Responses to CESR

The responses to CESR's call for evidence on the use of standard reporting formats are in, and they contain a mixed bag of answers. Of the 33 responses listed, only 31 appear to be valid (one was obviously misplaced, one materially empty). Furthermore, the categorisation of respondents used by CESR looks arbitrary, which is why we've applied our own.

Essentially, we were curious whether respondents supported standard reporting (Q1), and if so, whether XBRL would be fit for the purpose (Q2).

• Q1: Respondents were mostly in favour of standardisation (74%), although a sizeable part (7) of those favourable answers came from the XBRL community. Without them, 67% of responses are still in favour, notably investors, exchanges and service providers. The most outspoken opposition to standardisation comes from the issuers camp, especially (and unsurprisingly) from banking institutions.
• Q2: Respondents were overwhelmingly in favour of XBRL as the most appropriate format (90%, or 88% without XBRL community). Surprisingly, this even holds true for those respondents who were sceptical about standardisation in the first place. 

The responses from issuers (EAPB, EBF, ZKA, DAI) are remarkable in that they focus on the lack of effective standardisation (and thus comparability) in today's corporate accounts across countries and industries, in spite of those accounts being prepared under IFRS. They quote local laws and regulations as inhibitors to effective standardisation, which could not be overcome by simply applying the IFRS taxonomy because it did not provide the necessary local concepts, nor could it be ascertained that nominally identical concepts are materially identical in practice. In my view, these issues are known and need to be addressed by means of an appropriate system of standardised extensions of the IFRS taxonomy.

UNCTAD on fair value

I've had the honour of addressing the Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting, twenty-sixth session in Geneva yesterday. The subject matter was implementation issues of fair value accounting in an IFRS context. To my great surprise, there was hardly any criticism expressed of the approach, neither from the panel nor from the floor.

Are you prepared to be compared?

These are the slides which I used at the breakfast presentation yesterday, hosted by Likemind at the SwissRe tower in London.

Discounting pensions

The IASB proposes to modify the discount rate applicable to the valuation of pension liabilities in IAS19. The proposal would eliminate the requirement to apply government bond yields instead of high quality corporate bond yields where there is no deep and liquid market for such securities. The proposed modification is triggered of course by the massive expansion of the spread between corporate and government bonds in the wake of the crisis, which serves as an excuse for yet another instance of accelerated due process...

While I agree that applying government bond yields to discount pension liabilities makes sense in only a very limited set of circumstances, and definitely not as a generic fall-back position in the absence of a deep corporate bond market, the proposed discount rate suffers one important flaw. The Board argues (BC4) that comparability is served by reducing the range of rates used. Yet, the motive for not just fixing a single rate (maximum comparability in that sense) is probably that this would not reflect economic reality in any sense. But this purpose is not served by choosing high quality corporate bonds, either. What if the reporting entity is not of high quality (which is the rule rather than the exception nowadays)? The liability is overstated.

The economically correct discount rate to apply to the valuation of pension liabilities in my opinion is WACC. Cost of capital is calculated for each entity separately and thus cannot be compared uniformly, but it reflects the economic reality of financing decision making. As an analyst knowing about the many arcane ways in which pension liabilities are valued, I don't take the nominal amount of pension liabilities at face value anyway, so that comparison is of little interest.

BIS on the crisis and remedies

"And, in the future, a financial firm that is too big or too interconnected to fail must be too big to exist."

The Bank for International Settlements Annual Report is probably the only one that I read regularly for its content, rather than mine it for data. It contains authoritative interpretation of recent economic and financial developments, and is thus an important source of consensus narrative. This year's report is no exception.

Of particular relevance going forward is its chapter VII, outlining the current thinking about capital requirements by evaluating a Systemic Capital Charge and a Countercyclical Capital Charge. However, these capital charges appear to continue to rely on portfolio theory's (stable?) correlations, which is conceptually flawed, as we now know. Nevertheless, it is encouraging to see that countercyclicality is addressed not with perceptional placebos such as modified accounting standards, but with measures aiming at the economic heart of the matter, namely leverage and the capital base. Last, but not least: if Too Big to Fail were a victim of the crisis, it would have been worth it.

A busy week of acronyms

Today, influential Swiss daily Neue Z�rcher Zeitung NZZ has my article on XBRL. Which is perfect timing because of the forthcoming workshop that XBRL CH is organising next Monday. The subject matter of that event is the US SEC's new XBRL regulation, which is applicable for foreign filers as well - so, rather targeted. Back to back, but more generic, is the big XBRL show in Paris, beginning on Tuesday through to Thursday. Interactivity!

Impact of accounting and prudential regulation on pensions

"A long-term view involves short-term risk, whereas a short-sighted strategy involves increased risk over the long term."

EDHEC just released its impressive report Impact of Regulation on the ALM of European Pension Funds. Even though we disagree in some instances, we think this is mandatory reading for anyone in the pensions investment space because it highlights those areas of regulation which will be of increasing consequence for pension funds' investment strategies in the near future, as we have continued to stress over the recent past.

