Treasury Committee
Written evidence
CONTENTS
Memorandum from the Policy and Regulatory Group (PRG)
Memorandum by The Institute of Chartered Accountants of Scotland
Memorandum by KPMG LLP
Memorandum by Professor Michael Page
Memorandum by The British Bankers' Association (BBA)
Memorandum by Professors Vivien Beattie, Professor Stella Fearnley and Mr Tony Hines
Memorandum submitted by R3
Memorandum from the Investment Management Association
Annex
Memorandum from The Institute of Chartered Accountants in England and Wales
APPENDIX A
APPENDIX B
Memorandum from the UK Financial Reporting Council (FRC)
APPENDIX A
APPENDIX B
Memorandum from the Association of British Insurers (ABI)
Memorandum from the Centre for Financial Market Integrity (CFA Institute Centre)
10.APPENDIX I: ELABORATION OF BENEFITS OF FAIR VALUE
11.APPENDIX 2: IASCF RECOMMENDATIONS
12.APPENDIX 3: CFA INSTITUTE MEMBER POLLS
Memorandum from Dr R A Rayman
Memorandum from Markit
Memorandum from the UK Shareholders Association
APPENDIX A
APPENDIX B
APPENDIX C
Memorandum from the International Accounting Standards Board (IASB)
Memorandum from Northern Rock
APPENDIX A
APPENDIX B
APPENDIX C
Memorandum from Bradford and Bingley
Memorandum from Legal & General Investment Management Limited (“LGIM")
Memorandum from Public Concern at Work
Memorandum from Shelter
Memorandum from Unite
Memorandum from Which?
Memorandum from the Building Societies Association
Memorandum from SRM Global Fund
Supplementary memorandum from Unite
Supplementary memorandum from Which?
Memorandum from Leighton Jones
Memorandum from Martin Blaiklock
Further memorandum from Public Concern at Work
Memorandum from the Association of British Insurers (ABI)
Memorandum from Legal & General Investment Management Limited (LGIM)
Memorandum from Mercer
Memorandum from Deloitte & Touche LLP
Memorandum from ACCA
Memorandum from the London Investment Banking Association (LIBA)
Memorandum from the Futures and Options Association
Memorandum from CIPD
Memorandum from The Financial Times Limited
Memorandum from the National Union of Journalists
Memorandum from Odey Asset Management
Annexe 1
Memorandum from Shelter
Memorandum from David H Smith
Memorandum from the Campaign for Community Banking Services (CCBS)
Memorandum from Landsbanki Guernsey Depositors' Action Group
Memorandum from Incisive Media
Memorandum from the International Securities Lending Association
Memorandum from the States of Guernsey
Memorandum from the Association of Independent Financial Advisers
Memorandum from the Association of British Insurers
Memorandum from BDO Stoy Hayward
Memorandum from the Association of Mortgage Intermediaries
Memorandum from the UK Financial Reporting Council (FRC)
Memorandum from the Paragon Group of Companies PLC
Memorandum from Michael Power, Professor of Accounting, London School of Ecoonomics
Memorandum from News International Ltd
Memorandum from PPA
APPENDIX
Memorandum from CRESC (Ismail Erturk, Julie Froud, Sukh Johal, Adam Leaver and, Karel Williams (ESRC Centre for Research on Socio Cultural Change, University of Manchester)
Memorandum from Institute of Chartered Accountants of Scotland
Memorandum from Ken Cooney
Memorandum from Resources Compliance
Memorandum from KPMG
Memorandum from James Robertson
Memorandum from Save Our Savings (“SOS") a group of charitable creditors of Kaupthing Singer Friedlander Limited (In Administration)
Memorandum from Christian Aid and ActionAid
Memorandum from the Hedge Fund Standards Board
Memorandum from Jim Raeburn, Scottish Daily Newspaper Society
Memorandum from the Newspaper Society
Memorandum from the Investment Management Association
Memorandum from Which?
Memorandum from Pensions & Investment Research Consultants Ltd (PIRC)
Memorandum from Guardian News & Media Limited
Memorandum from the Financial Services Consumer Panel
Memorandum from the London Stock Exchange
Memorandum from the Building Societies Association
Memorandum from the Institute of Chartered Accountants in England and Wales (ICAEW)
APPENDIX 1
Memorandum from G W Carleton
Memorandum from the Policy and Regulatory Group (PRG)
Accountancy and the Banking Crisis: The Use of “Fair Value" in Financial Reporting in Times of Uncertainty and Illiquidity
I am writing on behalf of the Policy and Regulatory Group (PRG), which includes representatives of the six largest accountancy firms.
