"Spineless?" UK Pressure Targets Fair Value Weakening

Members of the Treasury Committee of Britain's House of Commons asked razor-sharp questions about the independence of the International Accounting Standards Board today — and especially IASB's relaxation of fair-value accounting rules to help banks weather the credit crisis.

"Spineless? Caved-in?" said Labor Party MP John McFall, the committee chair, as he crisply opened the hearing on "accountancy and the banking crisis." He then made a one-word demand of the man being questioned, IASB Chairman David Tweedie: "Answer."

Since early October, IASB has been under fire for reportedly submitting to political pressure in softening the accounting rules in the face of financial pressure on Britain's banks. One complaint against IASB has been that it sidestepped due process to rush out a rule allowing financial institutions to reclassify some loans as a way of avoiding marking those assets to market. By eschewing fair value accounting, the banks also avoid losses generated by a drop in asset value.

Critics of the fair value accounting — which includes banks — blame the methodology for exacerbating the current credit by forcing companies to take unnecessary writedowns on illiquid financial assets.

Tweedie said that the board had little choice but to rush through the rule changes to IAS 39 and IFRS 7 because the European Commission was bearing down on the organization and threatening to pass legislation that would allow reclassification of loans without also requiring proper controls or disclosures. Tweedie asserted that IASB faced a standard-setting dilemma that he hoped he would never encounter again — "a blunt threat to blow the organization away ... and that came very, very rapidly."

Tweedie explained that IASB first heard about the draft legislation in a speech by the EC commissioner, in which he proposed mandating a "carve out" or exception to the existing rules. The legislation, if passed, would have allowed banks to reclassify "held for sale" or "held for trading" loans to "held to maturity," effectively permitting banks to avoid losses associated with fair value accounting. The EC had a competitive reason for promoting the rule change. According to an Oct. 7 statement, the EC wanted to avoid "any distortion of treatment between U.S. and European banks due to a difference in accounting rules."

Quickly, IASB decided to speed through the rule change by adopting its American counterpart: FAS 115, which places restrictions around the reclassification process and includes disclosure requirements. "I think accounting in Europe would have been totally out of control if they had taken the option to go with the [EC] carve out," Tweedie told the HOC committee, which has oversight responsibilities for the UK Treasury, Revenue & Customs, and associated public bodies, including the Bank of England and the Financial Services Authority.

Originally, IASB expected to have at least a week to work through the EC draft to make sure it was aligned with U.S. generally accepted accounting principles and the ongoing convergence project between IASB and the U.S. Financial Accounting Standards Board. "But we didn't have a week, only a matter of days," noted Tweedie, who said it was important to investors to push through a rule change that included restrictions and disclosure requirements.

Although it did not have time to discuss the changes with constituents, IASB did consult with FASB, the U.S. Securities and Exchange Commission, and auditors, on whether the rule meshed with U.S. standards. Nevertheless, Tweedie insisted that the EC's draft legislation was a "surprise" that "came out of nowhere," and that the EC version would have brought about a "standard free for all" if IASB had not bypassed its due process.

Tweedie acknowledged that he could not guarantee that the EC would stay clear of the standards setting process in the future. In fact, Tweedie admitted that the independent status of the IASB had been damaged by the incident, and that he considered resigning.

But he stayed on because "I wanted win this one," he said, referring to the board's efforts to guarantee its independence against European political pressure. One way to fight back, opined Tweedie, is with the upcoming trio of roundtables that IASB has scheduled in conjunction with FASB, in which experts representing all constituents will come together to discuss accounting issues arising from the global credit crisis.

However, the reclassification controversy may have just been the opening salvo in the battle for IASB independence. On Oct. 27, Jorgen Holmquist, the EC director general for Internal Markets and Services, sent a letter to Tweedie noting that the commission welcomed the IASB's "prompt response" to the reclassification rule change, and continued that: "We now expect that IASB clarify certain practical aspects to ensure the effective implementation of the recently adopted amendments to IAS 39."

Further, Holmquist wrote that the endorsement of the IASB's recent amendments to IAS 39 and IFRS 7 on Oct. 15, "was only a first step in an ongoing process to comprehensively address accounting issues raised in the context of the financial turmoil."

According to the letter, the EC wants the IASB to come up with solutions for three fair value issues in time to incorporate the accounting changes in end-of-year results. Broadly, the EC would like IASB to extend the reclassification of assets beyond "held for trading" loans, and apply it to other financial assets that are currently recorded at fair value. In addition, the commission is looking for clarification regarding whether synthetic collateralized debt obligations include embedded derivatives. Finally, the EC wants to see adjustments to impairment rules that apply to available-for-sale financial assets.

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