The Regulatory Framework for Accounting and Auditing Lessons learned from the World Bank’s ROSC Program John Hegarty Manager – Financial Management Europe and Central Asia Region – The World Bank Baku, 17 May 2005

Financial Reporting and the World Bank  Strengthen financial architecture, and reduce the risk of financial market crises and their associated negative economic impacts (especially on the poor)  Improve the investment climate (foreign direct and portfolio investment, mobilization of domestic savings)  Facilitate financial intermediation by lowering the barrier of high information and borrowing costs  Allow investors to evaluate corporate prospects and make informed investment and voting decisions, leading to a lower cost of capital and better allocation of resources  Enhance corporate income tax collection  Support economic integration, both regionally and globally

Accounting and Auditing ROSCs  Reports on the Observance of Standards and Codes  Part of World Bank / IMF work on the international financial architecture, international standards initiative, Financial Sector Assessment Program (FSAP)  IFRS/IAS and ISA used as the assessment benchmarks  Assessments cover national institutional frameworks for accounting and auditing, comparability of national and international standards, compliance with national standards  38 accounting and auditing ROSCs completed by 30 June, 2004, confined to “ Part II ” countries 

What does it mean to “adopt international standards”?  Introduction of “ modern ” accounting and auditing practices  One-off “ transformations ” of financial statements prepared using national standards  Development of national standards “ based on ” IFRS/IAS and ISA  One-time-only adoption of international standards with no, or poor, subsequent updating  Adoption of selected subset of international standards  Program of “ convergence ” between national and international standards over time  IASB and IFAC promotional material not always helpful  Doesn ’ t compliance mean “ all or nothing ” ?

Mechanisms to grant national authority to international standards  Without force of law/regulation, “ international ” standards become “ offshore ” standards  Constraints on granting national public authority to international private standards  Backing for the standard-setting process or for individual standards, keeping up to date  Translation, copyright/royalties, gazetting  Role of legislation -v- standards  Company law or securities regulation as the legal basis for accounting and auditing requirements

Linkages between general purpose and regulatory reporting (incl. tax)  Policy objectives of international standards and national regulatory reporting regimes not always aligned  Risk of conflicts when international standards adopted through regulatory reporting mechanisms  However, specialist regulatory bodies can play a major and positive role in oversight/monitoring/enforcement  Avoid completely parallel systems, encourage adoption of a common general purpose reporting platform, keep reconciling items to a minimum, and harness the oversight/monitoring/enforcement capacity of regulators

Scope of application of international standards  Severe risks to the culture of compliance when the scope of application is inappropriate  IFRS/IAS not suitable for use by all enterprises  Widespread general purpose reporting obligations for enterprises other than “ public interest entities ”  Managing the “ Big GAAP / Little GAAP ” distinction  Future of ( “ Little GAAP Only ” ) national standard setters  ISAs suitable for all audits (or is a non-ISA audit an audit?)  Risks of an excessively broad statutory audit requirement  Addressing gaps/weaknesses in international standards  Linking the application of IFRS and ISA

The enabling environment Market demand for international standards  The role of disclosure in governance and regulatory regimes  Public access to audited financial statements  Patterns of financial intermediation and enterprise ownership  Significance of foreign direct and foreign portfolio investment  The political economy costs and benefits of transparency Capacity to comply  Education, training and experience  Reaching a critical mass of demand for relevant skills  Financial sustainability of capacity development mechanisms  Leveraging resources on an international scale

Oversight, monitoring, enforcement  The inability of third party users to observe compliance  Reliance on reputational agents; limits of self-regulation  Determining role of oversight/monitoring/regulatory bodies  Absence of agreed international best practice models  Lack of appropriate mandates, resources, methodologies  Lack of leverage when specialist regulators are not concerned with general purpose financial reporting  Problems of regulatory capture, effectiveness of judicial systems, macro-governance  International audit firm networks do not deliver consistently high quality internationally, and thus cannot be relied upon to compensate for weaknesses in national regulatory regimes

Getting the legal, institutional and policy preconditions right  Clarity required as to what “ adoption ” means  Proper balance of capacity and institutionalized incentives needed to ensure successful implementation  Effective legislative and regulatory mechanisms must be in place to grant national authority to international standards, and to oversee/monitor/enforce compliance  Scope of application of international standards should be appropriate  International audit firm networks cannot compensate for national regulatory weaknesses  IFRS/IAS and ISA do not constitute a comprehensive framework of principles to regulate accounting and auditing  Work needed to fill the framework gaps, monitor progress

The Regulatory Framework for Accounting and Auditing Lessons learned from the World Bank’s ROSC Program