We are well aware of the challenges facing policy-makers in dealing with the fast-moving developments in the financial markets. However, we believe it is vital to recognise that the current financial crisis is principally an economic issue, not an accounting issue, and that the effects of current market volatility are captured, but not caused, by the use of fair value in financial reporting. The accounting principles underlying the use of fair value for financial instruments strive to deliver transparent information to investors and other users of financial statements: the message may be harsh, but the messenger is doing its job.
Regulators and standard-setters in the European Union and other capital markets have prudently resisted pressure to abandon the basic principles of fair value accounting for financial instruments. A change in financial reporting standards, such as a “suspension" of the use of fair value, would paper over difficulties in the midst of a crisis and would not restore investor confidence in financial reporting or restore confidence to the capital markets.
We support the statement of the G7 finance ministers and central bank governors that accurate valuation and transparent disclosure of financial assets and consistent implementation of high-quality financial reporting standards are necessary. As such, the accounting profession will continue to work with standard setters (especially the International Accounting Standards Board (IASB) and its US counterpart the Financial Accounting Standards Board) and regulators to minimise differences in the application of financial reporting standards and to further the goal of convergence to one set of high-quality global financial reporting standards. We support the IASB in its commitment to continue to develop high-quality financial reporting standards through an independent standard setting process that involves adequate opportunity for input from a wide base of stakeholders.
It is our view that fair value should continue to be used for financial instruments in those circumstances in which it is currently required because, when supplemented with appropriate disclosure, it provides investors and other users with the best insight into how current market conditions affect the reporting entity.
The extreme market volatility and limits on liquidity have made the determination of fair value complex and challenging. We generally support fair value reporting where it is required and further believe that any changes made by the IASB should be subject to careful consideration and due process. We are also supportive of the efforts of the IASB to react to this ongoing crisis by looking at the key issues that have been raised, not least by Europe, in a timely way—for example the educational guidance published last Friday by the IASB's Expert Advisory Panel on Fair Value Measurement and Disclosure. This provides guidance to companies on applying the existing financial reporting standards in these unprecedented times. However, we do believe that continuing efforts will be needed to assist companies in applying the existing financial reporting standards in the current market conditions.
We also believe that there is scope to make the use of fair value a more effective tool in financial reporting through improved contextual disclosures. Such disclosures include explanations for significant changes in fair value and relevant information that enables investors to understand the possible impacts on future cash flows, the level of subjectivity in the fair value estimates, and attendant risks. Reports issued by regulatory groups such as the Financial Stability Forum, the US Securities and Exchange Commission, and the Senior Supervisors' Group have encouraged such disclosure. Providing clear disclosures allows investors to understand the fair values as currently recorded by a company and provides them with information to make their own judgements on future values based on their own assessments of future market conditions.
We note a number of banks have been asked to raise capital. It is for the companies and regulators to agree how much capital is required. We note that general purpose financial reports are designed primarily to serve the needs of investors; it is for regulators to decide the extent to which they will use general purpose financial statements for prudential supervision. If regulators are of the view that the actions being taken to raise or retain capital are unnecessary, they should consider providing relief through changes to capital adequacy standards.
The use of fair value to report financial assets and financial liabilities provides a timely measure of value; failure to report those values would keep investors, regulators and policy makers in the dark about credit and liquidity challenges. That is in no one's best interests.
Whilst this letter represents the views of the members of the PRG each firm may also decide to separately provide written evidence to the Committee.
3 November 2008
@HR25@
Memorandum by The Institute of Chartered Accountants of Scotland
1.The Institute of Chartered Accountants of Scotland (ICAS) is pleased to submit written evidence to the Treasury Committee. Please note that we would also be pleased to provide oral evidence on 11 November.
ICAS is the world's first professional body of accountants, receiving its Royal Charter in 1854. ICAS has over 17,000 members worldwide and in the UK the CA designation is reserved exclusively for their use. A considerable number of our members work in industry and, in particular, the financial services sector. We therefore believe that we have the required expertise to provide evidence on this topic.
Under the Royal Charter, the Institute works in the public interest. The objective of ICAS is to uphold the integrity and standing of the profession of chartered accountancy in the interests of society and the membership, through excellence in education and the development of accountancy and through service to members and the enforcement of professional standards.
As the Institute's Charter requires, the Committee must act primarily in the public interest, and our proactive projects, responses to consultation documents etc. are therefore intended to place the general public interest first. Our Charter also requires us to represent our members' views and protect their interests, but in the rare cases where these are at odds with the public interest, it is the public interest which must be paramount.
2.Executive Summary
2.1We believe the purpose of financial accounts is the communication of information to a wide range of users both to demonstrate that management have fulfilled their stewardship responsibilities and to assist users in decision-making.
