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Derivatives Accounting Reform in Europe Faces End-of-Year Deadline

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LONDON (–Phylon Fund, Ltd., a U.K.-headquartered hedge fund manager listed on the Irish Stock Exchange, announced a change of its accounting system from the international accounting standards to those of the generally accepted accounting practice in the United States.

The announcement, Feb. 17, upon which the company has declined to elaborate, was but one of several recent developments in a continuing struggle over the still-divergent accounting systems on opposite sides of the North Atlantic. The International Accounting Standards Board and the European Commission are at odds over the adoption of new mark-to-market accounting rules for derivatives as a deadline established two years ago approaches.

Jan. 1 has been the IASB’s deadline for the institution of these rules, which are modeled broadly after those adopted by the U.S. analog, the Financial Accounting Standards Board, Norwalk, Conn., in 2000 Previous HedgeWorld Story.

Both the United States and the European mark-to-market accounting rules limit the circumstances under which “hedge accounting” is allowed for derivatives, requiring in most circumstances that changes in the value of such instruments be marked to market, which means that fluctuations are reflected on their balance sheets. Until convergence is accomplished, companies that raise capital both in Europe and in the United States must use both the FASB’s standards, GAAP and the International Financial Reporting Standards. Also, until convergence is accomplished, there may be differences in the way the market values corporations under the two sets of rules that will allow hedge funds to make arbitrage plays.

The London-based IASB affirmed the 2005 deadline in the so-called Norwalk agreement of October 2002, with the Norwalk, Conn.-based FASB.

Perhaps the start of next year will mean less than the parties to that agreement hoped, though, because the banking community in Europe, in France especially, is digging in its heels. The banks don’t want to have to comply with IAS 39, Europe’s answer to FAS 133. Officials of the European Commission, the executive body of the European Union, such as Fritz Bolkestein, internal market commissioner, have sided with them.

Tavakoli’s Views

Janet Tavakoli, a consultant and expert witness on structured finance products, said Feb. 25 that the Bank of France is putting a lot of pressure on the French government to resist the pressure of the IASB. But there is resistance throughout Europe, and she sympathizes with it.

“To say that the world will come to an end if they don’t adopt the rules, I think, is wrong,” she added. First, there are substantial arguments to be made against the mark-to-market emphasis of the FASB. Not only should it not be adopted elsewhere, it should perhaps be reconsidered here.

Second, even an ideal set of accounting rules on the treatment of derivatives will not prevent Enron or Parmalat-style debacles. The more pressing issue is transparency, especially in Italy, which Ms. Tavakoli described as “almost a rogue accounting state.”

Third, the IASB has been making adjustments to the rule Previous HedgeWorld Story, so that even if it is adopted broadly before Jan. 1, there still will be discrepancies that will allow for transcontinental arbitrage plays.

The ACCA’s View

The Association of Chartered Certified Accountants, Glasgow, U.K., said in a recent statement that it deplores the possible delay in European take-up of the new International Accounting Standards IAS 32 and IAS 39.

“We are deeply alarmed to see that the EU may sideline the two standards if agreement cannot be reached. In view of the urgent need to have all European listed companies reporting on IAS by 2005 this is not a good message to send either to accounts preparers or to the investment community,” said Allen Blewitt, ACCA’s chief executive, in the statement. “We certainly do not believe that you can have one or two standards which vary from formal IAS.”

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