A PRIVATE member’s bill that would compel some financial institutions to prepare financial reports in parallel was designed to spark debate, said sponsor Steve Baker MP (pictured).
Due for its second parliamentary reading on 10 June, Baker said it is unlikely to be heard due to its position in the list, though nevertheless hoped the bill would lead to broad discussion and support, eventually compelling the government to take note.
The complaints aired in the bill echo those raised during the recent House of Lords auditor report; some critics have called them factually inaccurate and said that they do nothing more than rehash old complaints.
The question is, will the bill stand up to rigour or be consigned to the private member’s refuse heap, just another MP rattling his chains?
Baker took advice from Cobden Partners, a consultancy offering guidance to small countries with troubled banking systems. The bill focuses on accounting for derivatives and is based on the premise that International Financial Reporting Standards mean banks’ “true solvency” can be hidden, making them appear falsely profitable.
He said: “While complying with the rules, banks are producing accounts that grossly inflate their profits and capital,” and added “taxpayers deserve this bill”.
The problem with financial institutions’ use of global standards hinges on inconsistencies between IFRS and the Companies Act, according to Cobden’s Gordon Kerr. He argued that allowing jurisdictions to develop their own accounting standards would result in “survival of the fittest” and greater transparency.
A central tenet of the bill is that IFRS allows banks to record unrealised gains as profit, potentially paying out substantial staff bonuses on the back of these imagined windfalls. However, critics said the difference between realised and unrealised profits often hinges on whether a bank deems something realised or not, and UK GAAP could encourage banks to pointlessly realise gains for compliance reasons.
For a profit to be realised, gains must be converted into cash, as opposed to the market price increasing without the asset being sold. On this basis, banks would have to collect the cash on their investments before recording it as profit and paying out bonuses. However, experts say profits can rapidly be realised, before being recycled into equally ‘unsure’ investments, meaning that the banks’ financial status is no more secure.
The bill also claimed taht banks are prevented from making “prudent provision” for expected losses by allowing them only to record incurred losses, Opponents dismissed this concern as having little weight, saying work is already under way to move from an incurred to an expected loss model in IFRS. Standards expert David Cairns argued the model under UK GAAP was similar to current IFRS, saying judgement remains central to financial reporting and it is still the director’s responsibility to consider fiduciary duties.
The third spoke of the bill is that IFRS discourages banks from deducting staff compensation from profits, potentially inflating their bottom line. This is an argument that has blown up recently in relation to HSBC and Barclays, with critics saying the financial behemoths are not properly accounting for deferred bonuses and related tax liabilities.
Kathryn Cearns, technical accountant at Herbert Smith, said financial reporting rules vary as to when remuneration costs – such as bonuses – should be accounted for, meaning different contractual arrangements could lead to different results. When staff bonuses are committed they cannot be clawed back, and are therefore accounted for, as well as appearing in accounts when they are actually paid out. A staunch critic of the bill, she said it betrays a lack of appreciation of what banks do, what realisation is, and the legal rules behind distribution.
Kerr has hit back at critics, saying that the risk of fraud and financial mismanagement does not mean standards should be loosened and arguing that auditors are there to catch “soft” transactions motivated solely by profit realisation. He described the bill as a “close to perfect solution”, compelling banks to respect obligations in the Companies Act, adding that it is “the first rung” on the ladder of addressing the banking crisis.
As it is unlikely to be heard in parliament for a second time, perhaps the bill’s true value is as a litmus test for attitudes towards financial reporting. If it touches on shared concerns among politicians and accounting experts, it will surely be taken up as a fresh attack on IFRS and a new force to rally behind. If it passes with barely a ripple, the authors may have to accept that they are isolated in their fears and are not to be the new crusaders of transparent financial reporting.
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