Speech by SEC Commissioner:
Furthering the German-American Relationship: Our Mutual Interest in Maintaining Strong and Vibrant Global Capital Markets
Remarks to AmCham Germany
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
March 11, 2008
Good evening, ladies and gentlemen. I thank Special Envoy Gray for that wonderful introduction. It is quite a privilege und a great honor for me to speak to you here at the historic Pariser Platz in sight of the Brandenburg Gate.
And it is an honor to be with so many distinguished members of the Bundestag to discuss such an important topic: How do we further the German-American relationship?
And, I hope that my inevitable mistakes in your beautiful, but difficult, mother tongue will not too strongly strain the relationship between Germany and America.
I am sure that you appreciate that the views I express here are my personal views, and that I do not necessarily speak for my fellow Commissioners or the Securities and Exchange Commission.
I thank the American Chamber of Commerce in Germany and its members for organizing this event and also for the work they do in order to benefit people here in Germany and over in the United States. As U.S. Ambassador Timken is fond of noting, the United States is Germany’s second largest trading partner and the United States is not only the top investment destination for German companies, but also the largest foreign investor in Germany.
Ladies and gentlemen, the topic of European and American cooperation has been one that has fascinated me for many years. When I was a young lawyer in the middle of the 1980s in the Paris office of a New York law firm, I experienced the prelude to the opening of the internal market in the European Union — Europe’s “Big Bang” of 1992. Remember that many at the time doubted the effect of this effort? The transformations that have occurred within Europe since that time are breathtaking. The introduction of the Euro also was greeted initially with skepticism, but today the Euro is recognized as a success. There are many of us who thought that we would never see the fall of the Berlin Wall in our lifetimes. At long last, Pariser Platz and the rest of Berlin are being restored to their former glory from the decades of desolate existence while the Berlin Wall was in place. This beautifully rebuilt Commerzbank Building is a tangible example.
Although not free from cost, these events broke down trade barriers and had tremendously beneficial effect on economic growth. We in the United States during our history have experienced similar events — the creation of a common market through the adoption of our Constitution, which ended tariffs and trade barriers between our States, and the development of a common currency.
Germany’s leadership role — holding the presidency of the European Parliament following Chancellor Merkel’s tenure in the European Union presidency — provides an ideal opportunity to build on this strong German-American relationship and create progress on issues important to both countries. When Chancellor Merkel was President of the European Council, she and President Bush signed the “Framework for Advancing Economic Integration between the United States of America and the European Union.” The Framework created the Transatlantic Economic Council, which is co-chaired by a cabinet-level official of the United States and a member of the European Commission.
International Financial Reporting Standards
The Framework identified as one of its priority projects the mutual recognition by 2009 in both the US and the EU of U.S. Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS). Mutual recognition would remove any need for reconciliation between these two accounting standards. Reconciliation is like language translation: it is the expensive and time-consuming process of identifying the differences in results between the application of two accounting systems on a company’s financial statements, and then rendering the financial statements into the other accounting language. Because US GAAP served in effect as an international accounting language for more than 50 years, long before the development of an international accounting language like IFRS, the SEC has required reconciliation as a common base for investors to compare companies.
Needless to say, following the fall of the Berlin Wall, the development of the Euro, and the telecommunications revolution of the past 20 years, the global capital markets have become more closely linked. Because of our mutual desire to reduce barriers to trade, the United States and the European Union have long had a common interest in creating high-quality internationally accepted accounting standards. The SEC has been a leader in helping support the International Accounting Standards Board (IASB) in its development of IFRS. An ever-growing number of issuers are using IFRS, and investors are becoming more comfortable with IFRS. Indeed, besides the European Union, much of the rest of the world is shifting to IFRS.
Because of this growing use and acceptance of IFRS, the SEC recognized the strong arguments for the elimination of the reconciliation requirement. Reconciliation to US GAAP is an additional cost that is hard to justify for issuers and their shareholders. Because of the time required to prepare the reconciliation (months after the financial statements are issued in IFRS in the country where the company’s stock is listed), many investors trade the securities of companies using IFRS months long before the reconciliation is published. Indeed, last year at a hearing that the SEC held on this issue, a number of participants said that US GAAP reconciliations generally offer little new information and are of limited use to those who read financial statements.