2.2First and foremost, the Institute regards the credit crisis as an economic problem whose effects are being exacerbated by market psychology. To the extent that fair value accounting has played a role, the role has been positive: it has forced banks to face and address the economic losses they have incurred sooner rather than later.
2.3The Institute rejects the view that fair value accounting has somehow been a cause of the credit crisis and, equally, is not convinced that fair value accounting is reinforcing a downward spiral of confidence—the so-called “procyclicality" argument. Procyclical effects in a “boom and bust" scenario fundamentally reflect human behaviour; accounting is simply the language which tells us what this means for asset valuations.
2.4Although we do not believe that the creation of a Monitoring Group for the International Accounting Standards Board is strictly necessary; as it could be seen as layer of bureaucratic and unnecessary oversight, we accept its inevitability, to respond to the demand of politicians and other stakeholders for greater accountability and oversight. The creation of a Monitoring Group should also help in meeting the need for dialogue between the IASB/IASCF and the major public institutions. We also believe that the initial proposed membership looks to be sensible: and note that it will be reviewed over time.
2.5We believe that it is important that proper due process is followed in the process of amending accounting standards. We believe that the IASB's due process is transparent and robust.
3.The Purpose and Intended Audience, of Financial Accounts
3.1We believe the purpose of financial accounts is the communication of information to a wide range of users both to demonstrate that management have fulfilled their stewardship responsibilities and to assist users in decision-making.
4.The Role that Fair Value Accounting has Played in the Banking Crisis, and Whether any Change to Fair Value Reporting Rules and Requirements is Appropriate
4.1It is important to recognise that accounting is merely a language, the language of business. Like any language, it enables us to communicate and understand—in this case, the economic effect of business transactions.
4.2A particular approach to accounting—fair value accounting—is applied to certain financial instruments. The objective of fair value accounting is to tell us today's market worth of financial instruments. This is the most relevant value to know because it reflects the current economic position.
4.3In our view, it is critical to understand the current economic position—only then can informed decisions be made about current issues, such as how to manage the portfolio or what capital needs to be set aside. For this reason, we regard fair value accounting as the most helpful basis for measuring financial instruments.
4.4There is evidence to support our view that fair value accounting is helpful. Goldman Sachs, a bank which has a strong and unambiguous fair value culture, has also been the bank to weather the credit crisis better than any other. This is not a coincidence: Goldman Sachs picked up early indicators of problems before the rest of the market. Equally, we note that the absence of fair value accounting in Japan in the 1990s caused that financial crisis to persist much longer than would otherwise have been the case.
4.5Some banks would like to suspend fair value accounting, arguing that the losses it implies do not reflect the “true" worth of the assets in question. We reject this argument for the reasons given above. We do not see how the suspension of fair value accounting—and the non-recognition of losses that this implies—can possibly lead to an increase in inter-bank confidence. In our view, the suspension of fair value accounting will serve only to increase uncertainty and reduce transparency.
4.6The Institute is a leading advocate of principles-based accounting. In this case, the principle at stake is a fundamental one, namely to report the true economic position of banks. It is only through continuous reporting of the true actual position that inter-bank confidence can be re-built and lending between banks will recommence in earnest.
4.7For the above reasons, the Institute supports fair value accounting for certain financial instruments and believes it has played a positive role in forcing banks to face and address the economic losses they have incurred sooner rather than later.
4.8Those who criticise fair value accounting fail to recognise that accounting is merely a language and cannot of itself change the underlying economics. However, in revealing the true underlying economics, accounting can be the catalyst for decisions which do modify the economics. If that happens, then accounting has done its job.
4.9It should also be noted that accounting standards are developed under proper due process and there was very little criticism made of the use of fair value accounting for certain financial instruments when the markets were rising steadily.
5.The Role and Accountability of the International Accounting Standards Board
5.1Whilst the IASB already operates in a very transparent and accountable manner, we believe that the recently proposed setting up of a monitoring group should satisfactorily complete the effective oversight of the IASB by regulatory and public interest representatives.
5.2On its website the IASB provides information on its work plan and does liaise regularly with the various major accounting standard setting bodies round the globe, including the UK's Accounting Standards Board on such matters, as well as with other stakeholder groups.
6.The Process of Amending Accountancy Standards
6.1We believe that it is important that proper due process is followed in the process of amending accounting standards. In particular, it is important that the IASB consults with, and listens to, a wide range of stakeholders, and make its decisions on the basis of the broad range of views expressed, without undue interference from any one particular group. In all respects, we believe that the IASB's due process is transparent and robust.
3 November 2008
@HR25@
Memorandum by KPMG LLP
1.Executive Summary
1.1KPMG LLP has considered the written evidence provided by the Institute of Chartered of Accountants in England and Wales (“ICAEW") and agrees with the views therein.