International Accounting Standards (Delegation of Functions) (EU Exit) Regulations 2021

Lord Davies of Brixton Excerpts

Tuesday 27th April 2021 Grand Committee

[Lord Davies of Brixton (Lab) [V]]

My Lords, I must declare an interest as a practising actuary, as the remit of the UKEB extends to actuarial matters. Accounting standards are important, but it needs to be understood that they are not a neutral revelation of some absolute underlying truth. They inevitably incorporate views that, overtly or covertly, represent a particular view of how the economy should be run. In effect, they play a role in determining how economic power gets allocated and who gains and who loses. Hence the need for strong democratic oversight, including a role for Parliament. In other words, accounting standards are too important to be left to accountants.

This point was acknowledged by the Government, with the claim that parliamentary accountability has been built into the constitution of the UKEB, as the Minister just explained. Unfortunately, experience makes us doubtful that what is proposed will be sufficient. Too much of the involvement occurs after the event and is reactive rather than proactive. In my brief time in the House, I have already referred on several occasions to the phenomenon of regulatory capture; I see nothing here to allay my fears.

A couple of points arise directly from these regulations. First, once again, we see the delusions of the Brexiteers laid bare. The claim that the UK can exercise greater autonomy in accounting standards because it is outside the EU is nonsense. In practice, we have become rule takers rather than rule-makers when we worked with our European partners. International accounting standards are set far from our shores where, in reality, there is Hobson’s choice.

Secondly—this is my main point—the record to date of international financial standards does not inspire confidence. I am sure that my noble friend Lord Sikka will provide chapter and verse, but I want to say something about the standard with which I am most familiar: International Accounting Standard 19, on employee benefits. This comes of course under the aegis of the UKEB.

There are many reasons for the regrettable decline of defined benefit pension arrangements in the private sector over the past 20 years. We have ended up with the vast majority of private sector defined benefit schemes closed completely, closed to new members or closed to future accrual. Increases in life expectancy and low interest rates have certainly had a role in bringing about the increased cost for corporate sponsors.

Nevertheless, one of the key drivers in this decline has been how pensions are accounted for, as laid down by the international standard. The International Accounting Standards Board says that it sets accounting standards within

“a conceptual framework of understandability, relevance, reliability, comparability and timeliness.”

That is fair enough, but this has been interpreted as meaning an emphasis on the use of market prices, whether actual market prices or derived market prices where the thing being valued is not traded in a market. In valuing pension costs, what we have ended up with is a discounted cash-flow valuation using a market-determined discount rate to estimate pension liabilities and market prices to value pension assets.

The problem is that this disregards the true nature of a pension scheme, as it plays out over many years into the future. Such an approach has been detrimental to the sustainability of defined benefit schemes because it removes any respect for the interaction between pension assets/liabilities and asset liability cash flows when both are valued at a single point in time using discounted cash flows. Corporate accounts should recognise amounts that better reflect the long-term nature of a defined pension obligation.

The result of this approach is volatility in assets and liabilities, hence the need to recognise substantial and often volatile pension deficits in the statement of the sponsor’s financial position. These deficits are an artefact of the valuation method, but it leaves corporate managers to wish to divest the company of such liabilities. Therefore, applying fair-value accounting to defined benefit pension obligations has hastened the decline of such schemes as corporate managers increase the rate at which these schemes are closed to new members and to future accrual.

From this one example, I hope that noble Lords will forgive my lack of confidence in the international financial standards. Perhaps the Minister could give us in his reply a bit more detail on what real advantages we will gain from proceeding along the lines set by these regulations.