At the core of the report is the development of an asset allocation model in the presence of liability constraints. The solution involves the components cash, risky assets and the liability hedging portfolio. The state of the art model takes inflation and longevity risk management into account as well.

There is not enough space nor time for an in-depth review of this valuable piece. Nevertheless, I would like to mention two issues that have slightly moderated my enthusiasm for the report:

• There seem to be a few at least implicit factual inaccuracies in the parts describing the regulatory environment. The most glaring of which may be the assumption that the EU pensions directive is applicable in Switzerland - it is not.
• Accounting standards seem to be understood to effectively determine investment action. While it is not unheard of that managements structure transactions in such ways as to optimise their reporting, this clearly goes one step too far. We are well aware of the interdependence between perception (qua accounting standards) and (economic) reality, but at least in an academic report, the latter needs to retain some vestige of predominance over the former. Remember: pension funds' long-term time horizon, as accounting standards can and do change.

Accounting standards - pass or fail?

Swiss economic semi-weekly Finanz und Wirtschaft had a lead article�(in German) by Prof. Straubhaar the other day with which I almost entirely disagreed. In short, he gave international accounting standards a fail because they amplified the financial crisis. He preferred continental accounting standards and does not even mention investor requirements. Unfortunately, this reflects much of the continental European consensus, which is why �I wrote a somewhat extensive rebuttal.�This was published today.

New online resources

The design is about as appealing as can be expected from a body of professional accountants, but we are talking about the newly free access to an important part of the world's economic operating system, namely International Financial Reporting Standards, together with the statements of International Financial Reporting Interpretation Committee (IFRIC) and Standing Interpretation Committee (SIC). Now we have the narrative to go with the taxonomy ...

Slightly less globally relevant is the recent availability of the Swiss XBRL Jurisdiction's website.

XBRL presentation in Brussels

Here are the slides of a presentation I gave a few days ago at the Brussels Stock Exchange. That was probably the most splendid place I spoke at to date.

Finance 2.0

View more presentations from SCFAS. (tags: cfa accounting)

In the balance

The latest issue of the CFA Magazine has an article that I penned about accounting politics, meaning the high-risk game that high politics is playing with the international accounting standards setting process. The issue has been dormant during the last few weeks, but is sure to come back with a vengeance shortly, i.e. during the G20 meeting on 2 April in London. Comments, as always, are highly welcome!

XBRL final rule imminent

Well, we've got something wrong there, it seems. It wasn't the US SEC meeting deliberating on the final XBRL rule that was scheduled for 10 December, it was a Sunshine Notice�to announce the SEC meeting of 17 December. But what's a week in the greater scheme of things ...

Speaking of which - it's interesting to note that one of the seven milestones on the road to IFRS adoption in the US is going to be improvement in the ability to use interactive data for IFRS reporting (p27 ff). Specifically, the SEC would look for a more detailed IFRS taxonomy in its 2011 review, presumably containing standard industry extensions. Thus, XBRL has just been hiked up to a critical priority in a strategic project.

Accounting politics

On Saturday, Finanz und Wirtschaft has published an article of mine in which I discuss�the background to the current tensions in accounting politics between the EU and the IASB. To the casual observer, this conflict may look like it is entirely related to the financial crisis, but it is more about the independence of the IASB than anything else. That's where the interest of every investor should come into the equation.

Innovative ways of financing retirement

In this day and age where financial innovation is (wrongly!) blamed for the end of capitalism and the world as we know it lock, stock and barrel, the title of SwissRe's latest edition of Sigma is courageous. Nevertheless, it is a comprehensive assessment of the growing role that insurance will have to play in the provision of old age retirement funding, where insurance is to be understood in a functional rather than an institutional sense.�

An important section of the study is dedicated to managing retirement product risks. Longevity risk is identified as prominent among them, but its management is limited by the rather shallow depth and breadth of longevity risk markets. Notably absent from that section, however, are considerations on valuation techniques. If there is one thing that we can learn from the current crisis, then it is how crucially important it is to value & stress test innovative products properly over their entire life cycle.

Confidence in accounts

Today's FT has an article referring to a letter that we've co-signed. The letter's signatories object to the ongoing political activism to relax accounting standards relating to the measurement of financial instruments.�

I am concerned that this is the most ill-conceived part of ongoing bail-out activities, which have started on a wrong footing and which threaten the long-term functioning of capital markets through political interventionism rather than a calm hand. Corporate accounting is aimed to reflect economic reality, and thus must not be subject to political fiat. The current thrust of activism aims to put the ostrich's head back in the sand. But guess what - it doesn't belong there! The consequence of such ill-advised changes would be that users of financial statements will loose confidence in corporate accounts, which is expressed directly in valuations. So, the effect will be contrary to intentions.

