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The Economic Crisis

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The Economic Crisis Powered By Docstoc
					           RESTORING INTEGRITY IN THE GLOBAL FINANCIAL SYSTEM

               Center for Accounting Ethics, Governance & The Public Interest

                                    Robert Bunting, President

                            International Federation of Accountants

                                          March 18, 2009

Introduction

Good morning. I’d like to thank Dr. Kalbers and the Center for Accounting Ethics, Governance

& the Public Interest for inviting me here today. I would also like to thank all of you for taking

time from your busy schedules to hear what I have to say about restoring integrity to the global

financial system, which, I’m sure you will agree, is in dire straits.



Before we get started, I would like to extend a particular welcome to the students in the

audience. While it’s true that you’re inheriting a world that is in the worst financial shape that it

has been in many decades, it’s a great time to be entering the accountancy profession.



The importance of accounting and auditing is being reinforced as it never could be in times of

plenty. For example, who in the accounting world ever would have thought that we would be

asked to explain ―fair value‖ to our non-accounting friends and even strangers who have a

sudden interest in a financial reporting concept—let alone that they would be interested in our

responses? This is, indeed, a rare time for the accountancy profession.

      You will be entering a truly global profession in terms of rapid convergence to a single

       set of auditing and financial reporting standards.
      You will be on the ground floor of new systems for regulating the profession and the

       global financial markets.

      And, you may be participating in a debate about the purpose of financial reporting: Is it

       for regulators and marketplace stability, or for investors and credit grantors?



Now, I’d like to focus specifically on the economic crisis.



The Economic Crisis

The global economic crisis forms the backdrop of everything we do at IFAC and every speech

we make these days. I’ll leave it to the economic historians to resolve the causes, though at

present there seems to be no shortage of potential culprits and co-conspirators.



Regardless of who is to blame, the crisis was unquestionably exacerbated by corporate

governance failures. Today, we are seeing:

      A lack of proper risk management processes within companies;

      Too many incentive arrangements and remuneration schemes within companies that

       reward short-term rather than sustainable results;

      And, questions about the systems of governance that do not seem to provide adequately

       for challenging management’s risky strategies.



In addition, there have been significant ethical failures across a broad spectrum of business

activity. While scandals like Madoff, Standford, and Satyam may come to mind, these are really




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frauds rather than ethical failures, and fraud is not among the principal contributors to the global

meltdown.



Without tying them to any part of the crisis in particular, let me mention two broad-based areas

of ethical failure:



First, there’s the practice of lending and borrowing when there is little prospect of repayment of

the loans. Second, there’s a co-dependency of lenders, developers, credit-raters, appraisers,

hedge funds, and investment bankers, among others, who put short-term self-interest first, and

turned a blind-eye to the systematic risks they might have been creating—and did.



The Global Economy

What makes all of these problems so much worse, of course, is our global interconnectedness.

There’s no such thing as a local meltdown anymore—and shockwaves don’t only emanate from

the most powerful nations. Who would have thought, for example, that banking failures in tiny

Iceland would be felt in Russia, the UK, and Scandinavia, and that they would put the life

savings of thousands of retirees in those countries at risk? This is only one example of how the

interconnections that work so well in good times—as we sell, borrow, and do business with

entities a continent away—can cause such havoc in bad times.



Suffice it to say that no national system of regulation can protect its citizens unless it is

integrated into an equally rigorous international system.




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What Role Will the Accounting Profession Play in This Brave New World?

The most serious aspects of the crisis are beyond the ability of the accounting profession to

resolve on its own. We can’t get the banking system working again or stimulate economic

activity. Still, we have our roles to play—and they are significant.



For example, the auditor’s ―going-concern‖ opinion will be a tipping point for many individual

companies seeking access to finance. Hundreds of audited financial statements for GM and

Chrysler suppliers are being delayed in the hope that some kind of definitive future for those two

major companies will be resolved, and many other companies have covenants on their loan

facilities that make the loans due on demand in the event of a going-concern opinion.



More importantly, we have quite a lot to contribute to the development of a better designed

international financial system for the future…and that will be the focus of my remaining

comments today.



