Download publication

Parliamentary Testimony

EU Endorsement of the IFRS 9 Standard on Financial Instruments Accounting

Statement prepared for the European Parliament’s ECON Committee Public Hearing of 1 December 2015

By: Date: December 1, 2015 Topic: European Parliament

The International Financial Reporting Standard (IFRS) on Financial Instruments, IFRS 9, was adopted by the International Accounting Standards Board (IASB) in July 2014, following several years of technical work and consultations with stakeholders. The process for the endorsement of IFRS standards and their subsequent integration into EU law gives the European Parliament a specific role of scrutiny. [2] This motivates the consideration by the European Parliament of new IFRS texts, especially significant ones such as IFRS 9. I am grateful for the invitation extended by the Economic and Monetary Affairs (ECON) Committee and the opportunity to offer comments in this context.

In view of the current state of development of EU financial regulatory institutions, it is appropriate for the European Parliament to be involved in the IFRS endorsement process. Indeed, I am on record for having recommended the rejection by the European Parliament of an IFRS standard whose adoption I deemed not in the European public interest.[3] In the case of IFRS 9, however, the balance of arguments is overwhelmingly in favour of endorsement, both on the standard’s own merits and with consideration of the wider institutional context. The key corresponding arguments are developed succinctly in the rest of this statement.

IFRS 9 deserves to be endorsed on its own merits

IFRS 9 responds to the G20’s call to accounting standards-setters, made at the London Summit in April 2009, to move from an incurred-loss to an expected-loss model in accounting for financial instruments.

The world’s two main standard-setters, namely the IASB and its American counterpart the US Financial Accounting Standards Board (FASB), have failed to agree on a joint approach to address this challenge, and have chosen different definitions of expected loss for financial accounting purposes. This division is unfortunate, since the G20 had also called repeatedly for the IASB and FASB to converge towards a single set of standards. It is also unsurprising, as the two bodies have few incentives to heed the G20’s call for convergence and have also diverged on other important issues in recent years. I agree with the joint assessment made by experts from Lancaster University for the European Parliament, namely that none of the two approaches appears unambiguously superior to the other at this point, that future practice will help form a more concrete picture of the differences between them in practice, and that the divergence between IASB and FASB does not justify a refusal by the EU to endorse IFRS 9.[4]

In their submissions to the European Financial Reporting Advisory Group (EFRAG) as part of the endorsement process, the European Banking Authority (EBA) and European Central Bank (ECB) have supported endorsement of IFRS 9 with consideration of the assumed benefits of the expected-loss model for financial stability. The European Securities and Markets Authority (ESMA) has similarly supported the standard’s endorsement.[5] Experts commissioned by the European Parliament have likewise recommended endorsement of IFRS 9, on grounds both of its expected contribution to financial stability[6] and of its compliance with the criteria set out in the IAS Regulation.[7] I concur with these assessments and the resulting recommendation of endorsement.

IFRS 9 has come under criticism from a group of UK-based investment professionals who have been more generally critical of the IASB for a number of years, with legal arguments centred on the notion of true and fair view and no reference to the actual content of the standard.[8] It is relevant to note that, in my experience, such criticism is not representative of the UK investor community as a whole, let alone the broader European investor community. Indeed, prominent European investor representatives have come up strongly in favour of endorsing IFRS 9 without delay.[9]

A specific concern related to IFRS 9 is its impact on the European insurance sector. A number of European insurers have complained about the fact that it might create a mismatch between accounting conventions for assets on the one hand and liabilities on the other hand, as long as the IFRS 4 standard on insurance liabilities remains unchanged.[10] This sector-specific concern was highlighted by EFRAG in its endorsement advice to the European Commission. It does not, as of itself, justify a delay in the endorsement of IFRS 9. Reactions from ESMA and from the CFA Institute, among others, include forceful arguments on why a deferral in the application of IFRS 9 by insurers would not be aligned with the interests of investors and the European public interest. ESMA’s letter notes pointedly in this respect that “EFRAG’s analysis seems to be mainly based on the representations received from the insurance industry (…) ESMA encourages EFRAG to undertake further work, in order to objectively assess both quantitative and qualitative evidence supporting the assertions in the draft letter.” [11]

Endorsement of IFRS 9 is justified in the broader context of the EU’s adoption of IFRS