The fair value mindset

I like what the Chief Accountant of Xerox is reported to have said at the recent SEC round table on fair value reporting - but probably not in the way he would like me to. In essence, he says that fair valuing financial assets/liabilities is ok, whereas for operational items of non-financial firms it is not as it introduces volatility beyond the firm's control - they are used to mixed attribute accounting. And "managers will have to train themselves to think like market participants rather than operations experts".�

There is a lot to discuss there - but I'll try and make it short. Even operations experts should eventually think like market participants because economically, they need to take into account opportunity costs of their operational decisions, not least because their successor (average tenure, anyone?) or their boss might think like market participants ... Externally induced volatility is not a problem if it is real (and not an accounting artefact introduced by mixed attribute accounting), because it can be filtered, and users build confidence when they see it. Operational performance still remains visible. They like mixed attribute accounts? How dare they perform even the most basic arithmetic operations on numbers that do not have the same measurement attribute? Because it has been done for a long time and they are used to doing it does not make it any more sensible. So yes, I am in favour of full fair value, because financial reporting is made for users, not for managers. But I agree, there are some transition issues.

Pensions webcast

In yet another effort to increase its accessibility, the IASB makes its first ever recorded webcast about its recent pensions DP available to the public on its pensions project site. The webcast had about 120 participants and the included Q&A session was rather good.

I think that the IASB ought to add public webcasts to its ongoing projects due process. The ease of (global) participation and dialogue would enhance the reach of the IASB's due process to a new group of users (of financial statements) which was hitherto unreachable due to lack of time and attention.

Reducing Complexity

The IASB has made its discussion paper Reducing Complexity in Reporting Financial Instruments publicly available now. As complexity is a charge often raised against current accountancy trends by people who are either not aware of or uncomfortable with the more conceptual approach towards accounting used by the IASB, it would be interesting to observe the conclusions drawn in that paper. To make a long story short, I am quite happy with the outcome, namely that the DP accepts that fair value "seems" to be the only measure that is appropriate for all types of financial instruments, then going on to list no less than 24 different measurement methods for financial instruments (table 1). Some random thoughts in that context.

Complexity is bad. That seems to be the tenet of the proponents of reducing it. I tend to disagree, however. In line with Einstein's razor, there is a place for complexity in financial reporting where it faithfully represents economic reality. Complex economic reality necessitates an adequate level of complexity in its description, lest it over-simplifies. Where, however, complexity is merely a consequence of accounting artefacts, it may safely be dispensed with.

Fair value vilified. It is interesting to observe how some people try to make a case against fair value from the current financial market crisis, even though it is quite obvious that this is a clear case of trying to kill the messenger. This position is particularly difficult to understand coming from people with a background in engineering or science. There, it's evident that two variables can only be combined if they have the same unit of measurement: you cannot add metres and kilograms. In accounting, though, that seems to work just fine - it's currency units, after all. Or is it? Notionally, it certainly is, but I'd challenge anyone out there that a $'s worth of an asset measured at cost is very different from the same $ measured at, say, fair value. In short, the unity of measurement is an illusion under the mixed attribute model.

Don't miss!

On Thursday, 27 March the IASB is going to release its long expected discussion paper on post employment benefits. Don't miss IASB member Steven Cooper's live web presentation introducing the discussion paper from 1200h to 1230h (UTC). You can register for the event here.

It may be interesting to compare the IASB's position to the previously released paper of the UK ASB on the same topic. My guess is that the ASB's position will prove to be more aggressive, especially with regards to the highly controversial use of risk free interest rates to discount pension plan liabilities.

New pensions accounting to raise volatility

CFO.com reports Georgia Tech Financial Analysis Lab's research on�The Effects of Enacted and Proposed Pension Accounting Changes On Leverage, Profitability and Earnings Volatility, in which researchers simulate the impact of probably forthcoming accounting for pensions changes in the US on the DJIA components' income statement, extrapolating FAS 158 numbers to be run through the income statement. Unsurprisingly, they find a huge impact on the volatility of reported earnings, among other items and ratios. In the 2002-2006 period, volatility effectively doubles.�

As FAS 158 is likely to inform the ongoing work on the revision of IAS 19, this kind of research is valuable for European users, too because it allows us to get used to different accounting treatments resulting from fair value accounting. It is important to keep in mind that these accounting rule changes will bring reported numbers much closer to economic reality than current accounting treatment ever can. If this increasing transparency leads to more sustainable risk management policies in enterprise sponsored retirement plans, then so much the better. Users of financial statements will be able to adapt their interpretations of the numbers in any case.�

Assurance cost and disclosure neutrality

Here is the cross-post of a short entry that I wrote for the Data Interactive Blog.

Skepticism about XBRL seems to abound lately, although most of it is easily soothed. One issue stands out that may raise the hackles of preparers particularly: If XBRL were to have the same costs as Sarbanes-Oxley Section 404 implementation because of independent assurance, as one Reuters story suggests, that would be a big No-No indeed.

