The IAS Regulation will require all listed companies in the EU to prepare consolidated financial statements under IFRS. Member States will also have the option to permit or require other companies to prepare single company or consolidated financial statements under IFRS.
Use of IFRS will facilitate the comparability, reliability and quality of financial reporting. For this reason it is essential that the Regulation be a success. It is crucial, therefore, that there is effective enforcement of all IFRS in place by the 2005 deadline.
Having studied the mechanisms currently in place, and considered the further steps necessitated by the IAS Regulation, FEE has just published a Discussion Paper on Enforcement of IFRS within Europe. The paper concludes that urgent action is necessary to ensure that effective European enforcement of IFRS becomes a reality.
The wider corporate governance issues should be noted; an effective system of enforcement requires that all those with an influence on financial reporting play their part. FEE believes that there is a need to strengthen corporate governance arrangements so that they are equally effective across Europe in relation to financial information using IFRS. It is important that the enforcement body supports the effective functioning of the roles of management, Directors and the Supervisory Board or the Audit Committee and the external audit.
In the vast majority of cases, the combination of careful preparation, review and approval within the reporting enterprise and high quality external audits by the statutory auditor ensures that errors and omissions are avoided. The enforcement mechanism provides an additional safeguard to maintaining confidence and reliability of financial statements. The appropriate means of rectification of incorrect financial information should range from restatement of defective financial statements to subsequent disclosures or other forms of publication.
The primary emphasis of an enforcement body should be on correcting inappropriate application of IFRS, so that the integrity of financial information is upheld. While sanctions are an essential feature of effective enforcement, the means by which they are applied can vary. They should not involve an additional system to those already in place through other legal or regulatory arrangements. The new enforcement system for Europe should be accompanied by broadly equivalent sanctions.
Ultimately the objective should be to establish one enforcement system for all those that use IFRS throughout the world. However, a single enforcement system is currently an unrealistic goal. Therefore, European enforcement should be built on effective national enforcement bodies, with a European level coordination.
All EU Member States are recommended to review their arrangements for enforcement. In countries where such an enforcement body does not exist, it is recommended that an enforcement body be established, based on a review panel model (generating the broad stakeholder support necessary to meet the fast approaching deadline). Such a model would be sufficiently flexible to extend enforcement to all IFRS companies, including public interest companies, banks and insurance undertakings.
Although the scope could be limited to start with, ideally the enforcement system should extend to all documents that provide price-sensitive financial information using IFRS, and should not be limited to annual financial statements or just to listed companies.
It is the Committee of European Securities Regulators? (CESR) responsibility to make formal proposals at the European level on the enforcement of IFRS for listed companies. It must be remembered that non-listed companies will also use IFRS. All companies using IFRS should be subject to enforcement. Therefore it is important that effective enforcement mechanisms are also in place for non-listed companies using IFRS.
Interpretation of IFRS by enforcement bodies may give rise to difficulties. Enforcement should not result in inadvertent standard setting. In view of this, enforcement bodies should be cautious in issuing interpretations. Guidance should be referred to EFRAG and IASB to be considered for general application/ interpretation.
Furthermore, enforcement decisions on financial information prepared using IFRS need a European-level coordination in order to create a level playing field across Europe. Consistency is vital in order to avoid the unwanted possibility of ‘enforcement shopping’. A European Enforcement Coordination will require action by the European Commission, CESR and national enforcement bodies. The procedures for co-ordination will need to be carefully developed.
As envisaged by FEE, the coordination mechanism should be established as a partnership between the national enforcement bodies. Its aim should be to facilitate convergence and harmonisation of enforcement decisions. A mixed-model approach can be used, combining both the securities regulator and review panel models. The mechanism will allow information exchange on important enforcement decisions. Ideally, the coordination mechanism should be consulted before a national enforcement body takes a decision in an individual case on IFRS that could set a significant precedent of general European significance.
FEE has started a dialogue on the issues raised in the paper with primary stakeholders such as the Commission, the Committee on Auditing and CESR. If you have any comments, FEE would welcome your input.
- David Devlin is FEE deputy president & chairman of the FEE Capital Markets Advisory Group.