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International Financial Reporting Standards: European Parliament calls for more democracy, financial market stability and common interest orientation


The Economic and Monetary Affairs Committee of the European Parliament (ECON) has voted this Tuesday on the initiative report on the International Accounting Standards (IAS) evaluation and the activities of the International Financial Reporting Standards (IFRS) Foundation, European Financial Reporting Advisory Group (EFRAG) and Public Interest Oversight Board (PIOB). We as Greens have been criticising for a long time financing, composition and output of these standard setters. With yesterday’s landmark decision, the European Parliament has supported a lot of our criticisms.

Since 2005 listed companies in Europe have to draw up their consolidated accounts under IFRS. While prudence is the overarching principle in most local GAAP (generally accepted accounting principles), IFRS focus is on the information of investors and the valuation of assets at market prices. These standards are developed by the International Accounting Standards Board (IASB), a private body based in London. Within this organization, in fact auditors of big companies set the accounting rules which then have to be applied by the whole economy. EFRAG, also a private body situated in Brussels, is meant to represent the European voice in the IASB. In order to become effective within the EU, the standards have to be endorsed by the Commission. The European Parliament so far can only reject new standards but not propose any changes.

The initiative report calls for a stronger involvement of the European Parliament in the standard setting process, democratise the standard setters IASB and EFRAG and orient the standards towards the public good and financial stability. The decision was adopted with a vast majority in the Economic and Monetary Affairs Committee but still has to be confirmed in the plenary of the European Parliament. The agreement on this first comprehensive positioning on international accounting is considered pathbreaking for the vote in plenary. MEP Sven Giegold, financial and economic policy spokesperson of the Greens/EFA group and shadow rapporteur commented on the decision:

 

“The message of the MEPs is clear: We are not just letting others decide on new standards. The European Parliament needs to be included when new standards are negotiated. Since the EU funds 14% of IASB’s budget and 60% of EFRAG, both organisations have to follow European standards of democratic legitimacy, transparency, accountability and integrity.

Accounting standards are a public good. Standard setting expert bodies therefore must not only include former bankers and accountants but also small and medium sized enterprises, consumer protection agencies and finance ministries. The representation of women has to be raised. The Monitoring Board of the IFRS foundation must not continue to waste time on internal issues but should rigorously engage in guiding the standards oriented towards the public interest. The European Parliament should have hearings with candidates for the EFRAG presidency similar to the procedure for electing the EU Commission.

As they are based on fair values, the IFRS effectively functioned as fire accelerant during the financial crisis in 2007. Therefore, the EU Commission has to evaluate whether pro-cyclical market values are conducive to financial stability, a demand already asked by the “de Larosière” report. In the same way, the IASB has to assess the rules for off-balance sheet accounting of assets and liabilities. Still, not all risks are reflected on the balance sheet. The focus on providing information for the decision-making of investors must not be at the expense of the principle of prudence. This also includes that dividends may only be paid out of realized gains. Commission has to check compliance of IFRS with the capital maintenance directive and the accounting directive.

The Maystadt report specified for the EU that the standards have to be conducive to the public good. This means they must not threaten financial stability and should promote the economic development of the whole EU. The Commission must incorporate these conditions in the IAS regulation as obligatory endorsement criteria and modify already adopted standards, if necessary. Thus, EFRAG has to strongly increase its capacity in regards of impact assessments. Expanding IFRS to small and medium-sized enterprises is only imaginable after an encompassing impact assessment and must be closely monitored by the European Parliament according to the principles of ‘better law-making’. The IASB must get rid of its short-term orientation and avoid that new standards jeopardise long-term investment and instead take more strongly into account carbon risks.”

 

The draft of the IFRS initiative report can be found here:

http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//NONSGML+COMPARL+PE-575.121+01+DOC+PDF+V0//EN&language=EN

 

The amendments tabled by all political groups can be found here:

http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//NONSGML+COMPARL+PE-578.642+01+DOC+PDF+V0//EN&language=EN

 

The de Larosière report can be found here:

http://ec.europa.eu/internal_market/finances/docs/de_larosiere_report_en.pdf

 

The Goulard report on the role of the EU in international organisations can be found here:

http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//TEXT+REPORT+A8-2016-0027+0+DOC+XML+V0//EN

 

The IAS regulation can be found here:

http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2002:243:0001:0004:en:PDF

 

For specialists, we are happy to provide the most important demands of the IFRS initiative report in detail:

 

