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REGULATION – Accounting for the accountants.

With a year to go until the dawning of a new millennium, it’s hard not to look back and reflect on the ever increasing rate of change in the business world. While the period from the end of the war to the collapse of the Berlin Wall was dominated by the clash of capitalism and communism, it isn’t difficult to argue that business and finance are more heavily regulated now than at any time in history, despite the triumph of the “free market” west. This presents something of a dichotomy: on the one hand, globalisation is rendering state and national regulatory regimes redundant; and, on the other, the increasing power of capital demands that control is exercised to prevent abuse and to ensure that capital markets continue to work smoothly and efficiently. In the UK, high profile abuses have resulted not just in further tightening of the rules governing financial reporting – the set of basic numbers on which proper share valuations depend – but a dissatisfaction with the self-regulatory regime surrounding the professionals responsible for preparing and auditing those numbers. It’s for this reason that the ICAEW has proposed a new independent review board to oversee the regulation of the accountancy bodies, a proposal accepted by the government earlier this year. “It seemed to us that however hard we tried to get it right, an awful lot of people outside the accountancy bodies were very sceptical about whether we could get it right,” says Chris Swinson, President of the ICAEW. “Whatever we did, we couldn’t deal with the belief that ‘chaps regulating chaps’ doesn’t make sense. It’s difficult for us to say that yes, it is ‘chaps regulating chaps’, but actually we do it bloody well.” Having an overseer from next year should maintain a level of confidence in the profession, although the accountancy bodies will, in effect, still be self-regulating. The new board will have more outside members to provide greater balance, but there are still structural problems which Swinson can’t see going away. A good example of this is the criticism of the Joint Disciplinary Scheme, which exists to exclude wayward accountants from membership of the ICAEW and the ICAS. The process is agonisingly slow. John Turner, an accountant for Polly Peck, was excluded in 1998, eight years after the company collapsed. At the time, the JDS could only act if an official complaint was made, and none was forthcoming until 1993. This condition has now been amended. But as Swinson points out, the JDS often has to wait its turn. “You might have the Serious Fraud Office wanting to prosecute, you might have the DTI wanting to take disqualification proceedings against the directors – and those problems won’t change,” he says. Firms or individuals can also use their powers under natural justice to slow things down, and in a sense the ICAEW’s new system will simply make the regulatory framework appear more open. This is vital if the profession is to remain self-controlling, particularly as we enter recession when company bankruptcies will prompt creditors to seek redress. “The truth is that you cannot protect everybody from everything,” says Swinson. “It’s very easy when problems are happening for the regulators to fall into disrepute – however good they are, market failures can make them look pathetic.” For an example of how this can happen, the accountancy profession need only look at the pensions mis-selling scandals. Many observers questioned the role of the Personal Investment Authority, but much of the financial world is being shifted away from self-regulation and now falls under the eye of the Financial Services Authority. In fact, although regulation places some limits on the scope of actions for financial players, the FSA’s creation may well help customer confidence. The FSA is gearing up for statutory footing when the Financial Services Act comes into effect. “The government plans to give us broad powers to maintain market confidence, to promote public awareness, to protect consumers and to reduce financial crime,” says Howard Davies, the FSA’s chief, announcing his terms of reference. His statement is an excellent mission statement for any regulator. But giving the Henry Thornton lecture at London’s City University Business School, he explained the difficulty of a completely open remit: “Unless the case for further extensions are properly thought through, there is a danger of higher costs and reduced efficiency, leading to uncompetitiveness.” So it isn’t only the level of intrusiveness that presents a problem, but the feasibility of regulating within cost and time parameters. As Financial Millennium goes to press, the government has announced it is to revise the draft legislation enabling the FSA thanks to City concerns over its remit. There is a genuine fear that as “prosecutor, judge and jury” the regulator will have too much power. Derivatives provide an excellent example of the problems that market and professional regulators face. As one of the key financial instruments of the late 20th century they have the power to destroy companies, banks and possibly even entire economies. While