19 Aug 2013
Tasked with rebuilding trust in the capital markets following the financial crisis, and with key elements of the corporate reporting model clearly not working, what’s a responsible regulator to do? Well, regulate is the traditional and natural first reaction – and often with good reason as a great deal of reporting needs to be mandatory.
But is more regulation always the best approach to fixing a reporting regime that preparers say is too complex and onerous and leaves investors and analysts struggling to uncover a company’s true performance and risk profile?
The reporting labs are an innovative alternative to top-down regulation. Various labs have been set up by the UK’s Financial Reporting Council (FRC) and Japan’s Ministry of Economy, Trade and Industry (METI), along with the Enhanced Disclosures Task Force (EDTF) at the Financial Stability Board (FSB). By providing investors and companies with a safe environment to explore new reporting solutions, the regulators have cleared the way for market forces to devise improvements that better suit their needs.
Companies, analysts and investors collaborate with practical outputs in mind. They set the agenda, focusing on the areas of disclosure and presentation that they think most need fixing. Companies join in to find out how they can improve their reporting by getting a better understanding of user needs. Investors and analysts look to highlight examples of good reporting and tackle areas that can be made easier to understand or less frustrating for users.
The goal is not to come up with new reporting requirements, but to show how new approaches and practices can have an immediate impact on the relevance, practicality and usefulness of financial reports. Accounting and legal professionals add their perspectives, helping to find ways forward.
For a company, the collaborative lab approach can significantly bring down the cost and remove the guesswork from innovation in its reporting. While companies talk to investors every day, they rarely focus on the nuts and bolts of reporting.
The lab environment gives management a really granular insight into where they can make their reporting more valuable. And by testing a new approach, getting feedback and adjusting, they can introduce positive changes cost-effectively and quickly, without having to wait for the next reporting cycle.
Investors have welcomed the labs’ voluntary disclosure approach as a fast track to real improvements in company reports. The labs are promoting good practice and highlighting examples of good practice rather than generating white papers and exposure drafts. Key topics on the investors’ agenda are being addressed far sooner than they would be under formal standard- setting procedures, and are therefore having an impact in the markets.
The regulators deserve a great deal of credit for stepping back, setting aside their ‘thou shalt’ mandates, and creating the space for dialogue between the market players actually involved in the allocation of scarce resources.
Preparers often complain of a ‘laundry list’ approach to disclosures and question who really uses the information they are being asked to present, and why. In the lab environment, both the ‘who?’ and the ‘why?’ are embedded in every conversation.
It’s a win-win approach that is already producing results. Reports from the labs have been widely praised by the corporate and investment communities. The first round of financial reports that could include recommendations and examples devised in the labs are coming on stream now, and the signs are that companies are already adopting new practices.
Regulators have shown both their influence and imagination in setting up reporting labs. The concept has tapped a rich vein of creativity and innovation among participants with a genuine interest in finding solutions to common problems of communication and presentation. With successful precedents in place covering two major jurisdictions and a core global industry, it is now time for other regulators to follow suit.