sir andrew large : financial instrument accounting speech by sir andrew large, deputy governor of the bank of england, to the 13th central banking conference, london, 22 november 2004. * * * introduction the recent furore over ias 39 - the international accounting standard for financial instruments - has resulted in a situation which i think all agree is unsatisfactory. we now effectively have two versions of ias 39, one proposed by the iasb, the other by the european commission. i probably do not need to emphasise that meaningful accounting standards and their effective implementation are highly relevant to any central bank ’ s responsibilities for financial stability. they help to ensure the safe and efficient functioning of the financial system. so it is essential that accounting standards have a clear economic rationale, promote comparability and secure adequate disclosure. only in that way can investors, creditors and others judge the positions and risks being run by financial institutions and hence exert market discipline, and perverse incentives be avoided. together these can make an important contribution to financial stability. i suggest later that, despite intensive work to improve accounting standards for financial instruments in recent years, fundamental issues with financial stability implications remain to be resolved. one crucial question is : “ who and what are accounts for? ” another more specific issue is the appropriate role of fair value data. so what i want to do this morning is to discuss these issues in turn before commenting on the way forward regarding ias 39. i should add that while ias 39 applies to all users of financial instruments, i illustrate its implications below with particular reference to banking. who and what are accounts for? it is widely accepted that published audited accounts are prepared first and foremost for the owners of a business, that is the shareholders. however, it is often maintained that this information also meets the needs of other stakeholders, including creditors, customers, employees and so on. and so it does up to a point. yet there are many users who have an interest in the financial position of a firm. on the face of it, it would be rather surprising if a single presentation was ideal for all of them. let me try to illustrate this for the financial world - where the bank ’ s financial stability remit runs - by looking at the respective needs of shareholders, depositors and regulators of banks. shareholders are particularly interested in the returns being earned by a bank ( its profitability ), both current and prospective. they are looking mainly at the economic value of the going concern.

first to take a few steps back, before work starts on re - engineering the standard. i believe that many of those interested in the debate would be supportive of this approach. we perhaps need to look again at the process for considering, and reaching a conclusion about, the fundamental “ design parameters ” some of which i have touched on today. this is no small task, but if agreement could be reached on the fundamentals, these could be stated as clear principles in a preamble to any new standard, to guide the more detailed requirements. and it might enable the widely - held vision of a less detailed and prescriptive standard to be realised, to replace the hundreds of pages of complex rules. to address this, however, raises three questions : ( i ) on what is early consensus necessary? ( ii ) how should the transition be approached? and ( iii ) what does this mean in institutional terms? early consensus early agreement seems to me particularly important in three areas. the first is to review the conventional understanding on who the accounts are for, and clarify how the different interests of different stakeholders are to be met. the second is to agree where the standard should be placed along the spectrum between historic cost and fair value measurement. a particularly difficult conceptual question in this area is : precisely what economic meaning is there in so - called fair valuation of instruments in which ( a ) there is little or no secondary market, or ( b ) there is a market, but a clear intent to hold an instrument to maturity? finally, the implications of any increase in measured volatility will need to be assessed. here, i see a need for a process of communication and education by companies and others to shareholders, analysts and other interested parties, which should form part of the transition to any new standard. transitional considerations once the above objectives have been agreed, it will be important to articulate where we are, and where we want to be, and then to identify the optimal migration path. is it to be a gradual transition or a big bang? such decisions would need to consider : the rapidly moving environment of the financial industry, and regulatory techniques ; how to ensure comparability is maintained ; and the costs, especially in system terms, of alternative migration paths. procedures for setting international accounting standards a final issue concerns the procedures for setting accounting standards. concerns have been expressed by some about whether public sector interests, in particular, are adequately represented in the process. there is of course a clear public interest in