Just like everyone else who wants to be part of the future solution, we must start with a careful

examination of the standards and methods we are using and the strengths and weaknesses of

what we produce for the global economy. This includes such things as:

      Are we using the correct standards, and is their application consistent and fair?

      Are we doing enough to prevent and detect fraud?

      Are our going-concern opinions authoritative enough for the role they are playing in the

       current environment?




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      Are the results of fair-value accounting as reliable as they should be? I’d like to touch on

       this one for a moment, because it has come in for what I consider undue criticism—when

       it’s the shallow, illiquid markets produced by this crisis that are the problem, among

       many other problems. The harsh assessment of fair value only deflects attention from the

       more significant aspects of the world’s current financial woes, and finding ways to fix

       them.



Another matter I want to mention is balancing accountability of the profession with

sustainability. The accountancy profession is vital to the operation of capital markets and to

economic development and growth. Yet two issues continue to challenge its sustainability: audit

firm concentration and the ability to attract and retain professional accountants.



Plain and simply, the combination of unlimited audit firm liability in many countries coupled

with limited choices of audit firms for the largest international corporations injects additional

risk into the financial system. The majority of large global corporations use the Big Four

accounting firms for auditing work. If one of the large firms should fail for any reason, and

liability is the most likely possibility, the viability of the whole system would be placed in

jeopardy. This concentration issue is thus one we must address.

In addition, we must consider how the pressure for accountability reflects on the attractiveness of

the profession and its ability to retain high-quality people. I believe in accountability; it must,

however, be balanced and realistic.




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Putting the public interest first is a priority for our profession, but we must ensure that there are

professional accountants who can carry out this responsibility.



IFAC is taking a hard look at itself and the profession as it addresses these issues. And we are

doing so in collaboration with global regulators, such as the International Organization for

Securities Commissions (IOSCO), Basel Committee on Banking Supervision, and IFIAR—the

International Federation of Independent Audit Regulators.



While it is important that we examine our own past and future roles, we also must consider the

appropriate future roles of standards setters and regulators in the new and better future economy.

I’d like to share some thoughts in those areas.



Convergence

I cannot emphasize enough that the international nature of the financial system cries out for

convergence in financial reporting and a variety of other standards and practices. The G20 has

recognized this need in its work plan and working groups leading up to the planned April 2009

meeting of finance ministers from the G20 countries.



This is because operating in an interconnected way links directly to the global public interest.

The interconnectedness referred to above is a good thing. It has led to huge growth in developing

economies around the world. But there is a need for a ―level playing-field‖ if the system is to be

seen to be fair and, therefore, likely to achieve ―buy-in.‖ This is what convergence is about.




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Convergence has been a central focus for IFAC activity, across a range of areas – not only for

accounting and auditing, but also in ethics and education. This needs to be pursued even more

vigorously, moving the focus from adoption of international standards to their implementation.

In fact, this is one of the four major themes in IFAC’s strategic plan.



It is also at the heart of the global compliance program that IFAC has developed a program that

regulators and development agencies, such as IOSCO, The Basel Group, IFIAR, the World

Bank, and others, are quite interested in. The compliance program tracks national efforts to

implement our auditing, ethics, and education standards for all IFAC members in 122 countries.



At present, this is a self-assessment program supported by mentoring of developing economies

by developed economies, through support from international firm networks, and by improvement

work plans developed jointly with IFAC. A similar program is needed for the implementation of

International Financial Reporting Standards around the world.



Another area of focus in terms of convergence is the competence and expectations of the

preparers of financial information: professional accountants in business. While it may surprise

some of you in the audience, not all preparers of financial statements in the corporate world have

met the education, experience, and continuing professional development criteria required to be a

―professional accountant‖—and some do not subscribe to a code of ethics.



You might be equally surprised at the lack of professionally qualified accountants in many E-

suites and on the boards of public interest entities around the world—and the fact that not all



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governance structures subject senior management decisions to the rigors of financial and cash

flow analysis. Of the developed countries, only the United Kingdom has any sort of regulatory

requirement covering this area. There is some empirical data that suggests a positive correlation

between the presence of professional accountants in the E-suites of listed companies and their

transparency and quality of reporting, among other things. In part at the urging of regulators,

IFAC is supporting further data gathering and research to prove or disprove this notion.