So, I am pleased to report that the SEC has achieved this objective of the Framework. In December 2007, we adopted rule changes that allow foreign private issuers to file using IFRS, as promulgated by the IASB, without reconciling to US GAAP.
These changes were effective right away. Thus, many companies that file in IFRS and report by calendar year will be able to benefit immediately from the change. They will not have to reconcile their financial statements for the year 2007. The accountants working on reconciliations can put down their pencils. I hope that investors will benefit from the elimination of the costly reconciliation requirement and that businesses will be able to use their resources more productively.
IFRS is still a work in progress, and there are areas in which IFRS has no applicable standards. The U.S. Financial Accounting Standards Board (FASB) and the IASB have much still to do in converging US GAAP and IFRS, but both are committed to this work. Other issues that remain concern the funding and governance of the IASB, supporting the further development and consistent implementation of IFRS, encouraging education of accountants in IFRS, and working towards continued convergence. I expect that the SEC will be working closely with our counterparts in other countries to address these issues
All of this discussion regarding IFRS leads us to question our own situation in the U.S. If IFRS is good enough for non-US companies, then why not for American companies as well? The SEC is now considering whether to take the additional step of permitting U.S. companies to select between using US GAAP and IFRS.
My understanding is that the European Union is preparing its “equivalence mechanism” to permit acceptance of third country accounting standards. This year, US GAAP will be assessed under this mechanism. In January, the Committee of European Securities Regulators (CESR) held an open hearing on the equivalence of US GAAP to IFRS as part of the technical advice it is providing to the European Union on this issue.
I anticipate that CESR, like the SEC, will conclude that US GAAP and IFRS are equivalent. My hope is that both the SEC and its European counterparts will continue to push for a seamless global capital market in which investors have access to the information that they need to make investment decisions and companies have access to the capital that enables them to innovate, produce, and serve their customers.
Subprime Securities and Credit Rating Agencies
Ladies and gentlemen, another issue of global interest concerns the events unfolding in the capital markets in recent months. During that period, the markets for a number of financial instruments have experienced some rather unusual conditions, and financial institutions and investors have had to learn to their detriment what a “liquidity drought” means. By “liquidity”, I am referring to the willingness of buyers to come forth and make offers to purchase securities. If there are few or no offers, one says that the security is not liquid, because it is more difficult to sell readily. The deteriorating liquidity conditions in the subprime mortgage market and related markets have led to significant volatility in the capital markets. The effects have been felt throughout the world.
It is important to recognize that the current situation is still essentially a liquidity event. The reasons for the liquidity drought are readily apparent. Market participants began to question the value of a variety of financial products, especially those with complex structures and the assumptions underlying their valuation models. Consequently, liquidity in these products fell sharply. The lack of liquidity complicates the task of valuing complex instruments. In many cases, “mark-to-market” accounting rules (the increase or decrease in valuation according to the market value) resulted in the taking of additional reserves or recognition of lower book values by financial institutions in respect of these instruments.
We as regulators must not stand in the way of investors’ and market participants’ sorting this situation out. It would be most unfortunate for the economy — investors, workers, consumers — if regulators were to contribute to market uncertainty through interfering with contracts, judging the merit of products or business strategies (especially with the benefit of 20/20 hindsight), or setting arbitrary rules based not on economics but on conjecture. Uncertainty breeds aversion to risk, and aversion to risk has the potential to slow down our economy.
One area where much concern has been expressed is the role of credit rating agencies. Currently, the SEC — along with many of its international counterparts — is examining the role played by credit rating agencies in the current global market. Credit rating agencies have been criticized about the accuracy of their ratings, for failing to adjust timely those ratings, and for not maintaining appropriate independence from the issuers and underwriters. Our examinations will review whether the rating agencies diverged from their stated methodologies and procedures for determining credit ratings. They will also focus on whether the rating agencies followed their procedures for managing conflicts of interest inherent in the business of determining credit ratings.
We must carefully review the results of these examinations. We must keep in mind that ultimately a rating is an expression of opinion. More importantly, we must remember that a triple-A opinion — no matter how much expertise the rating agency may have — is no substitute for an investor’s making an informed decision and undertaking careful due diligence. We should not create a regulatory regime that creates a moral hazard for investors by encouraging them to rely unduly on credit ratings.
