UK GAAP convergence would increase PE burdens

The UK is in the midst of a review of its accounting standards, as it decides whether to move UK GAAP closer to IFRS. The UK's Accounting Standards Board is currently reviewing public comment on some of the changes it proposed recently – much of which was critical of the proposals.

According to SJ Berwin, among the biggest potential changes would be the creation of a three-tier system in which the application of standards varies according to the size and importance of the entity.

Private equity and venture capital managers would be classified under Tier I as “publicly accountable” entities, a term that refers to entities that hold assets in a fiduciary capacity for a broad group of outsiders. Such managers will have to comply with IFRS accounting standards, while groups in Tier II and III will be able to take advantage of UK financial reporting standards for smaller entities, which offer greater flexibility and reduced reporting requirements.

Under such a system, private equity portfolio companies would be treated as subsidiary group companies of the funds that control majority stakes in them. According to SJ Berwin, since such funds will have to apply international accounting principles, not only would many portfolio companies have to apply IFRS, but the fund would also have to consolidate the accounts of the fund and its investments according to international standards.

The additional costs that come along with such consolidation – such as potentially having to provide double accounts or renegotiate lines of credit – and the minimal value such reporting provides to limited partners are one of the main reasons why almost all UK and European private equity firms do not follow IFRS. It is also why efforts at harmonising US GAAP – which exempts private equity firms from consolidation – and IFRS have reportedly hit a roadblock.

Since the ASB announced its proposed changes last year, the British Venture Capital Association (BVCA) has proposed that fair value accounting could be used as an alternative to consolidation by private equity funds. The group recently met with the International Accounting Standards Board (IASB), which is considering the idea and is expected to make an announcement shortly.

The BVCA also sent a letter to the ASB in early February in which it expressed concern about the unwarranted burdens that convergence and subsequent compliance could have on its members. The BVCA added that forcing private equity and venture capital managers to prepare their annual accounts according to Tier I requirements is not appropriate, as fund investors are not generally the users of the accounts of such management entities. It also asked for definitions in the standards of “mutual funds” and those who “hold assets in a fiduciary capacity” to exclude fund managers.

In addition to the BVCA’s feedback on the three-tier proposal, the ASB also said it has received 150 industry comments, which were published to its website last week. After analysing the responses the board will publish an exposure draft outlining its recommendations for the future of UK GAAP later this year.

Below are some of the responses the ASB received over the possible changes:

“We believe that wholly-owned subsidiaries which are publicly accountable should be allowed to prepare reduced disclosure as currently allowed for wholly-owned subsidiaries preparing financial statements in accordance with UK GAAP, i.e. reduced disclosures for cash-flow statements, related party transactions and segmental reporting and financial instruments. We do not believe that users of accounts would derive any significant benefit from the inclusion of these disclosures when the entity is wholly-owned and the information is included in the parent company’s consolidated accounts.” – Charlotte Pissaridou, Goldman Sachs

“We would like to raise the question of benefit and relevance to our ultimate clients, the unitholder, for full IFRS convergence. Whilst the majority of unitholders do not choose to receive the long form accounts, they must be made available free of charge. Increasing the volume of disclosure for something that is rarely read, whilst frustrating, is understood in order to comply with the regulations. However, we feel that some disclosures may cause greater confusion. For example, stock lending disclosure within the portfolio statement. A UK equity may lend out all of its stock and receive UK gilts as collateral. It would be the gilts that would be disclosed in the portfolio, not the equities, which will make the appearance of the portfolio very odd indeed. Although we welcome efforts to take the industry forward, we do not believe that full IFRS convergence and/or removal of a Statement of Recommended Practices (SORP) (in whatever format) would particularly benefit the UK authorised funds industry.” – Robert Davis, Northern Trust

“We support the application of IFRS to entities with public accountability. However, we have significant concerns regarding the definition of public accountability and the accounting requirements applicable to subsidiaries of publicly accountable entities that do not themselves have public accountability. We believe that the Board’s proposed approach of issuing a new UK FRS should be a signal that the Board intends to retain the right to set UK accounting standards and that it will not necessarily be bound to adopt the IFRS for SMEs in full, including all future revisions thereto. The future of the Accounting Standards Board itself is an issue that may merit public consultation.” – Brian Creighton, technical committee chairman, London Society of Chartered Accountants