This post was published on the PIIE blog and on the Bruegel blog, and translated by Caixin and El Economista.
Mary Schapiro, the chair of the US
Securities and Exchange Commission (SEC), has announced that she will step down
from her position next month after four years in office. President Barack Obama
appointed one of the four other SEC Commissioners, Elisse Walter, to replace
her until a more permanent successor is chosen next year. The latter
appointment is likely to have momentous consequences, not only for US
securities markets but also, and perhaps mainly, for the global architecture of
financial standard-setting after the recent systemic financial crisis.
The SEC was created as an independent
federal agency in the 1930s as part of the Roosevelt administration’s response
to the 1929 stock market crash and the Great Depression. In recent years it has
operated under domestic political pressures on such issues as its inability to
prevent the Madoff Ponzi scheme, the regulation of money market mutual funds,
and various other cases of securities law enforcement. But the Commission’s
impact does not stop at the US border: The securities markets on which it has
jurisdictions are among the most internationalized parts of the financial
world. The 1930s law grants the SEC decision-making authority in determining
which accounting standards should be used by issuers of public securities in
the United States. This makes it a crucial player in the global development of
International Financial Reporting Standards (IFRS), a uniquely ambitious effort
at harmonization of financial standards that has achieved remarkable milestones
in the past decade. About half of the world’s 500 largest listed companies now
use IFRS for their public financial reporting, up tenfold from a decade ago.
The SEC has had a somewhat paradoxical
attitude toward IFRS. Broadly speaking, it has supported the International
Accounting Standards Board (IASB), the independent London-based body that sets
the standards, and has encouraged their adoption by other jurisdictions around
the world, including the European Union in a landmark decision in the early
2000s. But it has been much more cautious about making IFRS part of its own US
domestic order. Under Ms. Schapiro’s predecessor, former Republican
Representative Christopher Cox of California, the SEC made it possible for
non-US companies listed on US stock exchanges to use IFRS in their reporting,
rather than the domestic standards known as US GAAP (Generally Accepted
Accounting Principles). In 2007 under Ms. Schapiro’s tenure, the SEC designed a
possible approach, colloquially known in the accounting community as
“condorsement,” that would involve a gradual convergence between some
US GAAP standards and their IFRS equivalents, combined with an endorsement
of other IFRS that would thus be directly incorporated into US GAAP. But
this no-nonsense, gradualist approach remains on the drawing board for now, as
the SEC has yet to decide on it despite numerous reports and analyses from its
staff. The lack of progress can largely be attributed to Ms. Schapiro herself,
who as early as her confirmation hearings in January 2009 made it clear that
she was “not prepared to delegate standard-setting or oversight responsibility
to the IASB.”
Accounting standards are one of the
most important intangible infrastructures of capital markets, and their global
harmonization is both a consequence and an enabler of cross-border financial integration.
True, IFRS adoption per se does not deliver instant global comparability of
financial statements: Financial reporting under IFRS comes in many dialects and
accents, because some jurisdictions have not adopted them in full and many also
do not enforce their application rigorously enough. Some of the IFRS standards
themselves are unduly complex. Several of the IASB’s standard-setting choices
have been legitimately questioned—even though many of the criticisms, including
some of those directed at the use of so-called fair value accounting, have been
tainted by special interests or political jockeying among regulatory bodies.
The IASB’s governance and funding framework remains unfinished business and
will require further reform. But in spite of all this, the evidence suggests
that IFRS adoption makes sense. Many jurisdictions have adopted them in the
past decade. The transition has occurred at manageable cost to issuers.
Investors have generally applauded the change. Moreover, none of the IFRS
adopters is considering moving back to national standards. Like the headaches
that occur when a country adopts the metric system, misgivings and nostalgia
abound at first, but the larger benefits of a widely shared system quickly
become obvious.
The analogy with the metric system is
incomplete, however. This is because accounting standards, unlike physical
measurement units, are embedded in a wider social and political context that
makes them far from neutral from an economic standpoint. For this reason, the
successes of initial IFRS adoption may evaporate if the United States continues
to dither over adopting these international standards. In other words, if Ms.
Schapiro’s successor is unable to chart a clear path as to whether and how the
United States might incorporate IFRS into its domestic system, the momentum
towards accounting harmonization could go into reverse. The IASB’s framework
might suffer if it is not anchored by the US financial system, especially
because most market regulators outside the United States are less committed to
accounting standards that protect investors than the SEC.
In accounting as in other areas (such
as the Basel III banking regulatory accord), US leadership is more needed now
than before the crisis. The goal should be to ensure that global financial
markets remain open to cross-border activity while subject to consistent and
binding rules that foster orderly market functioning. Pre-crisis, the European
Union could act as an alternative source of leadership, as when the European
Union adopted IFRS or, in a different way, with the Basel II accord on bank
capital requirements. But Europe is now too absorbed by its internal
difficulties to project this sort of global impact. Meanwhile, no Asian
stakeholder, including China, is yet ready to take the baton of leadership, and
other players are too small to drive the global process. President Obama should
select someone who is keenly aware of this larger context as the next SEC
chair.