it might be intellectually possible to put in place controls on the trade of derivatives or to ensure that the instruments are properly explained, the market is far too fluid to allow these limits to be effective. And the cost of regulating such a market, even if governments could control the international flow of capital, would be prohibitive. One starting point is to ensure that the professionals are doing their jobs properly. International borders – or the effective lack of them – create other problems for regulators. While much UK legislation governing commercial life is designed to align UK law with that of Europe – for example, the new Competition Act will give the OFT more powers as it implements tougher European standards – the rules for accounting are radically different across the EU. This makes the level playing field hard to measure, let alone enforce. Look, for example, at the huge losses attributable to Rover, as measured by the German accounting standards used by BMW – despite the fact that under UK GAAP, Rover would have made a profit of over £90m. There are particular difficulties in applying accounting standards that have been developed for one environment in another. There are issues of culture, purpose, enforcement, interpretation and also the extent to which standards are suitable – pensions standards ideal for the Japanese might not go down so well in another country, for example. German accounts are predominantly aimed at keeping tax bills low rather than presenting a “true and fair view” as traditionally understood in Anglo-Saxon regimes. That said, there are ongoing attempts to iron out differences and make more practical international standards a reality. Within Europe, the arrival of the euro is making this all the more important. “In principle, it shouldn’t make any difference, but it’s a question of psychology,” says Andrew Leonard, assistant technical director at the Accounting Standards Board. “Whereas at the moment people can compare Fiat’s and BMW’s accounts and will realise they’re rather different documents (thanks to their different currencies), if they’re both expressed in euros, people will realise that the difference is mainly one of accounting, rather than anything else. That will create an impetus for greater harmonisation in Europe.” The International Accounting Standards Committee is nearing completion of a set of generally accepted rules. The real question is whether the world’s financial regulators – and in particular the SEC in the US – will accept the standards as laid down. But the ASB is likely to remain essential well into the millennium, not only because the IASC feeds off the expertise of the various national bodies, but to address particular UK issues. The important thing for FDs, Leonard concludes, is to make their voice heard. “The best advice is to take an active part in the debate that’s going on at the moment, both on the technical issues and on the constitutional and organisational debates,” he says. Regulation is like the Hydra – chop off one head and two more appear. As soon as someone questions or avoids one regulation, another emerges to take account of changing situations. In which case the effort required for compliance is simply going to grow, up to, and beyond, the millennium. See Accounting feature, page 23 A burden to business “I suspect it’s a function of modern government to interfere more and more and pile on the regulations,” says Maurice Fitzpatrick, head of economics at Chantrey Vellacott and originator of the Red Tape Index. The index is designed to chart the increasing cost of regulations on business. It’s a tough call, partly because an exact figure is almost impossible to calculate, and partly thanks to the rash of new provisions that firms are forced to assimilate. But just calculating the big ticket items is enough to make an FD blanche. “For the two-year period from May 1997 to May 1999, the major items are the EU working time directive, the minimum wage and self-assessment,” Fitzpatrick explains. “Those measures will shove up the cost of regulation by 17% over that period. And there’s quite a bit still to come – the Fairness at Work White Paper, for example, which implements some of the EU Social Chapter.” Estimates of the total cost of regulation vary from £12bn to £43bn, so Fitzpatrick has factored in a range of absolute values to ensure the Red Tape Index is as fair as possible. At the low end, he calculates the costs of complying with tax and other fiscal measures to be £8bn, based on a study by Bath University which claimed that it amounted to 1% of GDP. He then added in another £4bn based on a NatWest study which reckoned that for every pound spent on meeting the demands of fiscal compliance, businesses must spend another 50p on other government regulations. Total: £12bn. At the other extreme, the £43bn figure was derived from a 1993 study which was based on a survey of regulations listed in the official volume of Management Information for Regulatory Reform. Fitzpatrick points out that the final figure is somewhat dubious, however, thanks to questionable methodology and one-off factors. Using a mean figure, therefore, of £30bn a year, the 