IFRS update spring 2006 - French resistance

In association with PwC

When the French accounting
profession became a founding member of the International Accounting
Standards Committee (IASC) in 1973 it could never have realised what an impasse
this would one day lead to.

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The main point of contention is international accounting standard 39 (IAS 39)
and its demand for derivatives to be fair-valued through profit and loss. This
apparently innocent demand, part of the 2005 package of international financial
reporting standards, has caused an outcry in French political and banking
circles.

French president Jacques Chirac famously said in 2003 that IAS 39 would have
‘nefarious consequences for financial stability’. He foresaw it leading to
volatility among banks. Today, the battle is still rumbling on, even though
Chirac did help Europe win temporary concessions for two carve-outs from the
standard.

In 2005, one of the carve-outs on fair value was given up by the European
Union, but the second, concerning hedge accounting, has been kept.

Bernard Heller and Isabelle Santenac, Ernst & Young financial services
partners in France, say: ‘All the political pressure led to the carve-out and
the French banks are more comfortable with IAS 39 now. But the problem is that
the carve-out is a transitional situation.’

Heller and Santenac say the future is uncertain, but they doubt there will be
a specific rewrite of IAS 39. Instead, they believe the International Accounting
Standards Board (IASB) will re-examine the area of fair value, financial
instruments and hedging, which would include the issues raised in IAS 39.

Storm clouds are looming on the horizon already. On 31 January 2006, IASB
chairman Sir David Tweedie told the economic and monetary affairs committee of
the European Parliament that the issues raised by IAS 39 issue were still on the
agenda.

He outlined how IASB staff were continuing to press ahead with meetings with
bankers in Europe, especially the European Banking Federation (FBE), about the
next step in solving the hedge accounting issue.

The FBE reportedly raised doubts about any future definitions of hedging and
the way it is accounted. But Sir David has not been put off. He added in his
speech: ‘Once this and the other questions about IAS 39 have been satisfactorily
answered, the IASB team will prepare material for deliberation by the full IASB
in public.’

However, some French accountants believe it is the apparently unstoppable
IASB itself that is a cause of some of the friction in France. French
PricewaterhouseCoopers partner Claude Lopater politely says: ‘The IASB process
could improve.’ He adds that accountants and companies need more time to fully
understand and respond to the mass of accounting changes the IASB has driven
through already before new rules start to be floated.

This friction between the IASB and France will not go away easily. French
banks have managed their stability and the balance between their deposits and
loans by using hedging to offset interest rate risk. French banks rely on fixed
rate loans, rather than flexible ones. Hedging has offset this risk, but it has
always been done ‘off the books’.

Gilbert Gélard, a French board member of the IASB, says this is a tricky
problem: ‘French banks do not show derivatives on the books and these
derivatives help to smooth volatility.’

However, there may be a way out of the crisis. Gélard says the key problem
with IAS 39, which, he points out, the IASB inherited from the earlier IASC, is
that it tries to use a ‘mixed model’ of accounting. By insisting on ‘full fair
value’ accounting of financial instruments, and then also dealing with hedging,
it creates a mismatch of methods.

‘The situation can’t be mended,’ admits Gélard, but there is another way of
doing things. ‘If the new system was more orientated to fair value, people would
still hedge, but there would be fewer mixed attributes,’ he says.

Gélard also believes that whatever new model of fair value accounting the
IASB and European banks agree on, in the end it will have to be globally
compatible without major carve-outs.

‘The French banks are world players now. They have to play by worldwide
rules,’ he adds.

The last point is whether the French government would be prepared to throw
another tantrum on behalf of its banking industry. In four years, when the new
system looking at financial instruments will probably be proposed by the IASB,
Chirac, who so strongly opposed IAS 39, will probably be long gone.

The two presidential favourites for the 2007 presidential elections, Nicolas
Sarkozy of the right wing UMP and Segolene Royal of the Socialist Party, are
both seen as keen on economic reform and modernisation in France. They may be
less eager to stand in the way of a global accounting model with no carve-outs,
although French banks may again be successful lobbyists when it comes to a
fight.

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