However, looking at the Committee?s draft memo (page 75 and after), such dramatic headlines need to be taken with a ton of salt. Substantive assurance costs (if any) are likely to arise only if the production of XBRL formatted data were implemented in the least competent way imaginable, i.e., by means of what might be described as a parallel XBRL track of accounting. To assume that this is the default practice would not exactly reflect high expectations with regards to the professional competence of finance departments.

One of the basic tenets of XBRL disclosure is that it is in fact disclosure neutral, i.e., the numbers displayed in an XBRL instance document are identical to what is reported on (electronic) paper. For as long as XBRL filing is not the exclusively permitted way of filing, assurance of disclosure neutrality probably satisfies the needs of most users of financial statements. In a reasonably well structured accounting & auditing cycle, such assurance should come cheaply.

The future of public pensions

Richard Ennis' article�in the current issue of the Financial Analysts Journal may be aimed at the�ailment�of US public pensions, �but its tenets are equally applicable to European (including Swiss) public pension plans as well. A key issue is that of valuation, where current actuarial valuations are traditionally predominant under the pretext of perennial solvency of the state sponsor. Ennis convincingly demonstrates that the "issues are the value of the obligation, the cost to extinguish it, and on whom the burden of that cost falls. In a word, the concern is accountability." From a Public Choice perspective, his tenets are unlikely to be put into action just now, unfortunately. The increasing gulf between public and private pensions will have to get wider before this can be addressed fundamentally.�

CDI vs. LDI?

Wilshire has a fairly interesting white paper out with the title Commitment-Driven Investing (CDI): LDI as We 'C' It. The paper's rather semantic focus on commitment rather than liability is probably a consequence of its US accounting context, so we are not going to hold that against it. The thrust is certainly correct, namely that CDI, i.e. the Wilshire variety of LDI is aimed at managing the true economic funding ratio of pension plans and is therefore inherently a risk management technique.�

Confusing at best however is the frequent reference to two equally important (but partially conflicting) goals of CDI, whereas the only correct objective (from the sponsor's perspective) must be to minimise the cost of running the plan at a given level of benefit security. Also, the authors seem to be struggling - quite fashionably, one might add - with the rationale behind marking-to-market of pension liabilities. The impending revision of IAS 19 will deal with that issue.

Their conceptual conclusion, nevertheless, is an intriguing one: The�commitment discount rate is set to be a random variable described by the expected inflation characteristics of the individual plan's benefit stream. This is where the authors can start their optimisation engines, hopefully without being blinded by the light of past correlation stability.�

While we feel more comfortable with the more comprehensive approach recently proposed by Waring & Siegel, the authors deserve a prize for originality as this paper is the first that I know of to include the complete lyrics of a Springsteen song.

XBRL advisory council

The International Accounting Standards Committee Foundation (a.k.a. IASCF) today announced�the formation of an XBRL advisory council, which I have the honour to say that I am a member of on behalf of the CFA Institute. I am looking forward to contributing my small share to the further establishment of XBRL as a major agent of change in the preparation, dissemination and use of financial reporting.

Impact of funding risk

Interesting material our way comes! Watson Wyatt has had a close look at the funding status of Fortune 1000 companies 2004 - 06 with effective numbers becoming available for 2006 thanks to FAS 158. WW has developed a Pension Risk Index, which estimates the loss of the pension plan in percent of the corporate's market cap at a 5% probability of unfavourable market conditions, given the plan?s asset allocation, liability structure and sensitivity to interest rates.

An excellent article in the current issue of the Financial Analysts Journal goes an important step further: The author estimates the correlation between pension fund deficits and associated credit spreads. The results are statistically significant and show interesting characteristics: The sensitivity of spreads to unfunded pension liabilities is about five times larger for junk bonds than for investment grade bonds. Also, the sensitivity to pension liabilities is much larger than to ordinary long term debt - double for investment grade, triple for junk. The model was also run for samples from the UK and Japan, but those results only confirmed a generic sensitivity.

This is where the relevance of pensions for corporate finance becomes evident. We expect that the relevance will increase thanks to better, more relevant accounting information and increasing market attention.

Valuation of Swiss IORPs

Well known Swiss accounting and pensions expert Carl Helbling has a highly relevant piece on the valuation of Swiss pension schemes. In it, he comes to a rather disturbing conclusion: "Accounting standards IFRS and Swiss GAAP FER are too undifferentiated and can only be a limited basis for valuation [of pensions]." He lists a substantive number of instances, where, for legal reasons, apparent over- or underfundings of Swiss plans cannot be utilised as expected economically. Thus, accounting numbers may be substantially different from effective values.

Now, this is not exactly news as IAS 19 is hardly known to reflect economic reality thanks to its built-in shortcomings. But the instances listed do not even appear to be related to IAS 19 features to start with, but rather to what needs to be considered as accounting artefacts in the light of (legal) reality. One wonders how such numbers can be presented as true and fair?

