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Europe to Offer Good Hunting for Short Sellers

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LONDON (HedgeWorld)–New accounting standards apply with the new year for 7,000 companies listed on Europe’s stock markets, and one authority predicted that the new standards would significantly increase volatility on those markets.

Jeannot Blanchet, a managing director of Morgan Stanley and co-head of their European Global Valuation and Accounting Team, said that many stock analysts are missing the significance of these standards.

“They think that it’s ‘just accounting’ so it doesn’t affect the fundamentals,” he said. But they are wrong, in the opinion of his team. “We think in some cases there will be increased volatility because there will be confusion” among companies that aren’t prepared for the changes, as well as among investors.

The new rules, known as the International Financial Reporting Standards, are the brainchildren of the International Accounting Standards Board (see ). They concern the consolidation of businesses, accounting for convertible debt and the marking to market of employee stock options. Mr. Blanchet thinks the options valuation issue is especially important.

The IFRS doesn’t mandate a particular method of valuation, “some companies will use Black-Scholes, and some will use a binomial model.” The effect, though, of the rules as a whole will be “to force some companies to disclose more of what is going on,” and this may create opportunities for short sellers.

Mr. Blanchet said that he believes transparency is a wise policy and that, in time, Europe’s financial scene will benefit. But “in time” means after a choppy period of between three and five years. “If you’re focusing on hedge funds, that is an eternity.”

The new rules are mandatory because the European Union adopted a regulation in June 2002 that requires all EU listed enterprises to apply the rules of the IAB, then still known not as IFRS’ but as International Accounting Standards. The EU was dissatisfied with the patchwork of locally acceptable standards.

In a related matter, the oversight body for the IASB, the International Accounting Standards Committee, said Oct. 27 that it has reappointed three of its trustees for additional terms of three years each, i.e. through 2007. The chairman of the trustees, former Federal Reserve Chairman Paul A. Volcker, said that the board is “delighted that the organization will continue to benefit from the expertise and broad experience of Malcolm Knight, Jens Roder and Roberto Teixeira da Costa.” Three other trustees, John Biggs, Guido Ferrarini, and Koji Tajika will retire when their terms expire at yearend. All six “have been tireless advocates for the cause of high quality international accounting standards,” Mr. Volcker said.

European concern for the accounting standards that apply to its listed corporations received a much-publicized boost with the implosion a year ago of the Italian dairy group Parmalat spa and the fraudulent accounting that has come to light since. In 1992, 19% of Parmalat’s reported assets were “financial assets”–cash or financial instruments. By 2002, that percentage had nearly doubled, to 40%. This gave the impression of a company awash in cash and, accordingly, an excellent credit risk.

One close observer of the situation, asked recently whether rules similar to the proposed IFRS, had they been in place throughout that decade, might have headed off the meltdown. The observer said that these rules might rather have precipitated it. No accounting rules can prevent fraud, he said. They can, at best, alert potential victims to the presence or danger of fraud.

Contact Bob Keane with questions or comments at: [email protected].