My Lords, I have followed IFRS for some significant time, and it was part of my remit as chair of the Economic and Monetary Affairs Committee of the European Parliament. I also declare an interest as a director of the London Stock Exchange plc. Not only does that entity use IFRS, it is also a benefit for international companies to be able to list and report in IFRS or other standards deemed equivalent to UK standards. Having said that, my experience with IFRS has taught me to be wary of its limitations.
This is a very important statutory instrument because it is about the accounting standards under which companies prepare their financial reports, and of course those financial reports are audited using those standards and form a key part of annual reports. IFRS therefore plays a key role in audit and the standard of audit, and it will not have escaped your Lordships’ attention that audit, audit regulators and auditors have been or are coming under scrutiny in inquiries by Kingman, the CMA, Brydon and the BEIS Select Committee.
One of the lesser realised things about IFRS is that it is meant only for group level consolidated accounts, its purpose being international comparability. It is only for group level consolidated accounts that there is an EU requirement. A recent article published on 8 February this year by Nick Anderson, a member of the International Accounting Standards Board, states:
“it is important to remember that IFRS Standards, if only because of their international nature, cannot reflect in detail specific requirements of the multitude of different capital maintenance regimes among the more than 140 jurisdictions that now require the use of our Standards”.
However the UK, under the FRC, has gone further and converted UK GAAP into IFRS-like rules. An interesting impact assessment from the FRC, published in March 2013, explains:
“The FRC is issuing FRSs 100 to 102 (the Standards) following extensive consultation to move current Financial Reporting Standards (current FRS) towards an IFRS-based framework”.
The rest of the impact assessment looks rather more like a business plan for the big four, and, of course, we know from the Kingman review that the FRC is a captured regulator that was designed to take account of the companies and professions that it regulated.
IFRS tends to flatter accounts—the accounts of stakeholders—because it allows the inclusion of unrealised profits. It is this expansion of the conceptual framework of IFRS into company-level accounts—which continue to be updated as IFRS is updated—that has distorted UK financial reporting and made it depart from company law, which requires a prudent approach not a neutral one, and is central to the ongoing inquiries concerning audit.
Why do the public think they have been let down by auditors and had no warning? Auditors have followed a righteous-by-process approach of “true and fair according to accounting standards”, which has always been the FRC’s touted recommendation. The FRC has always wanted to get rid of parts of company law that it does not like. It wrote to the DTI in 2005 saying, “In short”, the Accounting Standards Board,
“is firmly of the view that outmoded and costly company law rules must swiftly be brought up to date”.
Against that background, it has taken a fair bit of campaigning and interrogation to get fulsome recognition that the company law true and fair test is an overarching requirement. From watching the evidence heard in the BEIS Select Committee from auditors, the fact of separately complying with company law seemed lost on most of them, yet it is in the Companies Act.
So I am grateful for the clear statement made by the noble Lord, Lord Henley, in reply to my Written Question HL13690. I am sorry it is one of 96 such Questions in and around these kinds of issues, but it has done a lot of good so far. Anyway, the Answer states:
“The true and fair test in section 393 of the Companies Act is the overarching test that is applied to a company’s annual accounts. If a company produces accounts, in accordance with the legal requirements, which are inconsistent with the Companies Act requirement to give a true and fair view, then the directors must depart from the accounting standards to the extent necessary to give a true and fair view. Particulars of any such departure, the reasons for it and its effect must be given in a note to the accounts.
The IAS Regulation (EU Regulation No. 1606/2002) includes requirements to consider the accounting standards system as a whole. Article 3(2) of that Regulation provides that a new form of international accounting standard can only be adopted if it is not contrary to the principle that an undertaking’s accounts must give a true and fair view of the undertaking’s assets, liabilities, financial position and profit or loss. This requirement ensures that no new form of international accounting standard is adopted for use in the UK if the application of that standard would lead to companies in general contravening the true and fair test”.
As I said, I thank the noble Lord for the comprehensive reply.