Conference presentation

A few days ago, I've had the honour to address the first IASCF conference in Asia in Singapore with a presentation about the CFA Institute's Comprehensive Business Reporting Modell in its final version.

IFRIC 14

For those happy few of our readers with only a cursory interest in pensions accounting, KPMG's IFRS Briefing Sheet summarising IFRIC 14 on IAS 19 might just do the job.

Mapping standards

Another interesting report from KPMG UK! This one creates a list of accounting items and maps those to the appropriate standards in IFRS and US GAAP, respectively. A 144-page "overview" is available for free download. However, it may soon be obsolete if the SEC permits US corporations to report using IFRS ...

New interpretations for IAS 19

IFRIC, the International Financial Reporting Interpretations Committee has issued an important interpretation of the limit on an asset recognised in the surplus of a defined benefit plan under IAS 19. Especially the treatment in the presence of minimum funding requirements is of interest in the European context. IFRIC 14 is only available to eIFRS subscribers, but its draft is openly available.

The quest for a global language

KPMG UK has an extensive new report about accounting out. It is a collection of essays from accounting dignitaries across the world and across different stakeholders, covering all relevant topics in accounting now that the first IFRS reporting period has been completed in the EU.

Auditing fair values

CFO.com has a short, but great story about the challenges in auditing fair values and the US PCOAB's response to the requirements of FAS 159. Without auditors (and accountants!) getting fair values right, they will never get off the ground.

Incentives for DB plans

The Governor of the Bank of Canada, Mr David Dodge, has been singing defined benefit pension plans' praises in a recent speech. He recognised that "an effective defined-benefit pension system is a tremendous asset for individuals, for employers, and for our society as a whole", but is currently hampered by a number of disincentives, which favour DC over DB for sponsors. Specifically, he lists

uncertainties over the legal status of actuarial surplus

overly restrictive solvency requirements,

transition from smoothed accounting numbers to fair value accounting

group longevity risk

insufficient transparency about cost / financing of newly introduced benefits

lack of large multi-employer DB plans.

We agree with both parts of the analysis, namely that DB plans are preferable to DC, and that there is currently a lack of incentives for DB plans. We strongly disagree however with Mr Dodge's opposition to fair value accounting. He claims, essentially, that we are not interested in today's values, but in expected values far into the future. We think that analysts of pensions are very much interested in today's values. For one, every expected future value can be discounted to a current present value (assuming that the term structure holds). Thus, Mr Dodge's distinction would essentially become moot.

More importantly however, it is not at all clear at which specific point "far into the future" the expected value would need to be formed - surely that cannot be discretionary? How about changes to those expected future values, based on variations of underlying assumptions? Finally, the volatility introduced to sponsors' balance sheets is not artificial, it's an economic fact. Cognition of that fact is a prerequisite of sponsors' ability to manage the inherent economic risk of their DB plans and, therefore, an enabler of an effective defined-benefit pension system.

Corporate Finance meets pension management

"Pensions are being transformed from off-balance sheet operations with results smoothed over many years, to large consolidated business units with high potential short-term volatility, bringing them to center-stage for executive managers."

Earlier in the year, JP Morgan has come up with a white paper that is very much in line with our thinking: Corporate Finance meets Pension Management: A new era for pension leaders. The paper is obviously targeted to the US market struggling with implementing the Pension Protection Act of 2006 and US GAAP SFAS 158, but as accounting (and regulation) follows economics in Europe, too, Europeans are well advised to consider this a sneak peek preview of their own not too distant future.

JP Morgan established a set of three strategic pension metrics, namely shareholder equity at risk, corporate cash flow at risk and earnings at risk. These metrics measure the impact of pensions on the respective variable of the sponsoring corporation. Putting the metrics into action will lead to important changes in the pension plans' risk exposure: JPM expects a shift from the currently too high equity exposure into an allocation of 25%-35% in non-traditional assets. As the paper originates from JPM's asset management arm, I have a feeling that the wish may have been father to the thought ...

Mortality assumptions

Today, the 7th Annual Conference of the IEBA has been brought to my attention because of its several presentations about pan-European pension funds (scroll down to Past Events).

While the presentations themselves did not strike me as out of the ordinary, I noticed the slides of an earlier event about mortality assumptions used in the EU. The slides present a good overview of this important paper. Most notable is the slide shown on the side. It displays the difference between observed and assumed future life expectancy of pension scheme members across a number of countries. The difference varies widely with Denmark, Switzerland & Germany showing the slightest differences whereas France, Spain and Ireland have the most "longevity reserves" built into their mortality assumptions: a plan using French mortality assumptions will show considerably higher liabilities than the same population of beneficiaries subjected to Danish assumptions.

Esse est percipi

McKinsey Strategy has a good piece on why accounting shouldn't drive strategy, exemplified with pensions accounting. While I fully agree with that statement, I think it's quite idealistic to the point of being utopian. It would be utopian to expect of preparers that they wouldn't use the possibilities they have to look as good as they possibly can. A mild form of such behaviour would be just presentational, i.e. immaterial, but as we know, accounting often drives transactions without any real economic motivation.