17% rise up to May 1999 comes from the £2bn cost of the working time directive; the £200m the Inland Revenue will squeeze out of business as a result of its Spend to Save initiative (it can claim an extra £1 of budget for every extra £7 it raises); another £200m for self-assessment compliance; and £2.7bn for the minimum wage. In fact, if Chantrey Vellacott’s low figure is applied, the increase becomes a massive 43% over the two-year period. But whichever way one cuts it, regulation is adding a serious financial burden to business – and the end is not in sight. “The Deregulation Unit at the Cabinet Office tells me that the watchword is now ‘better regulation’ rather than ‘less regulation’,” says Fitzpatrick, although he quickly adds: “To be fair to the current government, I don’t recall the previous administration doing much to cut regulation either.” Britain’s membership of the European Union is going to be a major source of new and costly regulations, and bringing British law into line with European rules on competition is one of the major reasons for the new Competition Bill. If it goes through, the OFT will gain new investigative powers and competition law will be based on prohibition, with fines for non-compliance. Such fines won’t make it into the Red Tape index, but the cost of compliance might. The problem, thinks Fitzpatrick, stretches back to the Second World War. “Just about everything was regulated then,” he notes, “and in the aftermath, we saw the zenith of the ‘man in Whitehall knows best’ approach. We still have a hangover of that. This government encourages enterprise, but it also has certain views on the minimum standards for employees. That may well be laudable, but by implementing them, they’re going to put more regulation on business.” GAAR – a regulation too far? Some rules are made to be broken; tax laws are made to be bent. At least, this used to be the case, but the proposals for general anti-avoidance rules (GAAR) published earlier this year are aimed at making the tax regulations rock-solid. Hardly surprisingly, the proposals were delayed long beyond the original publication timetable of early Spring – tax avoidance is, as a report by Arthur Andersen put it, a “thorny technical and practical issue”. The distinction between tax evasion and tax avoidance is well understood, but FDs and accountants are now seriously concerned that genuine attempts to find the most efficient taxation schemes will be scuppered by any new rules. “There’s an awful lot of administrative power being handed over to the Revenue with a general anti-avoidance provision – far too much power,” claims Francesca Lagerberg, senior technical manager at the tax faculty of the ICAEW. “It could drive people to operate on the wrong side of the law, to evade tax rather than plan it legitimately.” Lagerberg’s view is borne out by findings of an Andersen survey which revealed that two-thirds of businesses oppose the introduction of a GAAR. That survey also revealed that a majority of businesses think that such a scheme would also require an advance clearing procedure to allow companies to check whether their tax schemes will fall foul of the law. “A clearance system has got to be cheap, easily available and well-administered, and that’s got to be a nightmare for the Revenue,” Lagerberg points out. Since, under the provisions of the Spend to Save initiative, the Revenue can spend more on admin if it generates extra tax income, this could become a huge body in its own right. And if implementing the changes to legislation that may be necessary from time to time to keep the GAAR on track and having to check companies’ schemes wasn’t enough, other departments are also keen to go down the GAAR road. “You’ve got Customs & Excise about to bring in what they call a mini-GAAR,” explains Lagerberg. “Government departments may find it irritating to have to keep putting together lots of changes to legislation which could be dealt with by having a very general anti-avoidance provision.” The ingenuity of FDs and their accountants will also be a challenge. “I don’t think you’re ever going to get very far with a general anti-avoidance provision, because unless you can define ‘avoidance’, which is difficult, someone’s going to find a way round it,” she says. “It’s clear already that the European Court of Justice is chock-a-block with cases where you’ve got rules operating in one country which are going to operate in another – but there’s no harmonisation of tax in Europe at all,” Lagerberg points out. The volume of case law in the UK alone further clouds the issue, although some in the legal profession would rather have an established body of precedents than a brand new statutory provision which will probably need testing in the courts. The problems with GAAR are typical of the more general difficulties regulation presents: it’s costly to administer, time-consuming, creates bureaucracy, discourages innovation and may not even be workable. As Lagerberg says, “You only have to look at the financial services area to see how regulations don’t work very well when you change them frequently for each new problem that arises.”

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