International regulators should make sure that companies, auditors, and the European Union do not have undue influence on international financial reporting standards before the U.S. considers adopting them, the Council of Institutional Investors (CII) wrote in a Nov. 9 letter to the U.S. Securities and Exchange Commission.

"[A]t least three related … issues should be resolved as soon as possible and certainly before the [SEC] considers allowing U.S. issuers to prepare financial statements in accordance with [International Financial Reporting Standards]," CII General Counsel Jeff Mahoney wrote in the letter. These issues include the funding sources for the International Accounting Standards Board (IASB), the European Union's influence over the approval of standards, and the lack of sufficient investor representation on the IASB's 14-member board.

The SEC is considering allowing U.S. companies to use International Financial Reporting Standards (IFRS), the accounting rules set by the IASB, in addition to, or instead of, the Generally Accepted Accounting Principles (GAAP) that are used in the United States. On Nov. 15, the SEC voted to drop rules requiring foreign firms listed in the U.S. to reconcile their financial reports with GAAP.

Meanwhile, the European Union, Japan, and other nations have been urging the agency to allow U.S. companies to use the international reporting standards. The SEC received almost 100 letters on the topic between Aug. 9 and the Nov. 13 comment deadline. The commission has announced plans to hold roundtables on the issue on Dec. 13 and Dec. 17.

Most of the funding for the London-based IASB comes from voluntary contributions by fewer than 200 international companies and auditing firms. By contrast, the IASB's U.S. counterpart, the Financial Accounting Standards Board (FASB), is funded by mandatory accounting-support fees from U.S. issuers.

In the CII letter, Mahoney cited a concern raised by the FASB in its comment letter to the SEC: "We believe the current funding levels and staffing mechanisms of the IASB are not adequate for the tasks it will face if the … IFRS becomes the single set of global accounting standards."

In response to these concerns, the IASB has announced a "broad-based funding regime" that would give the organization an additional £12 to £16 million per year, beginning in 2008. Money would come from national funding schemes based on gross domestic product in countries such as Australia, the United Kingdom, and the Netherlands, while voluntary giving programs would continue in countries like China, France, India, and South Africa, the IASB said in a Nov. 6 press release.

Notwithstanding the IASB's new funding approach, the California Public Employees' Retirement System, the largest U.S. state pension fund, wrote in its own comment letter to the SEC on Nov. 14 that it is "not confident at this point that these steps will ensure an independent, well-governed IASB that is free of potential influence."

That concern was also raised during a Nov. 12 roundtable discussion on accounting convergence at New York University. Participants agreed that the IASB should have a more reliable source of funding as well as board stability.

The CFA Institute Centre for Financial Market Integrity, a worldwide organization of investment professionals, also told the SEC--in a comment letter on a related rule release--that the financial independence of the IASB is an important concern.

The CFA Institute also noted that there are "major gaps" in the IFRS that must be addressed before the U.S. could consider adopting those standards. The gaps, the group stated, include accounting for insurance contracts and extraction activities involving minerals, oil, and gas, as well as deficiencies in standards for pension plans and leasing.

The European Union's close involvement in setting international accounting standards is also cause for concern, the CII letter stated.

In July 2003, the European Commission, the administrative branch of the EU, voted to begin endorsing the standing IFRS, and any modifications to the standards in the future. The endorsement process is a long one that involves three independent financial standards committees and the European Parliament in vetting each new principle.

"The EU endorsement process has resulted in several incidents that raise serious questions about whether the process impairs the independence of the IASB," Mahoney wrote in the CII letter. He cites two instances--in 2005 and again in April of this year--when one of the independent committees recommended against a proposed change to IFRS, causing the measure to be delayed indefinitely or withdrawn.

Auditing firm PricewaterhouseCoopers has acknowledged that the endorsement process is a key factor in influencing international standards, but the firm stated in a July report that "EU adoption is a delay but otherwise not a concern."

Among the U.S. companies that submitted comments to the SEC, none specifically mentioned the EU role in endorsing IFRS. The tone amid companies commenting on the idea of using IFRS in the U.S. was almost entirely positive and welcoming of a single global standard.

Some issuers--like Cisco Systems and United Technologies--wrote that they were eager to see the FASB play a significant role in setting a global financial reporting standard. The two companies also questioned the financial independence of the IASB in their comment letters.

In an effort to include input from other governments, Charlie McCreevy, European Commission internal markets commissioner, met with SEC Chairman Christopher Cox, Japan's Financial Services Agency Commissioner Takafumi Sato, and Executive Committee Chair Jane Diplock of the International Organization of Securities Commissions. According to a Nov. 6 press release, the officials intend to create an international monitoring body that helps choose board members for the IASB.

Mahoney of the CII warns that this move would only ensure more influence from political appointees who may not have investment or auditing experience.

"We believe that, at minimum, four members of the IASB should be drawn from the ranks of pension fund investment advisors, equity security financial analysts … or other users of financial reports," Mahoney wrote.

Thursday, November 15, 2007

Is US GAAP at a Tipping Point?
Submitted by: Marc Siegel, Head of Accounting Research

The SEC is holding an open meeting today to discuss the possibility of eliminating a reconciliation to US accounting rules for those companies who report in international standards. This is an important step along the path of U.S. companies adopting international accounting standards and moving away from US GAAP. This could mean U.S. accounting rules are going to become less relevant and over time U.S. companies will migrate to international rules. It's a controversial issue, and RiskMetrics Group's Financial Research and Analysis unit issued a note on the topic yesterday.

To access the note, Tipping Point for US GAAP, please visit the Accounting Section of RiskMetrics Group's Knowledge Center. We welcome your thoughts on this topic.

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Thursday, October 4, 2007

Identifying European Non-Financial Companies with Potential Higher Exposure to an Adverse Credit Environment
Submitted by: Hemant Agarwal, Financial Research and Analysis Team

In the current credit environment, which European companies are more likely to be affected given their exposure to debt capital? To answer, RiskMetrics Group's Financial Research & Analysis team has sliced the universe of European companies (greater than $500 million market cap) in 3 different ways.

1) Companies which have higher short-term debt exposure and poor cash flow - We found 58 such companies, of which 5 had short-term debt in excess of 40% of their total capital.

2) Companies with overall high debt exposure and poor liquidity profile - These companies may potentially be in danger of breaching their debt covenants. We identify 28 such companies, of which 16 had negative free cash flow in either the last fiscal year or last 12 month period, or both.

3) Companies using debt capital to finance their acquisition driven growth - The current credit crunch may constrain these companies' near term growth prospects. We identify 18 such companies ; the ratio of debt/capital at three of these companies increased by more than 3000 bps in the last three years.

To learn more about European companies with higher exposures to an adverse credit environment , please join us for a webcast on Tuesday, October 9 at 11:30 a.m. EDT. We'll go over the findings from our new report, Identifying European Non-financial Companies with Potential higher Exposure to an Adverse Credit Environment. To register, please click here.

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