The only way out of this quandary is to devise financial reporting standards that make sense economically, i.e. under which you can only look good if you behave rationally economically. This is the purpose of the CFA Institute's Comprehensive Business Reporting Model with its thrust for full fair value accounting. That's when accounting comes full circle with enlightenment philosopher George Berkeley: Being is perceiving and being perceived.

Breakthrough Ideas for 2007

XBRL features as #10 (of 20) in the Harvard Business Review's List of Breakthrough Ideas for 2007. Other ideas we find particularly interesting are #4 (algorithms), #7 (partial attention), #13 (patriarchism) & #20 (accountabalism), of course.

Transparency in Greece

It was very interesting to contribute to the Greek Capital Market Commission's conference on the interaction between regulatory authorities and supervised entities and market competitiveness in Athens yesterday. Here are the slides of the short presentation, and this is an audio recording of it.

Pensions risk

Mercer HR has a new Global pensions risk survey which looks at the way corporations perceive their pension plans with regards to their risk exposure. It contains a fresh view in so far as it doesn't consider plan coverage, but rather the risk that the sponsoring corporation is exposed to through its plan. Those risks are widely considered significant, with important differences between the US and Europe. Furthermore, a majority of corporations either doesn't know how analysts assess the impact of pensions on corporate valuations, or they think it's done inaccurately.

In the light of forthcoming pensions accounting that is set to better represent economic reality, this survey is relevant. It indicates that the market is already moving in that direction, but possibly also that risks are currently overestimated (or advantages consequently underrated) because of a lack of precise information about corporate pensions exposure and ways to manage it.

P.S. CFO.com has another good summary.

Stability or transparency?

Here is the text of a short presentation I gave this morning on the occasion of the General Assembly of the European Federation of Accountants in Brussels. The general consensus emerged that there is no direct connection between financial reporting at the micro (firm) level and macroeconomic stability. This differentiation is crucial in the debate.

The subsequent Panel on the Internet - An opportunity to empower investors through accessibility or a risk for the reliability of financial information? with the US SEC's CIO Corey Booth among others made me doubt whether the European profession is really aware of the drastic impact that XBRL as a disruptive technology is going to have on the financial reporting value chain.

P.S. Other conference documents are available at the FEE's website.

IAS 19 to enter the risk-return continuum?

epn has an fascinating article about a possible approach to new pensions accounting, based on deconstructing any plan's risks into four distinct risk categories, accounting for them separately:

asset value risk

interest rate risk

mortality risk

compensation risk.

This way, it should be possible to move away from the current standard's black or white approach to classifying pension plans as DB if they do not match distinct DC criteria. Much of the article is dedicated to the analysis of Swiss and Belgian plans which by law feature a mix of DB and DC characteristics that force such plans to be accounted for as DB.

Faithful representation of the economic reality of plan liabilities appears to be much better warranted under such a structured approach. Furthermore, corporate sponsors' risk management towards pensions liabilities will be much improved, if not enabled, since the industry has built a lot of experience in structured instruments. Some preparers may be fazed by the approach's additional complexity, but once they realise that it might actually help them to better mitigate risk, they ought to embrace it.

A user's view on XBRL & assurance

Please find attached the slides from a short presentation I gave at the World Congress of Accountants in Istanbul this morning.

Accounting changes

It doesn't happen often that the debate about changes in accounting rules makes the Financial Times' front page. Today is the exception to the rule. The CEOs of the global Big Four audit firms (KPMG, PwC, Deloitte, Ernst & Young) together with their colleagues from smaller siblings Grant Thornton and BDO, are calling for wide ranging changes to global accounting and auditing in a Paris Symposium. The discussion paper is available online.

While initial comments tend to be skeptical, I share the thrust of the self-proclaimed conversation starter. Comprehensive change, including efficient delivery via XBRL and fair value reporting in real time is on the agenda, but will be strongly opposed by forces opposed to change. Unfortunately, using utopian language along the lines of Huxley's Brave New World is playing right into their hands.

XBRL has been a recurring theme at today's meeting of the IASB's Analyst Representatives Group, for instance. This is no Utopia, it's just fast change. Have a look at the SEC's Chairman's comment to a blog post (via CFO.com).

IASB RSS

The International Accounting Standards Board has redesigned its website and has taken its cue from the XBRL subdomain to offer an RSS feed. Welcome to Really Simple news distribution!

IFRS from an analyst's perspective

By popular request, here are the slides from my presentation (now complete with notes) about the Financial Analyst's perspective on Financial Reporting Standards which I gave this morning at the World Standard Setters' Meeting in London.

I've also made a recording of the introduction by Warren McGregor, my presentation and the subsequent Q&A session. Unfortunately the questions are not very easily understood, and the recording cuts off after an hour. But it works pretty well for being recorded on a simple mobile phone.

