2 December 2003

 

Mr. Fabrice Demarigny
Secretary General
The Committee of European Securities Regulators
17 Place de la Bourse
75082 Paris Cedex 02
France

 

Re: CESR's "European Regulation on the Application of IFRS in 2005: Draft Recommendation for Additional Guidance Regarding the Transition to IFRS" (Ref. CESR/03-323b)

 

Dear Mr. Demarigny:

 

The European Advocacy Committee ("EAC" or the "Committee") of the Association for Investment Management and Research ("AIMR")¹ is pleased to comment on The Committee of European Securities Regulators' ("CESR") consultative paper, Draft Recommendation for Additional Guidance Regarding the Transition to IFRS (referred to as the "Proposal"). The EAC is a standing committee of AIMR charged with reviewing and responding to major new regulatory, legislative, and other developments that may affect investors, the investment profession, and the efficiency and integrity of European financial markets. The Committee has 15 investment professionals volunteering from throughout Europe that provide a variety of viewpoints based on members' market experience and expertise, and that draw upon the collective knowledge of AIMR's global network of investment professionals.

 

General Comments

 

The Committee agrees that CESR Members should provide guidance for EU-based companies to help them transition toward the use of International Financial Reporting Standards ("IFRS" or the "Standards"). This guidance is helpful for both issuers and investors. Regarding issuers, many, particularly smaller, listed firms may not recognize the amount of work that this transition will require and the guidance provided by CESR Members will provide much needed help.

 

While many institutional investors are aware of the change to IFRS that will be required for EU-listed companies for financial years beginning on or after 1 January 2005, it is possible, if not likely, that many retail investors are not aware of this change. Moreover, both retail and institutional investors will benefit from narrative and tabular descriptions that describe the nature of the changes involved.

 

Nonetheless, the Committee has two primary concerns with the Proposal. First, the Committee believes CESR Members should make the disclosures mandatory, rather than optional, to ensure a smooth transition, not only for investors, but also for European markets in general. One reason these disclosures are needed is to mitigate the confusion among investors, a purpose the Committee supports. However, if given the option, it is likely that many firms will not see the benefits of disclosing this information prior to the full transition to IFRS and therefore will wait until it is mandatory. Such delays will not help either issuers or investors, and therefore should be prevented.

 

Second, the Committee is concerned that the information requirements in the Proposal do not provide investors with enough information to ensure that companies and their managers do not take advantage of this one-time event to make their performance and financial condition look better than it is. For example, in paragraph 13 of the Proposal, CESR suggests that the information required will include reconciliations of summarized balance sheets, profit and loss accounts and cash flow statements. Summary information obscures the detailed information investors need to analyse reporting companies' profitability and risk exposures. Consequently, the Committee strongly suggests that CESR Members require their firms to provide interim and year-end reconciliations of current GAAP and IFRS with at least the same level of detail as is required in the financial reports used in offering prospectuses.

 

In the following paragraphs we provide our response to CESR's specific questions.

 

Specific Comments

 

Question 1: Do you consider it useful that CESR Members provide recommendations to European listed companies on how to disclose financial information to the markets during the phase of transition from local GAAP to IFRS?
As mentioned in the Proposal, the guidance mentioned in the above question relates to matters not covered by International Accounting Standards regulation, but are closely linked to IFRS1 on "First Time Adoption of International Financial Reporting Standards." As such, the Committee is under the impression that CESR's Proposal is for guidance that supplements the requirements of IFRS1.

 

Based on this interpretation, the Committee supports having CESR Members recommend to EU-listed companies how to disclose financial information during the transition to IFRS. However, to ensure that investors in all EU Member States have information that is comparable regardless of the issuing company's domicile, the Committee urges CESR Members to coordinate their recommendations to avoid confusion among both issuers and users of financial information.

 

Question 2: Do you agree that European listed companies should be encouraged to prepare the transition from local GAAP to IFRS as early as possible?

 

Question 3: Do you agree that those companies should also be encouraged to communicate this transition process? If yes, are the 4 milestones identified by CESR for such communications appropriate?
As stated above in our General Comments, the Committee recommends that CESR Members require, not encourage, all listed companies to begin the transition process and communicate their progress. It also supports the Proposal to require that these communications begin as soon as possible.

