Turning a new page

Recent proposals from Lord Turner of the FSA and Sir David Tweedie of the
IASB for a new ‘regulatory page’ in company accounts – that is, separating
regulatory requirements from the accounting requirements of the capital markets
– are certainly worth exploring.

The financial crisis has led to pressure for a system that requires banks and
other financial institutions to smooth incomes and balance sheet variations, so
reserves could be built up in good years to provide a cushion against future

This pressure is legitimate. But if results were smoothed, the figures in
each year’s financial statements would not be a fair representation of the
outcomes for any year. Hence investors and analysts in the markets would not be
provided with the information they need to judge a company’s performance, and
thus to price capital efficiently.

The efficient pricing of capital is of benefit to everyone in society and, in
view of the size of the markets, even a small diminution of the information
needed to price securities accurately would have a significant negative effect
on the wealth of the world.

But the point about the efficient use of wealth is a technical matter, far
less visible to the public, the politicians and the press than the need to have
some buffer against bad times. It is easy to understand the regulatory pressure.

The answer to this dilemma is to show the prudential figures in a separate
section, as Turner and Tweedie propose.

This is the correct solution and the obvious solution. In the past, many
regulators have thought to regulate on the same figures as used by the capital
markets and, as a starting point, that appears to be reasonable. But, on
analysis, it can be seen that the aims are different and a separate solution is

Nor will the outcomes of a regulatory section in the financial statements be
difficult to understand.

Indeed the “fair representation”, as provided to the capital markets, will be
more useful if the outcomes can be judged in the light of the prudential
figures. And the regulatory figures will be auditable under rules laid down by
the regulatory authorities, hopefully internationally agreed and put into
accounting standards by the IASB to achieve coherence.

This discussion also raises the point that there are other aims which,
however valid in themselves, conflict with the aim of providing investors with
what they need. For example, some of those vitally interested in corporate
governance have argued – as have some regulators – against fair values for some
financial instruments. So perhaps we need a separate section for corporate
governance as well.

Again, such separate sections would not make the financial statements less
accessible – quite the contrary. The aim of each section would be clear and the
outcomes understandable, whereas the attempt to satisfy conflicting aims in the
same figures can only produce confusion.

David Damant is chair of the Consultative Advisory Group of the
International Auditing and Assurance Standards Board

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