This statutory instrument will replace the EU regulation, but two things are clear from the noble Lord’s reply: company law has an overarching true and fair test; and the true and fair principle applied in the endorsement process does not replace the company law test. Would the Minister confirm that I have stated that correctly and that the true and fair principle requirement in the UK endorsement process does not replace the Section 393 company law true and fair test? That is an essential statement in the context of how financial reporting and audit must be conducted for me to approve these regulations. It is a little pedantic, but some may say that this is a new law compared with the EU one that previously applied.
The second major part of this SI is about who we can trust to be in charge of IFRS standards, both in the UK and representing the UK in international discussions, because the instrument provides the Secretary of State the ability to delegate that decision-making and representation to a new body, named in the Explanatory Memorandum as an endorsement board to be hosted within the FRC.
I do not know when the SI was drafted, but perhaps it is unfortunate that it does not take account of the Kingman report into the FRC, which yesterday the Secretary of State confirmed would be followed. The search for the new chair and deputy has started as part of a process that has to lead to a change of culture, new terms of reference including the public interest, and the ending of self-regulation and cosy relationships with stakeholders consisting of the very companies, entities and professions to which regulation from the FRC applies.
The Explanatory Memorandum states that the endorsement board is being set up as a subsidiary body. The noble Lord, Lord Hodgson, has already drawn attention to the fact that it appears that that process is well under way. In any event, it seems that the setting up of a new and independent regulator requiring legislation would also take a certain amount of time. However, Kingman also said that there should be various immediate changes. As well as a change to the FRC leadership, he specified improvements to the FRC’s internal systems and controls, including a centrally managed complaints procedure. I am not sure how that is going because I am still seeing reports of aggressive and threatening letters from solicitors being sent to complainants. That is not the culture or central procedure that I want to see.
Kingman also recommends applying the provisions of Managing Public Money and applying the Regulator’s Code, the Freedom of Information Act and the Public Contracts Regulations. There is little evidence that that has yet been done, and there is nothing much in this statutory instrument, other than FoI, to ensure that the body receiving delegated powers is compliant with the list of things that Kingman has recommended.
I will not repeat what Secondary Legislation Scrutiny Committee’s Sub-Committee B has said, other than to recognise that it has made the point that the Secretary of State will need to be confident that the FRC is in an appropriate condition to be able to host the new body properly. In paragraph 11 of Sub-Committee B’s report, there is an explanation of the work that BEIS is doing with the yet-to-be-reformed FRC to build capacity to set up the new endorsement board. The usual stakeholders have been consulted. It looks as though they are the same ones that it is recommended the FRC gets less attached to—businesses which are the bodies to be regulated and their advisers. At a guess, might that happen to include the big four? I am not quite sure what the robust transparency provisions that the stakeholders have helped with are. The paragraph states that the SI includes the “long term public good”, but that comes from the EU regulation, not stakeholders, and anyway it refers to the standards, not the endorsement body.
The unreformed FRC will be in an oversight position, but the policy intention—it is just an intention; it is not written in the legislation—is that the chair and board members will be operationally independent. What does that mean if there is oversight from somewhere else? What does it mean if there are HR processes, which I would take to mean recruitment of the people on the board? Where is the public input? Where does it charge the body rather than the standards with the
public interest? When is the FRC applying the public interest recommendations from Kingman? Will delegation be deferred until then, and, in any event, has not the setting up of the endorsement board already been influenced in the old and suspect way? The whole project seems to have been rushed, premature and, I fear, unreformed.
Finally, why hand over important negotiations on UK requirements in IFRS to a regulator that has been so publicly criticised and, despite ongoing efforts, will have a long way to go to free itself from the cognitive capture that is so embedded throughout its organisation?
I understand the sensitivity that tweaking standards can tweak profits, and the UK way is not to have politicians doing standards, but there is the relatively unique circumstance in accounting standards that the profession dominates the standard-setting process. Bankers do not set banking standards and market participants do not set market operation conduct rules, so why should accountants set their own standards? At the very least, the Secretary of State needs to retain the ability to intervene.
In the EU, endorsement and representation power lies with the Commission, and the Parliament also has a veto. I do not see why in this instance, because there is this unusual circumstance of accountants setting their own standards, there should not be the intervention of some kind of Secretary of State and parliamentary procedure. Yet again, I find that Australia appears to be doing things better, because that is just what it has done. I would say that, if it is good enough for Australia, it is good enough for the UK.
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