 

The Committee also agrees with the four milestones proposed by CESR. If listed companies are to be ready for the change to IFRS for the financial years beginning on or after 1 January 2005, they will need to prepare for the change as soon as possible for three primary reasons. The first is to ensure that the individuals responsible for applying these new accounting standards have time to compare their interpretations with those of their external auditors before the new standards become the only reporting mechanism used. The second reason is to avoid to the extent possible the need in 2005 to restate year-old 2004 data to ensure they have restated prior-year figures for interim and year-end periods. And finally, by having practiced at applying these standards and disclosing these efforts, it will avoid much of the potential confusion that might otherwise develop as a result of the transition.

 

Question 4: What are your views on an encouragement to listed companies to disclose narrative information about their process of moving to IFRS and about the major identifiable differences in accounting policies this transition will bring about? Do you consider it appropriate to include such information in the 2003 annual report in the notes to the 2003 financial statements?
The Committee believes this kind of information is vital to investors and encourages CESR Members to require these disclosures as soon as possible, including the 2003 annual report. This information is useful even if it means that some companies have to report either estimated numbers or that they have no process in place.

 

This information is important because the transition to IFRS creates at least three new risks for investors. First, the new accounting standards are designed to make each company's reported performance comparable with that of other EU-listed companies. Through this comparison, the relative measures of profitability or financial condition of some companies, when compared with the measures of other companies, may appear to be relatively less favorable than expected, resulting in lower valuations. The sooner investors know this, the better able they are to take actions they deem appropriate.

 

Second, the transition to IFRS may divert company resources and management attention away from some revenue-generating activities. If a company does a poor job of handling the transition, it is an indication not only of the resources and attention the company still must deploy to the project, but also an indication of possible management weaknesses. It also increases the risk that someone can take advantage of the uncertain situation caused by the reporting transition to commit fraud or theft.

 

Consequently, the Committee recommends that CESR Members require, not encourage, companies to provide narrative disclosures about the transition process and to do so both in the notes to the 2003 financial statements and elsewhere in the 2003 annual report.

 

Question 5: Do you believe that listed companies should be encouraged not to wait until beginning 2006 for communicating about the impact of the transition to IFRS on the 2004 financial statements if such information is available earlier? Do you agree that quantified information in this regard should be given as soon as possible?
Again, the Committee supports the disclosures proposed, but recommends that CESR Members make these disclosures mandatory rather than voluntary. Such information will provide not only an indication of the affect on companies' reported performance and financial condition, but also give an indication of how prepared management is for the transition. The Committee also believes that companies should quantify the affects of this transition as soon as they have the information available so as to let investors incorporate these data into their valuation models.

 

Moreover, the Committee believes such information should be considered price-sensitive information under Article 6 of the Market Abuse Directive and, as a result, be made public promptly after it is created.

 

Question 6: Is it appropriate to refer to the Implementation Guidance published by IASB in connection with IFRS1 for defining which quantified information should be disclosed as a result of the recommendations in (paragraphs) 11 and 12 (of the Proposal)? Do you believe other disclosures should be envisaged? Do you agree with inclusion of such information in the annual report or in the notes to the financial statements?
The Committee supports CESR's Proposal to refer to the IASB's Implementation Guidance because doing so will ensure the most consistent application of the Standards and their required disclosures.

 

However, the Committee believes the use of summary balance sheet and profit-and-loss data, as described in paragraph 13 of the Proposal, will not provide enough detail to permit investors to understand the effects the transition will have on the accounts of issuing companies. Merely presenting line items for "total assets" or "total current assets" will not give analysts and investors the information they need to assess companies' profitability and risk exposures.

 

Therefore, the Committee suggests that CESR Members require listed companies in their jurisdictions to provide detailed comparable IFRS data to accompany detailed current GAAP data, and to present the information in a five-column format similar to the structure proposed under paragraph 26 of the Proposal. Furthermore, companies should include this information in the notes to the financial statements provided both in their annual reports and in their interim reports.

 

Question 7: Do you agree with the principle that any interim financial information published as of 2005 by listed companies should be prepared using the accounting standards that are to be used by those companies for the 2005 year-end financial reporting, i.e. IFRS, in the way indicated here?
The Committee strongly agrees with the principle described in Question 7.

 

Question 8: Do you agree that when listed companies do not elect to apply IAS 34 for quarterly information published in 2005, they should be encouraged to prepare and disclose financial data by IFRS recognition and measurement principles to be applicable at year end?

