12 November 2012

ESMA/Maijoor: Developments in European financial reporting regulation and enforcement

Consistent application of IFRS

Europe has been getting a lot of bad press lately. Some Member States have been criticised for endangering the euro, and the resulting debate is shedding new light on the economic governance of the euro area. The last months’ discussions have rightly focused on enhancing prudential supervision and consistency throughout the euro area, more particularly in the banking sector. Establishing a banking union will surely contribute to the stability of the European financial system. However, financial stability is not only a duty for banking regulators, but for all financial services regulators, including securities regulators whose actions have contributed to maintaining a level of financial stability since the outset of the financial crisis.

ESMA strongly believes that financial reporting with strong measurement principles along with entity-specific and relevant disclosures reflecting economic substance are important in underpinning market discipline. This contributes to investor protection and stability. Market discipline can only be achieved through the development and application of high quality accounting standards. This is where the IASB has an important role to play, by developing clear, auditable, enforceable and globally accepted standards.

The practice of forbearance

This concerns the situation where a borrower is in financial difficulties and does not pay on time, and the lender decides to wait and see, perhaps he even renegotiates the arrangement on more favourable terms. If a number of borrowers and banks have problems at the same time, the issue has not only a micro- but also an important macro-prudential dimension. ESMA is thus working, even more closely than usual, with the EBA and the European Systemic Risk Board in this area.

Under the practice of forbearance, the lender hopes to get his money back, waiting to see whether the borrower will eventually pay up which means taking a risk regarding the borrower’s ability or willingness to pay. While forbearance can in some cases be justified and economically rational, it can also become a waste of additional resources if the banks continue to lend to their old debtors rather than to new clients. Continuing to lend to old debtors may be a way of “kicking the can down the road”, so to speak, avoiding a credit event that would have to be entered into the books. Continuing to lend to old debtors may then become a case of throwing good money after bad. From the perspective of the overall economy, such a use, or misuse, of funds is an impediment to economic growth. Even if the old borrowers do not receive any new funds, banks with weak balance sheets may reduce new lending in order to make their balance sheets appear stronger, rather than by writing off old loans and recapitalising.

It is important for lenders to clearly reflect in their financial statements the credit risk they are exposed to in relation to forbearance. They should do this by providing clear disclosures (including both qualitative and quantitative information) that help investors to understand the extent of the forbearance practices when the exposure is material and to evaluate the need for potential impairments.

The US SEC non-decision on IFRS

The publication of the SEC staff report last July represents an important milestone for the SEC in its evaluation of IFRS. The SEC report was aimed to provide the SEC commissioners with the relevant information needed to decide whether, and if so, how, IFRS should be applied in the US. The SEC staff will provide a recommendation to the Commission on IFRS, but that no timetable for completing such work has been communicated.

Although fully understanding the domestic economic and political constraints of the US SEC, Mr Maijoor is personally disappointed with the lack of ambition regarding IFRS on the other side of the Atlantic. Patience has been a real virtue for us over the last few years and there have been a number of efforts to facilitate the adoption of IFRS in the United States. To name just two: the IASB/FASB memorandum of understanding, and the monthly joint Board meetings.

Some of the efforts to facilitate US IFRS adoption were difficult topics for the IASB’s constituents to accept, especially in Europe, but they were willing to pay the price to get the US on board. Today Mr Maijoor says he cannot avoid the feeling that all these efforts do not seem to be enough which suggests that it will never be enough.

Audit

Following the introduction of audit supervision in 2006, the European Commission now proposes to strengthen supervision, and to further improve the single market with harmonised standards, by for example requiring ESMA to issue guidance on issues like conducting audit quality assurance reviews. In the current European Commission proposals, ESMA is not going to supervise auditors directly; the competence for supervision remains with national oversight bodies who have a close understanding of the local market and its drivers. The knowledge and the good practices developed by some national regulators are an important cornerstone to build a stronger and harmonised European supervisory framework.

Full speech

© ESMA