Convergence also applies to corporate governance standards. At IFAC, we support global

convergence to the corporate governance principles of the Organization for Economic Co-

operation and Development (OECD), which reflect best practices. The OECD’s framework is

designed to promote transparent and effective markets and focuses on the roles and rights of

stakeholders, the responsibilities of management and the board of directors, and other parts of the

corporate governance structure.



Like IFAC, the OECD requires that its member states make best efforts to comply with its

guidelines and best practices—and, like IFAC, it believes that one should ―inspect‖ what one

―expects.‖ IFAC’s recently released international governance good practice guide is consistent

with the OECD framework.



Regulation in Times of Crisis

I’d like to comment briefly now on the direction of national regulation in the midst of a crisis. I

believe it is a time to seek out solutions—and for regulators to resist knee-jerk reactions, and the

search for scapegoats and silver bullets.



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I strongly believe that we must resist retreating into a national focus and its manifestations, such

as protectionism, national carve-outs of standards and regulations, and other short-sighted

political solutions. Rather, it is an opportunity to build stronger international institutions.


One of these opportunities is to strengthen the international financial institutions like the

Financial Stability Forum, which brings together national bodies of sector-specific regulators,

central bankers, and industry supervisors to deal with the consequences of the increasingly

integrated global economy.


It is also a time to build up newer organizations, like the International Federation of Independent

Audit Regulators, a three-year-old global organization that The Public Company Accounting

Oversight Board—the private-sector non-profit, created by the Sarbanes-Oxley Act to oversee

the auditors of public companies—has recently joined.


We at IFAC would be pleased to share our knowledge of how to make an international

organization work effectively to develop common standards and best practices.


We must keep in mind that a quality system of regulation is critical to the functioning of honest

and transparent markets. Such systems create an environment and culture that supports

compliance; must be supported through accountability and enforcement; and must be cost

effective—meaning that the cost of regulation cannot exceed the benefit to the public. In times of

crisis, when regulations are developed quickly and without due process, the consequences can be

as inimical to the public interest as the problems they were designed to solve. In particular, it is

important for regulators to keep in mind the challenges of small and medium enterprises and to



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avoid placing unnecessary burdens—and even unintended ones—on them. Doing so means

placing the potential growth of the global economy at risk.



I’ve already mentioned fair-value accounting and how its reliability has been questioned as

people look for an easy scapegoat for the crisis. There is another example of a concept that the

financial crisis and recent scandals have brought to the forefront: management audit firm

rotation.



Rotation of key players on audit teams every five to seven years makes sense as it injects new

perspective and a refreshed sense of objectivity into the audit team. If this is true, then audit firm

rotation would seem to make even more sense as it removes any ―firm‖ bias that may attach to

past decisions.



However, when considered in the light of another issue—audit firm concentration—it makes no

sense at all. In most parts of the world, there are not enough choices to allow for this without

forcing companies to choose audit firms that have no expertise in their industry, such as banking

and insurance, among others.



While several countries have experimented with and subsequently abandoned firm rotation, it is

being considered as a regulatory response to Satyam in India. This is not necessarily the right

solution. The point is that regulation must be considered pragmatic and cost effective. And it

must be both complemented and supported by high ethical behavior.




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I believe we must promote the value of the right balance between well-designed regulation and

the promotion of, and reliance on, ethical behavior within a professional setting.



True, it is difficult; but it is not impossible, and it must be done. This applies to a number of the

players in the international financial system, including the accounting profession but also

including the credit rating agencies.



Clearly, the public interest is best served when there is confidence in the ethics of the accounting

profession—this is a job for the profession itself, even when it operates within a regulatory

framework



Conclusion

In closing, I’d like to briefly summarize some of my key points today.



We’ve discussed how the global financial markets require many kinds of trust to operate

effectively—trust in the regulatory schemes and the regulators, trust in the financial information

providers and their institutions, and trust in those who provide safeguards, such as auditors and

insurance providers.



While the ethics of the accountancy profession have not been called into question in the current

crisis, we understand full-well the consequences of a failure of trust. Trust, ethics, and

confidence go hand in hand. The current crisis emphasizes in a very dramatic fashion how high

the stakes are when ethics are sidelined and confidence is lost.



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