Not all investors were burned or caught off-guard by the subprime problems. I was struck by the comment of one large U.S. investment manager: “We never rely solely on a credit-rating service. We look at what they have to say, but for us it’s just a starting point. Our investments are based on our own independent credit analysis.”
As we carry out these examinations, we must recognize the explicit intent that we not substitute the judgment of government regulators made in hindsight for that of the rating agencies. The government should facilitate market-based decisions, not substitute its judgment for them.
Sovereign Wealth Funds
Finally, I would like mention recent developments in our capital markets with respect to sovereign wealth funds, whose rapid growth of assets raises a number of issues. Today, these funds have an increasingly larger influence on the global financial marketplace as their size, estimated to be currently $2.5 trillion, is significantly larger than all of the world’s hedge funds combined. Some estimate that sovereign wealth funds may become as large as $12 trillion in the next eight years.
Deputy Treasury Secretary Robert Kimmitt has spoken often on this subject and recently published an article drawing distinctions among four variations of government investment in the marketplace: international currency reserves, public pension funds, state-owned enterprises, and sovereign wealth funds. International currency reserves are funds that countries hold for use by their central banks and treasuries; these funds traditionally have been held in safe instruments — gold and debt of other governments — to provide a sound basis for currencies. Public pension funds invest money to meet promises made for retirement of public employees (or more broadly, depending on the beneficiaries and obligations of the pension system), and these funds traditionally have been invested in domestic markets. State-owned enterprises are wholly or partially nationalised businesses that compete with private-sector companies on the global market. Sovereign wealth funds supposedly invest as if they were private investment funds — for profit.
With these distinctions drawn, I sympathise with the worry by many of how state-owned enterprises can compete fairly with private enterprises. If anything but the maximization of profit and the value of their shares motivates them, then the potential for mischief in our markets increases. These are very legitimate worries. With respect to sovereign wealth funds, however, it would be wrong to consider restrictions on their investments based solely on their status as a sovereign wealth fund. In fact, the ongoing debate about sovereign wealth funds is reminiscent of prior debates over protectionism. Although we should be mindful of the possibility that sovereign wealth funds might become a tool of political foreign policy or even economic espionage, our financial, regulatory, and security review processes in the U.S. provide effective checks on illicit activity. In addition, the size and dynamism of the marketplace itself make it difficult for manipulation. We have many nimble entrepreneurs willing to compete with large bureaucratic companies, especially if they are controlled by bureaucratic state ministries.
We must work to determine how best to address issues relating to transparency, independent regulation, de-politicizing of investment decisions, and conflicts of interest. A variety of national and international groups, such as the International Monetary Fund, are looking at this issue. In the U.S., the Treasury Department is leading the consideration of this issue through the President’s Working Group on Financial Markets, of which the SEC chairman is a member. I hope that some form of consensus about the best practices for the operation of sovereign wealth funds in the public capital markets will be reached.
A voluntary code of conduct governing the investment activities of sovereign wealth funds recently has been proposed for approval by the European Commission. Peter Mandelson, the European Trade Commissioner, has indicated that the code would set out basic standards of governance and transparency for the funds, with an emphasis that their investments should be on commercial motivations, not national or strategic considerations. I look forward to reviewing the proposed voluntary rules for sovereign wealth funds from the EU, the IMF, and other groups. These proposals will contribute to international efforts to set a framework for improving the openness and accountability of sovereign wealth funds.
Ladies and Gentlemen, our two countries can continue to build on our individual progress through a strong relationship with each other. Historically, our two countries have had important ties not only through commerce. Germans make up the largest ethnic group of our population — a testimony to the large number of immigrants from the 1700s to the present. Americans thank the Prussian army officer Baron von Steuben for training the young American Revolutionary Army at its low point in 1778 into an army that could fight and win. And, I cannot count how many times Germans have asked me if the legend is true that English beat out German as the official language of the United States by one vote? (By the way, that apocryphal story is just a myth.)
Germany and the other member states of the European Union are crucial allies for the United States. Our friendship and our mutual respect are of greatest importance, and this is of even more importance in the interesting times in which we live.
Ladies and Gentlemen, thank you for your patience this evening. If you find yourself in Washington, please feel free to stop by to see me at the Securities and Exchange Commission.