Given the particular significance of IFRS 9, the decision on its endorsement will have implications in the broader context of the EU’s adoption of IFRS. This discussion relates to the debate on the governance of the IASB and its parent organization the IFRS Foundation, a debate which is as old as the IASB itself. A recurring theme is that the EU has insufficient influence in IFRS standard-setting.[12]

It is important to keep in mind here that IFRS represent a remarkable case of EU global leadership. Indeed, it is arguably the single most prominent example of the EU successfully leading the way in international financial reform in the past two decades, with its initial adoption of IFRS in 2005 followed by an increasing number of jurisdictions in the ensuing years. There can be little doubt that the IFRS Foundation would have struggled to achieve so much without the initial impetus provided by the EU, whose decision was formed at the political level in 2000 and enshrined in EU legislation in 2002. Against this background, the EU has a stake in the continued success of the IFRS project.

The EU must thus resist the potential temptation to use the process of endorsing individual standards, such as IFRS 9, to make statements or create leverage about the governance of the IFRS Foundation and the EU’s role therein. On the contrary, concerns about the integrity and reputation of both the IASB and the EU itself demand that discussions about individual standards be strictly separated from those about the standard-setting organization and its governance and funding arrangements. The heavy-handed pressure exerted by the EU in October 2008 to force the IASB to modify its then standard on financial instruments, IAS 39, in order to suit short-term interests of some European banks, provides a cautionary tale of questionable practice which has left deep scars and should not be repeated.

The governance of the IFRS Foundation is pioneering and experimental in nature, since no directly relevant precedent exists for this kind of standard-setting function at the global level, even though useful lessons can of course be learnt from other experiences. As such, this governance is intrinsically imperfect and can be improved. In particular, a better definition of the Foundation’s prevailing global stakeholders, a clearer framework of accountability vis-à-vis these, and a related overhaul of funding arrangements, appear desirable to this observer.[13] One should be under no illusions, however, that a simple fix might comprehensively address most governance concerns directed at the IFRS Foundation. Specifically, the notion of democratic accountability raises difficult questions when envisaged on a global scale, given the heterogeneity of political regimes across the world’s jurisdictions, including those that have adopted IFRS or substantially model their standards on them.

The issue of EU influence is separate from that of the IFRS Foundation’s governance, in which Europeans are certainly not underrepresented – to give only a few examples, the current chairman of the Foundation’s Trustees is French; the chairman of the IASB is Dutch; and its Vice Chair, while originally from New Zealand, also has a strong European background as former chairman of the UK Accounting Standards Board. To the extent that EU influence over IFRS is an issue, it is related to the fragmentation of mandates over accounting policy among different authorities. The European Commission has the leading role in IFRS endorsement; national authorities are charged with enforcing IFRS implementation by listed companies; and ESMA fosters cooperation and convergence in this area. By contrast, in most other jurisdictions, these functions are all performed by a single organization, e.g. the Financial Services Agency in Japan or the Securities and Exchange Commission in the US. Reform of relevant EU arrangements might be usefully considered in the new context created by the Capital Markets Union project.[14]

Conclusion

In the above-mentioned note to the ECON Committee on the endorsement of IFRS 8 in September 2007, I wrote: “In most advanced economies, it is not usually the role of Parliament to intervene directly in accounting standard-setting decisions. However, EU arrangements have given the European Parliament a voice in the IFRS adoption process. In my opinion, this voice should be used actively only in (hopefully) rare cases when all other actors in the chain of decision-making have failed to defend the objective of high-quality standards in the interests of users of financial information.” At the time, I concluded that such intervention was warranted in the case of IFRS 8, an opinion I still hold. I do not see, however, that a similar assessment can be made in the case of IFRS 9.

The EU should endorse IFRS 9 expeditiously. Separately, it should keep engaging with the IASB in the preparation of adequate follow-on adjustments in anticipation of the forthcoming review of insurance accounting.

[1] I am a Senior Fellow at Bruegel (Brussels) and a Visiting Fellow at the Peterson Institute for International Economics (Washington DC). I am also an independent board member of the derivatives trade repository arm of DTCC, a financial infrastructure company that operates on a not-for-profit basis, and in 2015-16 I work additionally as a consultant for the International Monetary Fund’s Independent Evaluation Office. In 2014 I represented Bruegel in the Informal Expert Group that supported the European Commission’s evaluation of Regulation (EC) 1606/2002, also known as the International Accounting Standards (IAS) Regulation. More complete information is available on www.bruegel.org.