Summary of the most important points in the initiative report on IAS evaluation and the activities of the IFRS Foundation, EFRAG and the PIOB as voted in ECON on 26 April 2016

Financial stability

– recalls that in its statement of 2 April 2009 the G20 called for reducing the complexity of accounting standards for financial instruments and for achieving clarity and consistency in the application of valuation standards internationally,

– whereas the G20 and the De Larosière report highlighted key issues with respect to accounting standards ahead of the crisis including, inter alia, off-balance sheet accounting, the pro-cyclicality related to the mark-to-market principle and of profit and loss recognition; the underestimation of risk accumulation during cyclical upturns and the lack of a common and transparent methodology for the valuation of illiquid and impaired assets; calls on the Commission to examine in detail whether the recommendation of the de Larosière Report were fully implemented, in particular recommendation number 4 which considers that a wider reflection on the mark-to-market principle is needed;

– is of the opinion that the off-balance sheet accounting issue has not yet been properly and effectively addressed as the decision on whether an asset has to be reported on balance sheets or not is still subject to a mechanistic rule which can be circumvented; calls on the IASB to correct these shortcomings

– welcomes the intention of the IASB to reintroduce the principle of ‘prudence’ and re-inforce ‘stewardship’ in the new Conceptual Framework; regrets that IASB’s interpretation of ‚prudence‘ only means ‚prudent treatment of discretion‘; notes that the IASB’s understanding of the principle of prudence and stewardship is not the same as what the ECJ jurisprudence and the Accounting Directive states; believes that the principle of ‚prudence‘ should be accompanied by the principle of reliability; calls on the IASB to examine systematically whether a revised Conceptual Framework requires changes to existing accounting standards and make modifications where needed;

– calls on the Commission and EFRAG to examine the shift in pension asset allocation from equities to bonds as a result of the introduction of the mark-to-market accounting under IFRS;

– is concerned about the persisting complexity of the IFRS; calls for this complexity to be reduced whenever appropriate and possible when developing new accounting standards;

Governance of the IASB

– notes the dominance of private actors in the IASB; points out that medium-sized businesses are not represented at all; underlines that the IFRS Foundation continues to rely on voluntary contributions, often from the private sector which may give rise to a risk of conflicts of interests;

– whereas the European Union contributes around 14% to the budget of the IFRS Foundation and therefore is the largest financial contributor; whereas the involvement of the European Parliament in the standard setting process is not sufficient and is not commensurate with the EU budget financial contribution to the IFRS Foundation;

– calls on the Commission to urge the IFRS Foundation to aim for a more diversified and balanced financing structure also based on fees and public sources;

– recalls its request made in the Goulard report for enhancing democratic legitimacy, transparency, accountability and integrity which, inter alia, concern public access to documents, open dialogue with diverse stakeholders, the establishment of mandatory transparency registers and rules on transparency of lobby meetings as well as internal rules, in particular prevention of conflict of interests

– supports the Commission recommendations that the Monitoring Board of the IFRS Foundation should shift the focus of its attention from the issue of internal organisation to discussing matters of public interest that could be referred to the IFRS Foundation

– points out that IASB’s legitimacy is at stake if the Monitoring Board continues to disagree over its responsibility while depending on consensus decisions; supports a better integration of the IASB into the system of international financial institutions and efforts to ensure a broad representations (such as consumer representation agencies, finance ministries) of interests as well as public accountability ensuring high quality accounting standards

– supports the Commission in urging the IFRS Foundation to ensure that use of the IFRS and the existence of a permanent financial contribution are conditions for membership of the governing and monitoring bodies of the IFRS Foundation and of the IASB; calls on the Commission to explore ways to reform the IFRS Foundation and the IASB to end veto rights of members which do not fulfil the aforementioned criteria;

Endorsement process of IFRS in Europe

– takes the view that the scrutiny process for the adoption of IFRS in the EU should be formalized and structured by analogy to the scrutiny process applicable for  ‚level 2‘ measures  in the field of financial services; recommends to the European authorities to invite civil society stakeholders to support their activities including at the EFRAG level; calls on the Commission to create a space for stakeholders to discuss fundamental principles of accounting in Europe;

– calls on the Commission to comply urgently to the Maystadt recommendation regarding expanding the ‘public good’ criterion – i.e. that accounting standards should neither jeopardise financial stability in the EU nor hinder the EU’s economic development –  and to ensure that this criterion will be fully respected during the endorsement process;

