Co-ordinated and consistent enforcement of IFRS is essential if investors in one country are to be able to trust the financial reports from another - if they cannot, the benefits of harmonised accounting principles will be lost. However, improving international enforcement will result in much greater regulatory intervention and a need for companies to be more robust with their financial reporting systems and documentation.
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What enforcement means
There are three main stages for enforcement, once good accounting standards are in place: -
Internal control systems (including internal audit) supported by management dedicated to good financial reporting. Management should be dedicated to good financial reporting not just because it is ethically right, but also because good financial reporting will lower the company�s cost of capital. By comparison, untimely disclosure of errors, or practices that fall short of the best practice benchmarks, can very quickly lead to a crisis of confidence, reduced share prices, reduced debt ratings and an inability to refinance borrowings.
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Independent external auditors able to draw on expertise in the standards. The second stage works best when the auditors are strongly supported by management and regulators. If it is clear that an active and powerful regulator exists, good management and good auditors can insist on good financial reporting without fear that they will be temporarily outmanoeuvred by those pursuing a different agenda.
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A monitoring mechanism with powers of enforcement held by a regulator. This is the focus of the discussion in this article.
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Current approaches to enforcement vary widely around Europe and elsewhere, from relying on local magistrates, to a private sector body, to action by national securities regulators. Monitoring and enforcement models take various forms:
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Securities commissions. The most obvious example is the governmental regulatory body founded in the US after the Wall Street Crash of 1929. Similar bodies exist in France (the COB) and in Italy (the CONSOB). These bodies regulate financial reporting and, in some countries, the auditing of listed companies.
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Stock exchanges. They impose regulations on their listed companies, and their ultimate sanction tends to be de-listing.
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Other private sector bodies set up in the public interest but with some legal backing, such as the UK�s Financial Reporting Review Panel (FRRP). They can investigate and then take companies to court to require directors to amend �defective accounts�.
With the forthcoming arrival of IFRS for the consolidated statements of listed companies in 25 EU countries, Australia, Russia, South Africa and several other countries, we have a major opportunity to ensure that domestic reporting is comparable on an international basis. What we must have alongside high-quality IFRS standards is consistent, good enforcement on an international basis.
Action in Europe
The good news is that, at least in Europe, comprehensive proposals for effective enforcement mechanisms have been issued by those with the ability to act on their conclusions. In April 2003 the Committee of European Securities Regulators (CESR) published its first of two enforcement standards which national securities regulators are currently implementing in their member states. CESR was set up to advise the European Commission and comprises the national securities regulators in the current 15 member states, plus Norway and Iceland.
The first standard - Enforcement of Financial Information in Europe - provides guidance for regulators in the form of a set of 21 basic principles for enforcement activities. These are intended to be applied nationally to the financial information provided to the market by listed companies. The standards require:
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enforcement activities to be performed by �competent independent administrative authorities� in each country
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financial statements to be selected for review partly on the basis of risk - and not simply on a random or sample basis
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a range of sanctions to be available, including public correction of misstatements, where accounts are found to be deficient.
CESR�s latest draft standard, Draft Standard 2 on Financial Information - Co-ordination of Enforcement Activities, published in October 2003, proposes co-ordination of enforcement activities by �supervisors of information� in Europe. It responds to the need identified by CESR to �ensure robust and consistent enforcement� of an internationally recognised set of accounting standards.
These principles include:
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�European enforcers co-ordination sessions� to discuss issues that have arisen
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the development of a database containing decisions taken by EU national enforcers as a practical reference tool. CESR is considering making this information available publicly, so that issuers, auditors and non-EU regulators may have access to the decisions
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regulators should take into account existing decisions taken by EU national enforcers.
A global approach
The publication of CESR�s first two standards demonstrates that national agencies are beginning to co-ordinate their approaches to regulation. Companies need to be aware that the enforcement authorities will be examining IFRS compliance in a more systematic way than under national GAAP. They should examine their systems and documentation processes to ensure that they are robust enough to pass the additional scrutiny. They should also feel reassured that, in future, investors will be able to understand the standards of regulation that will apply across the EU, and can expect them to be applied consistently.
The next step is to extend this approach on an international basis. The word on the street is that CESR is in contact with regulators in other major countries that will accept IFRS financial statements. The prize is consistent enforcement on a global basis.
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CESR�s Draft Standard 2 on Financial Information -
Co-ordination of Enforcement Activities
The key proposals, which will shape regulators� approach, are in the form of �Standard No 2� and establish a set of principles. These are highlighted below. -
Principle 1: all supervisors should take into account existing decisions taken by EU national enforcers. These EU national enforcers would form part of the proposed membership of the European Enforcers Co-ordination Sessions (EECS). Additionally, CESR proposes that, where practicable within constraints of time and confidentiality, discussions with other EU national enforcers should take place before significant decisions are taken.
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Principles 2 and 3: the development of a database as a practical reference tool which sets out decisions taken by EU national enforcers, to provide a record of previous decisions reached in particular cases. The database of enforcement decisions will set out the principles upon which decisions have been taken by EU national enforcers. CESR will develop further guidelines shortly on how to manage this database. This will include a confidentiality regime.
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Principle 4: in order to ensure a broad coherence and harmonised approach to enforcement decisions, CESR members will discuss decisions and experiences with national enforcers on a regular basis within a formalised structure - the proposed EECS would fulfil this function.
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Ian Wright is the global corporate reporting leader at PricewaterhouseCoopers.
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