, keep reconciling items to a minimum, and harness the oversight/monitoring/enforcement capacity of regulators Is the IASB sufficiently attentive to regulatory concerns?

Accounting Regulation - International Dimension IAS/IFRS: Current Challenges (1/2) Guiding principles - Independent standard Prioritization Relevance & reliability Convergence setting - Principle based standards - Thorough due process Resource constraints Existing guidance Quality What is convergence? - Old approach was “harmonization” - National standard-setters work with the IASB - Convergence with the FASB

Accounting Regulation - International Dimension IAS/IFRS: Current Challenges (2/2) Barriers on the road to harmony: serious issues or “teething problem? ” Accounting agenda driven by the U. S. model (accounting framework)? U. S. : Financial statements present “value” information for the market Europe/U. K. : Reporting on stewardship by directors is an important aspect Fair value potentially misleading (e. g. , UPM Kymmene)? Pine and spruce assets to be fair valued using a discounted cash flow methodology with assumptions stretched over the 70 -year life of a tree. Fair value discretion and variation (subjective modelling)? Clarity of communication lost in complexity? The other side of the coin… Trillions of dollars of unaccounted for derivatives now on the books Pension deficits once buried in the footnotes now on the books Share-based compensation not previously recognized as a cost… Stop “games” on provisioning (e. g. , on acquisitions and big-bath provisions)

The Lessons Learned Scope of application of international standards Severe risks to the culture of compliance when the scope of application is inappropriate IFRS/IAS not suitable for use by all enterprises Widespread general purpose reporting obligations for enterprises other than “public interest entities” Managing the “Big GAAP / Little GAAP” distinction Future of (“Little GAAP Only”) national standard setters ISAs suitable for all audits Risks of an excessively broad statutory audit requirement Addressing gaps/weaknesses in international standards Principles-based standards -v- rules-based enforcement

The Lessons Learned The enabling environment Market demand for international standards The role of disclosure in governance and regulatory regimes Public access to audited financial statements Patterns of financial intermediation and enterprise ownership Significance of foreign direct and foreign portfolio investment The political economy costs and benefits of transparency Capacity to comply Education, training and experience Reaching a critical mass of demand for relevant skills Financial sustainability of capacity development mechanisms Leveraging resources on an international scale

The Lessons Learned Oversight, monitoring, enforcement The inability of third party users to observe compliance Reliance on reputational agents; limits of self-regulation Determining role of oversight/monitoring/regulatory bodies Absence of agreed international best practice models Lack of appropriate mandates, resources, methodologies Lack of leverage when specialist regulators are not concerned with general purpose financial reporting Principles-based standards -v- rules-based enforcement Problems of regulatory capture, effectiveness of judicial systems, macro-governance International audit firm networks do not deliver consistently high quality internationally, and thus cannot be relied upon to compensate for weaknesses in national regulatory regimes

The Lessons Learned Filling the regulatory gap The need for international consensus on a comprehensive framework of principles for the regulation of accounting and auditing IFRS/IAS and ISA are not a complete framework Making explicit the implicit assumptions about legal, institutional and policy preconditions which underlie international standards Enhancing cooperation and consistency between regulators, both nationally and across borders National/regional models are not necessarily replicable internationally Building on the linkages with other standards and codes Trade and competition policy considerations Global monitoring of progress

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

Financial Reporting Infrastructure All supporting pillars need to be strengthened Accounting Standards Statutory Framework Monitoring & Enforcement Education & Training Accounting Profession & Ethics Auditing Standards

From ROSC to Reform From Diagnostic to Reform Country Strategy and Action Plan (CAP) Country Action Plan Support funding the CAP, mobilizing financial support from Bank and development partners. For example: GDLN Program in Accounting and Audit Regulation for EU 8 (12 modules) Road to Europe – Program of Accounting Reform and Institutional Strengthening, including: GDLN Program in Accounting and Audit Regulation for South East Europe (28 modules, 14 locations, 8 languages) Vienna Workshop on Accounting and Audit Regulation (March 14 and 15, 2006) Critical Success Factor: Integration with other areas of regulation / standards and codes