The impact of IFRS on transparency October 15th 2007 Jaime Vázquez Castro Director of Accounting Policies and Own Funds

Index 01. INTRODUCTION: FINANCIAL REPORTING AND TRANSPARENCY 02. HOW DO IFRS HELP TO ACHIEVE THE OBJECTIVE OF TRANSPARENCY? 03. THE CHALLENGES 04. CONCLUSIONS

These are necessary goals for good financial reporting Defining transparency Able to be seen through, clear; easily detected, understood; obvious, evident; ingenuous, frank; shining through These are necessary goals for good financial reporting

Defining transparency (cont.) As Basel Committee on Banking Supervision said, transparency is also a: “public disclosure of reliable and timely information that enable users of that information to make an accurate assessment of a bank´s financial condition and performance, its business activities, and the risk related to those activities”

Because the objectives of financial reporting are to create a communication framework that: to make economic decisions to assess the accountability of management provides information about the entity’s financial performance and financial position The objectives above can only be satisfied if the information included in financial statements possesses relevance, reliability, understandability and comparability.

One way to achieve transparency in financial reporting… …is to prepare information in accordance with a robust, high-quality set of generally accepted accounting principles.

Additionally, companies do play in a new global capital market Improved information and communication technologies This has brought new international investors Business is more complex today than in the past IFRS is set to fulfill this role

So, IFRS is making an impact on the international scene Mandatory for consolidated financial reporting of publicly quoted companies in the European Union Endorsed and recommended by the IOSCO for cross-border stock exchange listings, subject to national treatments where need to address outstanding issues

Index 01. INTRODUCTION: FINANCIAL REPORTING AND TRANSPARENCY 02. HOW DO IFRS HELP TO ACHIEVE THE OBJECTIVE OF TRANSPARENCY? 03. THE CHALLENGES 04. CONCLUSIONS

1. IFRS is principles-based It is a unique but flexible framework available for companies in all countries and all sectors. This principles-based factor enhances transparency as transactions must be registered in accordance with their substance and not merely their legal form: no differences between the reality of an economic transaction and its reporting.

2. Extended public disclosures The old standards (IAS) were criticized for minimal disclosures New standards (IFRS) include great level of additional information The implementation of the new financial instruments disclosure standard (IFRS 7) in 2007 will also provide with more transparency about how management control financial risks on a day-to-day basis.

3. The use of fair value Fair Value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm´s length transaction Transparency is instrumental in achieving faithful representation and the object of that faithful representation is better expressed in fair values for some assets and liabilities (I.e. business combinations, shared- based payments, initial recognition for financial instruments)

4. Segment Reporting New Standard about Operating Segments (IFRS 8) closes the gap between companies internal reporting and what they report to the public. Requires companies to disclose information based on products and services, and on geographical areas operating segments, which requires management to report how it has used its resources to manage the entity Enables users of financial statements to see an entity through the eyes of management Will reduce cost of reporting segment information

5. And there are also many specific criteria in IFRS which enhance transparency Derivatives are included in balance sheet at fair value. Goodwill is not amortized anymore. It is subject to the impairment test. No hidden provisions can be built up. The scope of the group consolidation include all subsidiaries and special purpose entities, many of which were not consolidated before.

6. Auditors do help Auditors guarantee the accurate application of IFRS This is indispensable to building trust within the marketplace What's more, if these auditors belong to large multinational audit firms with strong global focus and control, consistency of application is ensured and transparency of information becomes also global

Index 01. INTRODUCTION: FINANCIAL REPORTING AND TRANSPARENCY 02. HOW DO IFRS HELP TO ACHIEVE THE OBJECTIVE OF TRANSPARENCY? 03. THE CHALLENGES 04. CONCLUSIONS

1. Ongoing process of changing standards IASB is immersed in an vertiginous process of issuing modified and new standards, mainly because of the convergence project with US GAAP, but also because of its aim to improve the standards. Time is required to assess and understand the changes introduced by the new standards. Preparers have a role in making this as easy as possible for users of financial statements.

2. Avoid national adaptations of IFRS Regarding the consolidated financial statements, local supervisions have lost regulatory capacity in accounting and reporting affairs. In order to benefit the goal of transparency, they should avoid making national adaptations of the accounting and reporting criteria. Their role could be to help preparers interpreting and enforcing IFRS in order to get greater consistency of application and improved transparency.

3. Establishment of a single supervisor for financial institutions Main objective of Supervision is to preserve financial stability Supervision is becoming more complex and difficult due to: Financial institutions are becoming increasingly international Financial institutions are becoming financial conglomerates and covering all financial services The consolidation of financial institutions is progressively increasing both within border and across border Financial products have become increasingly complex and sophisticated.

3. Establishment of a single supervisor for financial institutions (cont.) The present structure and systems of supervision have an increasing difficulty to cope with these challenges, even more in the case of an unexpected systemic crisis A single supervisory model should be achieved: based in the soundness of every local regulator in the European Union, it is not reasonable to say that any interpretation made by one regulator is better than the one made by another, and therefore it could not be said that any discrepancy in this regard means a deficient application of IFRS

4. The accounting standards convergence Despite IFRS´s international acceptance, foreign listed companies in USA (which applies IFRS) must still reconcile their financial statements to US GAAP The IASB and FASB are working towards making the reconciliation less onerous, by working to eliminate differences between US GAAP and IFRS Furthermore, the SEC has proposed to accept from foreign private issuers their financial statements prepared in accordance with IFRS as published by the IASB without reconciliation to US GAAP However, although much efforts are made in convergence, in our opinion, biggest transparency could only be achieved if just one worldwide set of accounting and reporting standards is applied.

5. Great disclosure is sometimes confused with transparency Good disclosure should be: Provided on a regular and timely basis. Easily and broadly available. Correct and complete; Consistent, relevant and documented High-quality public disclosure improves capability of market participants to make informed decisions

5. But extended disclosures don´t mean transparency An example of an international bank Balance between transparency and disclosure is the goal

6. The fair value must have a limited use Despite the advantages of fair value, fair value is not a panacea: Lack of a clear definition Concerns about verifiability Scope for managerial discretion As a result, financial entities use mixed measurement model for financial instruments.

6. The fair value must have a limited use (cont.) For instruments managed based on Fair Values, fair value has a predictive value and gives the representation of the financial position and performance of the company For those instruments not managed based on Fair Value, as loans for banks (non- trading), historical cost gives more faithful and useful information

6. But still IFRS are not perfect A gap exist between the ways risk managers do manage the different risks a Company is subject to, and the way that this strategies are shown in the financial statements. This creates some asymmetries that are shown in the financial statements, which therefore are not in compliance with the principle of faithful representation, therefore neither with transparency. Although hedge accounting seeks to correct this mismatch by changing the timing of recognition of gains and losses on either the hedged item or the hedging instrument, still some changes has to be made as hedging rules are very strict

Index 01. INTRODUCTION: FINANCIAL REPORTING AND TRANSPARENCY 02. HOW DO IFRS HELP TO ACHIEVE THE OBJECTIVE OF TRANSPARENCY? 03. THE CHALLENGES 04. CONCLUSIONS

Conclusions IFRS is a set of robust and high- quality accounting and reporting standards which is directly applied or taken as reference in nearly 100 countries ( including European Union, Australian and South Africa). This extensive use of IFRS allows investors and other users of financial statements to have more transparent information that is comparable across borders and among companies in the same sectors. However, there are still big challenges for regulators, supervisors, preparers and users in order to achieve an improved transparency.

Thank you Jaime Vázquez Castro Director of Accounting Policies and Own Funds