Financial reporting is witnessing a period of evolution as the needs of users become more complex. Javier de Frutos, Chairman of the Commission on Financial Reporting of the European Federation of Financial Analysts’ Societies (EFFAS) and CIO at the investment firm Sailbridge Capital in New York talks to Mazars about his thoughts on the direction in which financial reporting is heading and how it can contribute to improved financial decisions.
You have spoken about how a better understanding of financial reporting can contribute to the quality of the decision-making process. What do you mean by this and how can it be achieved?
Coherence and reconciliation are key. Financial reporting should be coherent in the sense that it has to mean the same things in order for it to be comparable. We have been discussing for a while now with standard setters and stakeholders on how financial information is reported. I think that the quality has improved a lot in terms of disclosures and breakdown of financial information, although improvements can still be made. In terms of reconciliation, if you take the complexities of some of the standards issued in the past three years, particularly with regard to regulation of the financial sector, then going forward the ability to reconcile standards such as IFRS 9 with Common Equity Tier 1 (CET1), for example, is increasingly important. Reconciliation will facilitate users to analyse and come up with educated decisions.
I’m not suggesting standardized reporting as, even within the same sector, companies have different reporting needs and requirements. Indeed, the key or main items are already included in all financial reports, so it’s more a question of how that information is disaggregated and is comparable for users. This is what I mean about reporting coherence.
Companies in the Financial Services sector now disclose solvency reporting in addition to traditional reporting requirements. Do both reporting requirements have the same importance to you?
What’s important is that they are complementary. With traditional requirements we have the basis for general reporting though then you have to know the impact of applying Solvency 2. So the two of them are needed and, again, the reconciliation of how you go from one to the other is very important as this impacts the reliability of information and overall compliance. Having looked at the financial reports of a selection of insurance companies they are certainly moving in the right direction to achieve this.
Geo-political and global trade concerns, economic volatility and technological disruption are just some of the issues affecting markets at present. How are these issues impacting financial reporting in the Financial Services sector?
If we take issues such as Brexit then, in my opinion, UK companies should remain within IFRS. As we know, IFRS standards have a much broader scope of application than the European Union (EU). So, regardless of how Brexit pans out, from a global perspective it makes sense for UK companies to continue with IFRS. In terms of economic volatility or global trade issues certainly the main impact would be on financial services companies, particularly banks in terms of any tremendous fluctuation in exchange rates or companies with foreign subsidiaries. I think companies are already disclosing the impact on their business activity in the management report, and economic volatility shouldn’t have a direct impact on financial reporting.
Technological change is a little bit different because it affects the way financial institutions report. For example, we know that the European Securities and Markets Authority (ESMA) requires electronic reporting for listed companies by 2020, but for me there’s work to be done in order to bridge the gap between where regulators are and the preparation companies have made in terms of making the transition more familiar to financial report users.
In this regard, it should be highlighted that data analysis is a starting point for users. ESMA should guarantee that the chosen digital reporting format, apparently iXBRL, will facilitate users’ work and will prompt capital markets to channel and allocate more efficiently financial resources to companies in Europe.
In terms of improving quality, analysts and investors are generally already very familiar with electronic models to forecast and estimate. Therefore while such technological change will be good in terms of pinpointing information in a 100-page report, for example, the question goes back to how the information is broken down and ultimately comparable. There is a need to be more familiar with how to connect the different financial models electronically, particularly when it comes to work with big data.
Integrated reporting is an area that companies are beginning to embrace. Mazars is an active supporter of having an integrated reporting framework and helping companies look at how to report effectively on the vast range of financial and non-financial performance factors, including CSR, ESG and human rights. What are your views on how the Financial Services sector is approaching integrated reporting?
Integrated reporting is a rapidly changing area that everybody is talking about right now. Let’s put it this way, the quantitative side is essential and indispensable to understand how the company looks in terms of financial strength and cash flow. This is the bread and butter for decision-making. However, increasingly investors and pension funds will not make a decision based strictly on numbers. In fact, investors and pension funds want to invest in companies that can demonstrate social responsibility and sustainable growth. So with topics such as CSR and ESG becoming more important to the decision-making process, then everyone has to play their part. If we take Green Bonds, for example, companies have to meet certain requirements to issue them and regulators are looking at giving some kind of flexibility regarding capital requirements. Companies, reporting in a more homogenous and more user-friendly way non-financial information, will provide collateral for improving the general accessibility of integrated reporting information.
The Financial Services sector is facing a lot of changes, particularly in terms of new accounting and reporting standards such as IFRS 9 and 17. With countries at different stages of regulatory implementation, how do you see these standards progressing? Is complete international harmonization of standards the ultimate goal and is it achievable?
At the end of the day each country has its own regulations that can overlap and, sometimes, complement IFRS and other European regulations. I don’t think it’s a question of eliminating national regulations – analysts and investors have to live with that – it’s a matter of coherence as I mentioned at the beginning. There are sectors that are sensitive to a country’s economy, so more specific, national regulations will tend to apply. Even within those sensitive sectors there will be country-specific differences depending on the characteristics of that sector. For example, French banks tend to specialize more on investment products whereas Spanish banks focus on the lending side and national regulations and reporting requirements have to take this into account. In terms of regulatory harmonization, we have the example of the recent action plan by the EU Commission for financing sustainable growth, which requires sustainable issues and their wider impact factored in to the decision-making process. I think most countries agree with this approach and it’s in cases like these when harmonization on reporting standards should be achieved from inception.