SEC to Rebuild Public Disclosure System

Wow! The US SEC is rebuilding its public disclosure system entirely based on XBRL, thus "paving the way for universal XBRL filings by companies". This in effect is just short of announcing that once the three announced contracts have been completed, the SEC will introduce mandatory disclosure based via XBRL. More about this on CFO.com.

Accounting precepts

These are the 11 Precepts of the IASB and the FASB, which I've picked up during a recent meeting. They are very reasonable and appear applicable beyond accounting.

Concentrate on converging and fixing what's broken.

Reason from "first principles".

Don't confuse concepts with conventions.

Focus on the underlying real-world economic phenomena.

Weigh alternatives comprehensively and evenhandedly.

Press naysayers for better alternatives.

Be clear what the concepts mean - and don't mean.

Resist the temptation to "peek ahead".

Remember the consequences of diverging.

Acknowledge that changing thinking will take time.

Don't "Paper Over" Real Differences.

BIS on fair value

Great timing! The Bank for International Settlements (BIS) has just published a series of four papers on fair value accounting:

208: Including estimates of the future in today's financial statements

209: Fair value accounting for financial instruments: some implications for bank regulation

210: Institution-specific value

211: Do accounting changes affect the economic behaviour of financial firms?

Why is this great timing, you may wonder? Well, it is very useful material for my upcoming presentation at the World Standard Setters Meeting in London on 26 September.

Pension deficits: up & down

What I wouldn't find myself on Mercer's website, Google did for us: Here is Mercer HR's recent summary report about top UK and European companies' pension exposures and trends as at 30 June. The charts & findings are interesting, but I am not entirely convinced about information consistency, what with this being rather novel concepts for many of the preparers.

IAS 19: new draft interpretation

On 24 August, the International Financial Reporting Interpretations Committee (IFRIC) has released a draft interpretation of IAS 19 for public comment until 31 October. To quote from the IASB's website: The proposals clarify how to determine in normal circumstances the limit on the asset that an employer?s balance sheet may contain in respect of its pension plan as well as how the pensions asset or liability may be affected when there is a statutory or contractual minimum fu nding requirement.

As Swiss pension schemes are subject to statutory minimum funding requirements, this new IFRIC interpretation should come under close scrutiny in Switzerland.

Accounting for Pensions [UK]

The Economist has a summary of the recently published Annual Survey 2006 of Accounting For Pensions UK & Europe by actuaries Lane, Clark & Peacock. Unfortunately, the summary only covers the British part of the survey, which continues the proud tradition of differentiating between the UK and "Europe".


LCP has surveyed the component firms of the DJ STOXX 50 index. While the disclosure quality has risen overall, it is not yet at the same level as the UK's, which has been substantially improved following a recent appeal by financial analysts based in London. A similar appeal obviously is required at a pan-European level now! The common denominator of the survey's findings is that despite of a considerably more narrow basis of reporting standards (from 12 sets down to 4), the amount & quality of information vary as widely among the sample as the material information itself, as can be seen from the interesting table above (click to enlarge). Strangely though, an entire section of the report is dedicated to to the analysis of an unadjusted corporate average deficit per country. This ratio does not seem to have any relevance whatsoever.

US Pensions accounting

Since David Zion's piece Analyzing the Impact of Retirement
Liabilities has pensions accounting under US GAAP for object, it is prima facie not relevant for the purposes of this blog. However, such a standpoint would clearly be too short sighted. Both the US FASB and the IASB are currently preparing to revise their respective pensions standards with a view to a converged standard, fully cognisant of the very large importance of pensions on the corporate balance sheet, and the potentially even more severe impact on its cash flow statement. I am sure that standard setters will read such scathing criticism from investors of the current standard very carefully, especially since most of the provisions addressed are common to both sets of standards.

Liability Driven Investment

JPMorgan has a very interesting new survey of liability driven investment (LDI) across Europe (via epn). LDI uses characteristic parameters of scheme liabilities as benchmark and is therefore most relevant to DB and guaranteed return schemes (such as the Swiss).

The survey has the best coverage in the UK, the Netherlands and Denmark / Sweden (where the regulatory environment are rather similar). The survey looks into attitudes towards LDI, asset allocation impacts, the ongoing duration mismatch between liabilities (ca. 20 years) and assets (still below 10 years), derivatives strategies (mostly the usage of swaps) and funding levels with a significant difference between UK deficits (74% of schemes in deficit) and other countries' schemes mostly covered or in surplus.

Pensions accounting

This interesting overview article in epn discusses the current state of affairs and expected developments in accounting for pensions in US GAAP, UK GAAP and IFRS (changes to IAS 19), largely from the perspective of users of financial statements. As the proposal to revise IAS 19 is currently working its way through due process, it is expected that the revised standard should become effective in four years.

