ASEM IFRS Seminar

Implementation of IFRS – A World Bank Perspective

Shanghai, 25-26 March 2006

John HegartyManager, Financial ManagementEurope and Central Asia Region

THE WORLD BANK

The World Bank – Our Role

Introduction

Making the link between financial reporting and poverty reductionAdvocate for improved standards and complianceContributor to the policy formulation processAssessorAdvisorFinancierFiduciary 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 Architecture1990s – Emerging Market Crises and contagion effects

East Asia (Thailand)

Philippines

Malaysia

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

Accounting and Auditing: A fundamental pillar

Securities Regulation

Banking Supervision

Accounting & Auditing

Corporate Governance

Insurance Supervision

Insolvency & Creditor Rights

Introduction

Importance of High Quality Accounting and Auditing

Accounting and

Auditing

Development of Capital Markets

Job Creation

Financial Stability

Private Sector Growth

Financial Sector Development

Improved Access to Credit

Financial Information

ECONOMIC GROWTH

Introduction

Economic Goals

- 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

Promote: Avoid:

Introduction

A&A ROSC: Assessing the Quality of the A&A Framework

Economic Context

Legal & Institutional Framework

Accounting in Practice

Auditing in Practice

RecommendationsFINDINGS

Factu

al A

ssessm

en

t

Perc

ep

tion

s

Accounting and Auditing ROSC Program

A&A ROSC: Global Coverage

A&A ROSC: Europe and Central Asia

A&A ROSC: Assessing the Quality of the A&A Framework

Benchmarks:

International Financial Reporting Standards

International Standardson Auditing

Acquis communautaire Good international practice

Accounting and Auditing ROSC Program

What does it mean to “adopt international standards”?

The Lessons Learned

Introduction of “modern” accounting and auditing practicesOne-off “transformations” of financial statements prepared using national standardsDevelopment of national standards “based on” (a selected subset of) IFRS/IAS and ISAOne-time-only adoption of international standards with no, or poor, subsequent updatingProgram of “convergence” between national and international standards over timeUnderestimation of practical implementation challengesIASB and IFAC promotional material not always helpfulDoesn’t compliance mean “all or nothing”?

Mechanisms to grant national authority to international standards

The Lessons Learned

Without force of law/regulation, “international” standards become “offshore” standardsConstraints on granting national public authority to international private standardsBacking for the standard-setting process or for individual standards, keeping up to dateTranslation, copyright/royalties, gazettingRole of legislation -v- standardsCompany law or securities regulation as the legal basis for accounting and auditing requirementsExample of EU IAS Regulation / endorsement mechanism

Linkages between general purpose and regulatory reporting

The Lessons Learned

Policy objectives of international standards and national regulatory reporting regimes not always alignedRegulatory reporting includes that for taxation and company law purposesRisk of conflicts when international standards adopted through regulatory reporting mechanismsHowever, specialist regulatory bodies can play a major and positive role in oversight/monitoring/enforcementAvoid 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 regulatorsIs the IASB sufficiently attentive to regulatory concerns?

IAS/IFRS: Current Challenges (1/2)

Guiding principles

- Independent standard

setting

- Principle based standards

- Thorough due process

Prioritization

Relevance &reliabilityConvergence

Quality

Resourceconstraints

Existing guidance

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 marketEurope/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?

Trillions of dollars of unaccounted for derivatives now on the booksPension deficits once buried in the footnotes now on the booksShare-based compensation not previously recognized as a cost…Stop “games” on provisioning (e.g., on acquisitions and big-bath provisions)

The other side of the coin…

Accounting Regulation - International Dimension

Scope of application of international standards

The Lessons Learned

Severe risks to the culture of compliance when the scope of application is inappropriate IFRS/IAS not suitable for use by all enterprisesWidespread general purpose reporting obligations for enterprises other than “public interest entities”Managing the “Big GAAP / Little GAAP” distinctionFuture of (“Little GAAP Only”) national standard settersISAs suitable for all auditsRisks of an excessively broad statutory audit requirementAddressing gaps/weaknesses in international standardsPrinciples-based standards -v- rules-based enforcement

The enabling environment

The Lessons Learned

Market demand for international standardsThe 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 complyEducation, training and experience

Reaching a critical mass of demand for relevant skills

Financial sustainability of capacity development mechanisms

Leveraging resources on an international scale

Oversight, monitoring, enforcement

The Lessons Learned

The inability of third party users to observe complianceReliance on reputational agents; limits of self-regulationDetermining role of oversight/monitoring/regulatory bodiesAbsence of agreed international best practice modelsLack of appropriate mandates, resources, methodologiesLack of leverage when specialist regulators are not concerned with general purpose financial reportingPrinciples-based standards -v- rules-based enforcementProblems of regulatory capture, effectiveness of judicial systems, macro-governanceInternational audit firm networks do not deliver consistently high quality internationally, and thus cannot be relied upon to compensate for weaknesses in national regulatory regimes

Filling the regulatory gap

The Lessons Learned

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

Importance of the financial reporting infrastructure not just accounting and auditing standards

Statutory Framework

Monitoring & Enforcement

Education & Training

Accounting Profession &

Ethics

Accounting Standards

Auditing Standards

Financial Reporting Infrastructure

All supporting pillars need to be strengthened

Statutory Framework

Monitoring & Enforcement

Education & Training

Accounting Profession &

Ethics

Accounting Standards

Auditing Standards

Financial Reporting Infrastructure

From Diagnostic to Reform

From ROSC to Reform

CountryStrategy andAction Plan (CAP)

Support funding the CAP, mobilizing financial support from Bank and development partners. For example:

GDLN Program in Accounting and Audit Regulation for EU8 (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)

CountryActionPlan

Critical Success Factor: Integration with other areas of regulation / standards and codes