– calls on the Commission to put forward a proposal to implement Maystadt’s definition of the ‚public good‘ criterion into the IAS Regulation; calls on the Commission, together with EFRAG, to examine systematically whether the ‚public good‘ criterion as defined by Maystadt requires changes to existing accounting standards and then cooperate with the IASB and national and third-country standard setters to obtain wider support for modifications where needed

– calls on the Commission to remind EFRAG to strengthen its capacity to assess the impact of new accounting standards on financial stability with an explicit focus on European needs that should be introduced into the IASB’s standardisation earlier on in the process;

– calls for a more coordinated approach in developing new standards, including coordinated timelines for application in particular with regard to the implementation of IFRS 9 Financial Instruments and the new IFRS 4 Insurance contracts; urges the Commission to put forward diligently legal proposals with this respect  and to ensure that any delay does not result in misalignment or disruption of competition within the insurance industry

Governance of EFRAG

asks the Commission to take – as recommended in the Maystadt report – formal steps to encourage Member States that do not already have a National Funding Mechanism to establish one

– calls on the Commission to grant the European Parliament the possibility to receive a short list of EFRAG Board President candidates so as to organise informal hearings ahead of a vote on the retained candidate

– calls on EFRAG to extend the number of users, currently only one, in the Board and to ensure that all relevant stakeholders are represented in EFRAG

– calls on the Commission to assess the opportunity and possibility to transform EFRAG into a public agency

 

Sustainability

– supports in particular the Commission’s proposal to consider the reporting needs of investors with different investment time horizons and to provide specific solution in particular to long-term investors, when developing their standards; calls on the Commission to make sure that IFRS 9 serves the EU long-term investment strategy, especially by restricting provisions which could introduce excessive short-term volatility in financial statements

– welcomes the activities of the IFRS Foundation/IASB in carbon and climate reporting; is in particular of the opinion that key long-term structural issues such as the valuation of stranded carbon assets in undertakings‘ balance sheets should be explicitly added to the IFRS working programme with a view of developing related standards; calls on the IFRS bodies to put the challenge of carbon reporting and carbon risks on their agenda.

Dividend distribution

– whereas an IFRS should not be contrary to the true and fair view principle as included in the Accounting Directive which requires that financial statements must give a ‘true and fair’ view of a company’s assets and liabilities, financial position and profit or loss; whereas dividends and bonuses should not be paid out of unrealized profits which ultimately means out of capital as Capital Maintenance Directive requires;

– notes that the Commission’s evaluation of the IAS Regulation has shown some evidence that differences in enforcement of IFRS persist between Member States; underlines that capital maintenance and dividend distribution rules have been cited in the report on the evaluation of the IAS Regulation as a source of legal challenges which can arise in certain jurisdictions where Member States permit or require the use of IFRS for individual annual financial statements on which distributable profits are based; points out that each Member State considers how to address such issues in their national legislation within the framework of the EU capital maintenance requirements;

– calls in that respect on the Commission to ensure compliance with the Capital Maintenance Directive and the Accounting Directive;

Accounting and tax fraud

– calls on EFRAG and the Commission to examine as soon as possible whether accounting standards allow tax fraud and tax avoidance and to make all necessary changes to correct and prevent potential abuse

 

IFRS for SMEs

 

– believes that as a condition to continue work in this field, the IFRS have to be less complex, must not promote pro-cyclicality and that SME interest should be sufficiently represented on the IASB; is convinced that the relevant stakeholders should be represented in the IASB; calls on the Commission to undertake a proper impact assessment on the effects of IFRS on SMEs before taking any further steps; requests that such an evolution should be carefully followed and the European Parliament fully informed taking into account the ‚better regulation‘ process;

Gender balance

Calls on the IFRS Trustees, the IFRS Monitoring Board and the IASB to promote an appropriate gender balance within the respective forums;

Enforcement of IFRS

– deplores that several Member States do not comply and do not intend to comply with the ESMA guidelines on the enforcement of financial information; calls on these Member States to work towards compliance;

– calls on the Commission to assess whether ESMA’s powers make it possible to ensure consistent and coherent enforcement across the EU and if not to explore other ways to ensure proper application of enforcement

IFRS in the public sector

notes ongoing efforts for enhancing transparency and comparability of public accounts by developing European Public Sector Accounting Standards (EPSAS);

PIOB

calls on PIOB to re-enforce its efforts to ensure integrity in the audit profession;

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