[2] IAS Regulation (EC) 1606/2002, modified by Regulation (EC) 297/2008 which introduces the Regulatory Procedure with Scrutiny in the area of financial accounting standards.

[3] Nicolas Véron, “EU Adoption of the IFRS 8 Standard on Operating Segments”, Bruegel Policy Contribution, September 2007, based on the author’s participation in the ECON Committee hearing on this topic on 19 September 2007.

[4] John O’Hanlon, Noor Hashim and Weijia Li, “Accounting for Financial Instruments: The FASB and iASB IFRS 9 Approaches”, Study for the ECON Committee, European Parliament, September 2015.

[5] The corresponding letters are available on the EFRAG website: respectively http://www.efrag.org/files/IFRS%209%20endorsement/IFRS_9_DEA_-_CL44_-_EBA.pdf; http://www.efrag.org/files/IFRS%209%20endorsement/IFRS_9_DEA_-_CL45_-_ECB.pdf; and http://www.efrag.org/files/IFRS%209%20endorsement/IFRS_9_DEA_-_CL43_-_ESMA.pdf. See also Mario Draghi’s speech in London calling for swift EU endorsement of IFRS 9, 9 July 2014, available at https://www.ecb.europa.eu/press/key/date/2014/html/sp140709_2.en.html.

[6] Zoltan Novotny-Farkas, “The Significance of IFR 9 for Financial Stability and Supervisory Rules”, Study for the ECON Committee, October 2015

[7] Jannis Bischof and Holger Daske, “IFRS Endorsement Criteria in Relation to IFRS 9”, Study for the ECON Committee, October 2015.

[8] See e.g. comment letter from the UK Local Authority Pension Fund Forum, available on the EFRAG website at http://www.efrag.org/files/IFRS%209%20endorsement/IFRS_9_DEA_-_CL6_-_LAPFF.pdf.

[9] e.g. Eumedion letter to the ECON Committee on 30 November 2015, http://www.eumedion.nl/en/public/knowledgenetwork/letters/2015-11-ifrs-9-letter-to-ep-and-iasb.pdf.

[10] This issue is explored in more detail in an IASB staff paper of September 2015, available at http://www.ifrs.org/Meetings/MeetingDocs/IASB/2015/September/AP14-IFRS%209%20and%20IFRS%204.pdf.

[11] EFRAG endorsement advice letter to the European Commission of 15 September 2015 is at http://www.efrag.org/files/IFRS%209%20endorsement/IFRS_9_Final_endorsement_advice.pdf. The relevant letters of ESMA and the CFA Institute are respectively at http://www.esma.europa.eu/system/files/2015-1749_esma_comment_letter_to_efrags_draft_letter_to_the_european_commission_supplementing_its_endorsement_advice_on_adoption_of_ifrs_9.pdf and http://www.efrag.org/files/EFRAG%20public%20letters/IFRS%204%20IFRS%209/CL18_-_CFA_Institute.pdf.

[12] This theme was discussed at length in the report “Should IFRS Standards Be More ‘European’?” delivered by Philippe Maystadt to the European Commission in October 2013, available at http://ec.europa.eu/finance/accounting/docs/governance/reform/131112_report_en.pdf. See also Sebastian Botzem, “The European Union’s Role in International Economic Fora / Paper 7: The IASB”, Study for the ECON Committee, June 2015.

[13] See in particular Nicolas Véron, The Global Accounting Experiment, Bruegel Blueprint, April 2007; “Suggestions for Reforming the Governance of Global Accounting Standards”, Bruegel Policy Contribution 2011/04, May 2011; and “Keeping the Promise of Global Accounting Standards”, Bruegel Policy Brief 2011/05, July 2011.