 

IAS 34 provides guidance on the presentation of interim financial statements. This includes direction regarding minimum content and sets out recognition and measurement principles for these kinds of updates.
The Committee recommends that CESR Members should require listed companies to apply IAS 34 for quarterly reports in 2005. This would ensure that investors receive information that is prepared under comparable accounting standards and with comparable disclosure requirements. In the long run, this will enhance investor confidence, which should produce greater turnover in EU financial markets.

 

As stated in its response to Question 6 above, the Committee also believes that CESR Members should require issuers in their jurisdictions to provide detailed IFRS data, rather than summary data, to ensure investors have sufficient information about the effects of the transition.

 

Question 9: Do you agree with the proposed encouragement for European listed companies to either fully apply IAS 34 for half-yearly reporting as from 2005 or, if this standard is not applied, to prepare the key half-year financial data that are to be published, in conformity with IFRS recognition and measurement principles to be applicable at year end?
For the same reasons stated above in its answer to Question 8, the Committee recommends that CESR Members require European listed companies to apply IAS 34 to their interim reporting.

 

Question 10: Do you agree with the proposals that: A) comparative figures should be provided and restated using [the] same accounting basis as for the current year; B) previously published information for the previous period may be provided again; C) explanation of restatement of comparative figures should be given; D) in case of presentation of financial statement over 3 successive periods the restatement of the first (earliest) period could not be required; E) indicative format ("bridge approach") for the presentation of comparative information on the face of the financial statements when the first period presented is not restated?
The format proposed by CESR to provide comparative information about prior-periods' results would look like the following:

 

Items of Financial Statements

First quarter 2005 Under IFRS

First quarter 2004 Under IFRS (restated)

First quarter 2004 Under Previous GAAP (as published)

First quarter 2003 Under Previous GAAP (as published)

 

The Committee strongly approves of the tabular format for presenting prior-period results (item E in Question 10). It provides the amount and kinds of information that investors need to analyse the changes brought about by the transition to IFRS, and does so in a format that is easy to understand. However, the Committee reiterates that investors need detailed financial information for this kind of reconciliation to be meaningful.

 

The Committee agrees that companies should have to report prior-period figures that are restated using IFRS to provide comparability for financial statement users (item A). An explanation of the assumptions and interpretations that went into these figures (item C) would allow investors to further assess the appropriateness of the interpretations made by management to make the transition. Likewise, the Committee believes that permitting companies to present previously published information (item B) - assumed to be information presented under previous GAAP - would provide useful information to investors, particularly if presented in the tabular form shown above. Finally, while the Committee would prefer that the earliest period in a three-year presentation be restated to IFRS (item D), it finds it acceptable not to restate the information so long as the narrative and tabular reconciliation of 2004 information is provided.

 

Question 11: Do you agree that, in addition to the presentation of comparative information in conformity with IFRS1 (i.e. prepared on the basis of IFRS provisions), it could be deemed useful to present again the comparatives prepared on the basis of previously applicable accounting standards?

 

Question 12: Do you agree that, when presentation of financial statements over 3 successive periods is required, it would be acceptable not to require the restatement to IFRS of the first (earliest) period? If yes, do you agree with the indicative format ("bridge approach") for the presentation of comparative information on the face of the financial statements when the first period presented in not restated?
In general, the Committee's answer to Questions 11 and 12 are the same as its answer to Question 10 above. Specifically, the Committee would accept the publication of prior-period information under previous GAAP so long as the company provides a reconciliation between previous GAAP and IFRS for financial year 2004 in tabular and narrative form.

 

Closing Remarks

 

The EAC appreciates the opportunity to comment on the CESR consultative paper on the Draft Recommendation for Additional Guidance Regarding the Transition to IFRS. If you or your staff have questions or seek amplification of our views, please feel free to contact James C. Allen, CFA, by phone at 1.434.951.5558 or by e-mail at james.allen@cfainstitute.org.

Sincerely,

 

Frederic P. Lebel, CFA Chair European Advocacy Committee

James C. Allen, CFA Associate AIMR Professional Standards & Advocacy

 

¹ With headquarters in Charlottesville, VA and regional offices in Hong Kong and London, the Association for Investment Management and Research® is a non-profit professional association of more than 67,000 financial analysts, portfolio managers, and other investment professionals in 116 countries of which 50,607 are holders of the Chartered Financial Analyst® (CFA®) designation. AIMR's membership also includes 127 Member Societies and Chapters in 46 countries.