Usefulness of IFRS in Europe

A new PwC survey of UK fund managers offers a rare & differentiated, therefore highly relevant glimpse of the usefulness to users (i.e. investors) of the first wave of European financial statements that are prepared under mandatory application of IFRS. The survey looks at diverse issues like the usefulness of IFRS vs. UK and US GAAP, support for fair value, the impact of the IFRS angle on investment decision making etc and displays the change of such perceptions over the recent past. I hope this survey will be continued in the future and will be extended to other European countries!

Convergence conference materials

Regular readers of this blog will be aware that my contribution to the IASCF's Frankfurt conference was available online. The IASB has now published all conference materials on their own website.

Proposed changes to FRS 17 [UK]

The British Accounting Standards Board has issued for comment proposed changes to its FRS 17 Standard on Retirement Benefit reporting. These modifications would take into account recent changes in the UK regulatory environment and would align FRS 17 more closely with IAS 19, its international counterpart. Both IAS 19 and FRS 17 are subject to an ongoing fundamental review which is expected to result in the removal of valuation corridors. This will lead to a more faithful representation of the economic nature of the relationship between pension scheme and its sponsor.

Contingent assets in UK pensions [UK]

The UK Pensions Regulator has issued guidance today on the usage of contingent assets in funding pension schemes. This is of particular interest to pan-European schemes since they require full funding.

A contingent asset of a pension scheme generally will be treated as a contingent liability of the employer. According to IAS 37, such contingent liabilities usually will not need be recognised in the employer's balance sheet, but require disclosure only. Therefore funding pension schemes by means of contingent liabilities may be an attractive funding option for employers.

Transparent longevity assumptions

Interesting! Following a January call of an informal group of London's leading investment bank and fund management analysts (the "Corporate Reporting Users Forum"), a number of companies have started publishing and thus exposing to be challenged their longevity assumptions used for the valuation of pensions schemes, which are obviously critically important (via FT). Virtually at the same time, an assessment of pensions liabilities of 26 Swiss SMI-component firms has been published (via Vorsorgeforum). The average discount rate applied, while being in line with Swiss legal requirements, is an unsustainably high 4.25% (down from 4.61%). I suspect that longevity assumptions are not published.

This is precisely the way ahead with full fair value valuations as well, especially in those cases where price information is not directly attainable. There needs to be a critical dialogue between users and preparers of financial statements concerning assumptions used. This dialogue obviously checks preparers' position of power, which is probably why they are often reluctant to participate in that dialogue.

Pensions in M&A

While this highly acclaimed new Corporate Finance textbook with its fresh angle from political economy doesn't even mention pensions as an index entry, this interesting IFRS update article makes the point that - even under the regime of IAS 19 - pensions need not be a deal breaker, they are merely an important pricing factor.

If that is so, then there is probably a case to be made for consolidating a firm's pensions operations in one European IORP, especially if the transaction reaches across borders. In a takeover, the seller will be able to put a price tag on improved transparency and risk management capabilities of such a structure, as opposed to the incumbent compartmentalised country solution. This better price tag is likely to go some way in covering the set-up cost of setting up such structures.

Convergence

I've been invited to speak at the IASC Foundation Conference in Frankfurt about financial analysts' views on convergence of accounting standards, specifically the convergence of US GAAP and IFRS. Rather than going into the details, I addressed the direction which convergence should take in the longer term by summarising the 12 principles of the Comprehensive Business Reporting Modell of the CFA Institute. There were a lot of sceptic vibes to be felt from the huge audience (some 400 people), especially from preparers of financial statements about the full fair value postulate. But there you are: debate is only advanced by bold ideas - I think I can say that since those ideas are not mine alone. The presentation is available online.

The end of net income?

It was very interesting to participate in a rather controversial roundtable organised by Universit� Paris-Dauphine on the subject of net income and performance reporting. The fact that the event was held in French posed quite a challenge, but I hope that my presentation was comprehensible nonetheless.

IFRS convergence & consistency

The documents and transcripts of the FEE Seminar on IFRS Convergence & Consistency are finally available. The seminar took place on 1 December 2005 in Brussels and I was asked to represent the views of financial analysts.

Spinning pensions

This excellent article in the Economist reminded me of an important paper that has been on my To Read List for way too much time without careful consideration. The paper evaluates DB pensions schemes from a strictly economic point of view, which has striking - and disagreeable, in the present environment - consequences. Much of the British pensions crisis can be attributed to changed views as a consequence of this.

What is the situation in Switzerland? In the UK, it is mostly actuaries who evaluate pension schemes, and the profession has a bit of a cartel in opinion making. This cartel has decided to adopt an economic view. In Switzerland, critically important rates (technical interest rate, the conversion rate) are defined legally and subject to political opinion making. This rates have been fixed in a period when interest rates were considerably higher, and to adapt them to economic reality now would create a lot of pain. But this is the nature of the ficticious contract of generations: the present generation fixes the terms of the contract for its own benefit.