[14] See specific recommendations in Nicolas Véron and Guntram Wolff, “Capital Markets Union: A Vision for the Long Term”, Bruegel Policy Recommendation 2015/05, April 2015, page 12.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More by this author

Parliamentary Testimony

House of Commons

Exiting the European Union Committee

On 19 April 2017 Zsolt Darvas appeared as a witness at the Exiting the European Union Committee, the House of Commons, United Kingdom.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, House of Commons, Testimonies Date: June 20, 2017
Read article Download PDF More by this author

Parliamentary Testimony

European Parliament

Combating inequalities as a lever to boost job creation and growth

This presentation was delivered in Brussels at the Employment and Social Affairs Committee (EMPL) of the European Parliament on 29 May 2017.

By: Zsolt Darvas Topic: European Parliament, Testimonies Date: June 20, 2017
Read about event

Past Event

Past Event

Fintech and the digital transformation of banking

FinTech is changing the financial sector. What are the challenges associated with this and what policies should we adopt in response?

Speakers: Xavier Corman, Cora van Nieuwenhuizen, Georgios Petropoulos, Ezequiel Szafir and Pēteris Zilgalvis Topic: Finance & Financial Regulation, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 20, 2017
Read about event More on this topic

Past Event

Past Event

Bail-ins and bank resolution in Europe

This invitation-only event will feature a presentation by Thomas Philippon of a report on bail-ins and bank resolution in Europe. Failed financial firms should not be bailed out by the taxpayers. Europe, unfortunately, has a weak track record of following this principle of good governance and sound economic policy. The banking union, with its new […]

Speakers: Thomas Philippon Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 19, 2017
Read about event More on this topic

Upcoming Event

Jul
5
11:00

The EU27’s trade-offs in setting policy on central counterparties

This workshop aims to investigate the trade-offs involved in the next steps of decision-making for the future EU27 policy regarding central counterparties (CCPs / clearing houses).

Speakers: Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Past Event

Past Event

Sovereign exposure limits

On 19th June, we are hosting an invitation-only workshop on sovereign exposure limits.

Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 19, 2017
Read about event

Upcoming Event

Jul
6
12:30

Is there a way out of non-performing loans in Europe?

At this event we will look at the issue of non-performing loans in Europe. The event will also see the launch of the latest issue of "European Economy – Banks, Regulation and the Real Sector."

Speakers: Emilios Avgouleas, Giorgio Barba Navaretti, Giacomo Calzolari, Maria Demertzis, Martin Hellwig, Helen Louri and Laura von Daniels Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

External Publication

A New Liquidity Risk Measure for the Chilean Banking Sector

This paper introduces a new metric for central banks – and in particular for the Central Bank of Chile – to measure liquidity risk in their banking sector using the bidding behavior of commercial banks in their open market operations.

By: Grégory Claeys, Sebastián Becerra and Juan Francisco Martínez Topic: Finance & Financial Regulation Date: June 7, 2017
Read article Download PDF More by this author

Policy Contribution

German Bundestag

Charting the next steps for the EU financial supervisory architecture

The combination of banking union and Brexit justifies a reform of the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) in the near term, in line with the subsidiarity principle and the accountability of EBA and ESMA and their scrutiny by the European Parliament should be enhanced as a key element of their governance reform.

By: Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation, German Bundestag Date: June 7, 2017
Read about event More on this topic

Past Event

Past Event

Substance requirements for financial firms moving out from the UK

In the run-up to Brexit, UK-based financial firms are considering how to organize their operations across the future divide between the UK and EU27. This event will discuss the regulatory requirements on how self-sustaining the operations in the EU should be, and implications for the single market and third countries.

Speakers: Gerry Cross, Simon Gleeson and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 2, 2017
Read article Download PDF More by this author

Policy Contribution

The governance and ownership of significant euro-area banks

This Policy Contribution shows that listed banks with dispersed ownership are the exception rather than the rule among the euro area’s significant banks, especially beyond the very largest banking groups. The bulk of these significant banks are government-owned or cooperatives, or influenced by large shareholders, or prone to direct political influence.

By: Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: May 30, 2017
Read article Download PDF

Policy Contribution

European Parliament

Is the recent increase in long-term interest rates a threat to euro-area recovery?

After reaching historically low levels, European long-term sovereign yields experienced a notable rise at the end of 2016 and beginning of 2017. This paper discusses the factors behind it and the potential implications for the euro-area economy, public finances and ECB policy

By: Grégory Claeys and Konstantinos Efstathiou Topic: European Parliament, Finance & Financial Regulation Date: May 29, 2017
Load more posts