Financial Reporting and Capital Market Regulation in an enlarged Europe

The New Economy

Driven by years of strong, low inflationary, productivity-driven growth with high investment in information and communication technology, a fundamental change has taken place in the US economy. It is here to stay -- the recession, the events of September 11 and even the implications of Enron -- will not alter its course.

The New Economy is not about the rise or fall of the stock market or the valuation of securities, it is about a new way of doing business - directly impacted by information and communication technology - labelled by some the "networked" or "knowledge" economy.

This economy is changing the world -- propelled by the growing power of global capital markets (which are eager for capital) and the influence of global investors (which are eager to diversify). Companies seek the advantages of globalising their businesses, production and distribution channels. Why not? When it comes to sharing information - or ideas or software -- geographic borders are growing increasingly meaningless. This provides both tremendous opportunity as well as tremendous pressure to compete in a global framework.

The New Economy is characterized by technology, innovation, and collaboration.

Technology. Only think back 5, 10 years to remember how far we have come. New technologies are rapidly disrupting existing business models and established markets. This does not suggest that only new industries will survive -- witness the bursting of the dot-com bubble -- but rather the application of new technologies is altering the way traditional industries operate and is making them more competitive.

Innovation. Great ideas are the currency of the New Economy. While process innovations like agile manufacturing and supply-chain management are important, these do not address the core issue of value innovation. Newer technologies in communication and information technology are empowering buyers - across borders -- to find the best product/value. There is constant pressure to rethink the basis for business success. (At PwC we have witnessed the speed with which our clients are able to innovate around a product.)

Finally, collaboration. Before you could only collaborate if you were in the plant -- now you are networked all over the world. This capability is taken for granted. Alliances are key to innovation: different companies combine to create/distribute or offer a product/service and then disband.

Implications for Enlarged Europe

The dynamics and drivers of the New Economy are applicable in Europe and on a global basis, even though the results in economic terms, like employment, GDP growth, etc. may differ for countries depending upon their economic structure and policy.

The neoclassical idea of creating wealth through free trade or by lowering the cost of trade is gaining new momentum in Europe through integration on the one side but also through continued innovation, technology spending, and all the important consumer demand. As Ludwig Erhard said, quote: "I can not imagine a human being who isn't always encountering new desires or needs." To successfully compete, companies and countries in Enlarged Europe will gravitate to special fields where they enjoy a comparative advantage such as low cost production or high value added engineering. The accession countries will have to capitalise on the opportunities presented by the rapid emergence of the new, knowledge-based economy - an area where rapid further growth can be anticipated in the next few years.

According to a PwC survey, the strategic benefits of enlargement appear greater for smaller international businesses, especially those from the EU. For these companies, investment in the candidate countries is now seen as more attractive then regions further afield, such as Latin America and the Far East. Already German firms account for the largest proportion of the stock of inward investment in the Czech Republic, Hungary and Poland.

To reap the benefits of the single market and the single currency, an enlarged Europe needs enhanced market integration. Our PricewaterhouseCoopers Eurofirm Structure is such an example. PwC firms in over a dozen European countries have joined together to improve cross-border coordination, eliminate internal barriers and thereby create a competitive advantage. Similar to the EU, this structure allows us to better understand the respective viewpoints of each country. PwC Eurofirm leaders already work closely with their colleagues in Central Europe and it is foreseeable that further expansion will occur as the markets continue to integrate.

Market Regulations and Financial Reporting Standards

Developing common financial reporting standards and accepted capital market regulations is critical to successfully integrating an enlarged Europe. Companies and potential investors demand reliable business information - now more than ever -- in this post-Enron world. The old economy may have been about processes; but the New Economy is about standards -- with transparency as the ultimate goal.

No amount of market regulation can eliminate the possibility of loss. What market regulation can and should do, however, is to make sure that investors have a solid platform of reliable information for use in analysis, including information about the analysis itself. Internationally, capital market regulation needs to converge on the basis of reciprocity of acceptance of transparent principles. An example might be to agree on the principles of disclosure for an IPO, while the details of the requirements might differ from country to country. Progress is already being made in Europe on a common "passport" to global cross-border listings - presently proposed as an annual prospectus.

We think that one of the biggest challenges facing the global capital markets is ensuring the same standards of financial reporting quality are applied worldwide. Global accounting standards are complicated by 215 sets of national laws and the profession's "Alphabet Soup" of standardising bodies.

The benefits of global GAAP are many:

• Increasing the availability, and reducing the cost, of capital through globally competitive capital markets;
• Reducing companies' cost of compliance with different accounting rules;
• Raising all national standards of accounting to "world class";
• Encouraging foreign investment; and
• Facilitating the provision of low cost capital to developing nations.
  

The introduction of a globally recognized financial reporting framework, based on International Accounting Standards, for businesses across the European Union will, we believe, make life more straightforward for most companies.

The European Commission has set a target date of 2005 for the adoption of IAS. We support the EC plan for single capital market - an accounting and auditing strategy based on convergence around global standards (IAS and ISA). We urge other countries, not least the US, to do likewise. When Europe moves to IAS, it will be far more difficult for others to abstain.

The biggest part of this puzzle, however, is enforcement. It is important to avoid a situation where interpretations at a national level, including those by the US SEC, conflict with one another. Reconciling this will involve some concessions on national sovereignty by all countries.

For companies themselves, now is time to begin putting the issue of IAS conversion on the boardroom agenda. Some of the standards are complex and conversion is a not simple push-button exercise. In a recent PwC survey of 16 European countries, 79% of the 700 European CFOs polled said they were aware of the EC's plans to introduce IAS by 2005, but had yet to make it a key issue for their boards of directors.

The Corporate Reporting Future

There is a need not only to create uniform global standards but standards with a propensity for innovation, transparency and competition that assess information relevant to the New Economy. Our current system, based primarily on historical cost information, is constrained by antiquated laws, rigid rules, and punitive legal systems that chill innovation in corporate reporting. This challenge - to produce financial information more relevant to the New Economy -- is the subject of a new PwC book entitled: "Building Public Trust: The Future of Corporate Reporting."

We think a principle-based approach to accounting is the best foundation for making financial reporting more relevant to investors and other stakeholders. This framework assigns responsibility to management to select the most appropriate accounting methods that reflect the economics of the transaction, not just those accounting methods dictated by narrow rules. Principles allow management scope to explain in appropriate detail how the principles have been interpreted and why. Principles also require that auditors exercise more judgment as well.

One of the central propositions of the book is that when investors have access to more reliable and more timely information about company performance-in large measure, the same information that executives use to run their businesses - better investment decisions will be possible.

The migration of corporate reporting onto the Internet will continue to increase the speed and frequency with which information can be reported, both internally and externally. We see Extensible Business Reporting Language - known as XBRL -- as the reporting technology of the future. XBRL exchanges data between different software applications through the use of information tags that self-describe what a piece of information is. The information delivered is more meaningful than ever before-more complete, higher quality, more useful, more quickly received and ready for reuse. When a company adopts XBRL, it not only reduces its own costs (as much as 60 percent over traditional publishing methods), but also levels the playing field for the entire stakeholder community by offering everyone, from elite analysts to individual investors, the full picture of its financial condition.

Where might this all lead? Let's take a quick look perhaps ten years into the future. Enlarged Europe stands at over thirty countries with more on the threshold. Global GAAP has been crafted by some of the most brilliant minds in several professions and from many different countries. It is supported institutionally by a strong interpretative function that collaborates on a global basis and is enforced by empowered market regulators. XBRL has been universally adopted by all listed companies and has proven to greatly simplify the corporate reporting supply chain while channelling much more useful information free of potential conflicts of interest. As a result, capital is being allocated more efficiently all over the world, to the benefit of wealth creation for society as a whole.

This is the future of corporate reporting for an enlarged Europe and the world. This is the kind of transparency I think the public will demand.

Thank you.