Cablegate: Prospectus Directive: Final Adoption Is Milestone

Published: Tue 2 Sep 2003 01:33 PM
This record is a partial extract of the original cable. The full text of the original cable is not available.
E.O. 12958: N/A
SUBJECT: Prospectus Directive: Final Adoption is Milestone
- Important Details to Follow: Possible Requirement for US
Firms to Use IAS a Huge Issue
This cable is sensitive but unclassified. Not/not for
Internet distribution.
Ref: A) Brussels 3470; B) Frankfurt 2582
1.(SBU) Summary: Adoption of the Prospectus Directive in
July by the European Parliament (ref A) and Ecofin Council
is a milestone event in the EU's Financial Services Action
Plan. The text was much improved over the European
Commission's initial proposal and solved the major question
of "issuer choice" to the satisfaction of the banking and
primary dealer community. A host of other issues, however,
are still to be solved in the implementation process. The
Committee of European Securities Regulators (CESR) has
produced its final advice to the Commission on the minimum
information requirements for a prospectus. This was also
not an easy process, as CESR's initial proposal was heavily
criticized as too cumbersome and detailed.
2.(SBU) A major issue for non-EU issuers will be whether
home country accounting standards, such as US GAAP, can be
used instead of International Accounting Standards (IAS), as
endorsed by the EU, as required for EU firms listed on stock
exchanges. Such a requirement, or even requiring
reconciliation of US GAAP to IAS could be very expensive and
could drive some US issuers out of the European markets in
which they currently list or offer their securities for
sale. Now that would not be in keeping with the EU's
objective of creating a strong European capital market,
would it? US officials have raised the issue with DG
Internal Market officials who concede that such a policy
would be like shooting themselves in the foot. In a new
consultation paper, CESR states that the question is still
open, but proposes that large, wholesale debt issuers may
not have to use IAS or reconcile their accounts. End Summary
Adoption of the Prospectus Directive: A Long and Windy Road
--------------------------------------------- --------------
3.(SBU) Following behind the scenes negotiations among key
officials of the European Commission, European Parliament
and member state Finance Ministries, the European Parliament
on July 2 adopted the proposed Prospectus Directive (ref A).
The Council adopted the directive on July 15. The directive
represents the end result of a hared-fought and contentious
effort to introduce a introduce a "single passport" for
issuers of securities, allowing them to use a prospectus
approved by one member state competent authority in all
other member states. Member States have 18 months to
transpose the directive into national legislation.
4.(SBU) Commissioner Bolkestein hailed the agreement as
demonstrating that the Commission, Council and Parliament
can overcome initial differences of views "through a
constructive spirit of compromise." Not known for his
mastery of the understatement, this one is a beauty. The
Commission's initial proposal of May 2001 was thoroughly
trashed as a terrible example of legislative drafting.
Rather than consulting with market experts, a senior DG
Internal Market official plead that time was pressing and
they needed to issue a draft quickly. (In retrospect, he
conceded that the document was poorly drafted and submitted
in haste to make progress on the Financial Services Action
5.(SBU) Parliament proposed over 65 amendments, essentially
re-writing the text. The Commission "modified" its proposal
in August 2002, incorporating many of Parliament's changes.
The Council also had a difficult time wrestling with issues
of language, application to sovereign issues and whether
authority to approve prospectuses could be delegated to
6.(SBU) One major issue for investment firms and issuers of
non-equity securities in particular was whether issuers they
could chose the competent authority to approve their
prospectus. In the current euro bond market, issuers of
debt securities can have their issue approved in London or
Luxembourg, markets where they intend to offer the debit
issue for sale, rather than in their home market. Several
member states opposed such "issuer" choice. In the end, the
final text will permit issuers of non-equity securities in
denominations of at least euro 1,000, to be able to choose
the competent authority to review and approve their
7.(SBU) In a joint statement, the Banking Federation of the
European Union (FBE) and the International Primary Market
Association (IPMA) declared that finalization of the
directive "marks the success of a tremendous effort by the
financial services industry to make its voice matter in the
political process of structuring a "passporting" system."
They went on to state that "the financial services industry
notes with satisfaction that issuers of more than 90% of all
bonds will have the right to determine where to file their
prospectus, as they do today, and that debt issuance
programs, or Medium Term Notes (MTNs), a structure which is
now used by 90% of international debt issues, will continue
to operate."
8.(SBU) All is not well, however. FBE/IMPA still has "some
substantive concerns." Among these is that convertible
bonds will be categorized as equity and subject to more
stringent requirements than at present, that the definition
of qualified investor (e.g. professional investor) is not
clear; and high translation costs for cross-border issues
(the summary may have to be translated into the host
country's language). They note that some securitized
derivatives will have to be discontinued. Several
investment bankers complained about information requirements
imposed on non-equity issues, since a lighter information
regime would apply only to issues in denominations of euro
50,000 or more. Such changes will alter the present
operations of the euro bond market, in their opinion.
9.(SBU) The compromises, however, were hard fought.
Indeed, up to the last day in the plenary a German Finance
Ministry official thought that an aggressive push in
Parliament to give all issuers investor choice could allow
the French to re-open the entire issue rather than fixing on
a compromise. Commented a Parliamentary staffer: "We got
what we could, but couldn't get everything."
Important Details: Enter CESR
10.(SBU) Passage of the directive provides "framework"
legislation that needs to be filled in with details by the
European Commission based on advice from CESR. This is
tough, technical slogging. CESR began to develop details
already in March 2002 when the Commission gave it its first
mandate on the prospectus directive. The text of the
directive has changed since then, giving CESR somewhat of a
moving target.
11.(SBU) CESR's first a consultation document was a flop
(ref B). It demanded many details, many of which were
considered inappropriate, particularly for bond issues. The
format for documentation was considered cumbersome and
overly rigid for a market place in which new financial
instruments can be engineered overnight.
12.(SBU) To its credit, CESR took these criticisms to
heart. It held public hearings and listened to industry
representatives. On July 31 CESR issued its advice to the
European Commission on (a) disclosure obligations (e.g. for
equity securities, retail and wholesale debt, asset-backed
securities, etc.); (b) incorporation by reference of
previously published information (e.g. annual reports); and
(c) publication of a prospectus (availability, contents of a
notice, methods of publication (e.g. email). CESR noted
that it had reduced information requirements, particularly
for debt issues, and used existing IOSCO standards, which
had been developed without much public consultation, as a
benchmark rather than as minimal standards. One bond expert
who had participated in consultations with CESR reported
that the initial sessions were highly confrontational. By
the time of the last consultation in June he said it was "a
love feast." This is not to say there has been complete
satisfaction with all details. But CESR work has improved
as a result of its consultation process.
13.(SBU) Bond representatives might have won that skirmish.
But a major potential battle looms.
Accounting and Auditing Standards: Content of a Prospectus
--------------------------------------------- -------------
14.(SBU) An issue that arose in the first round of
consultations with CESR was the use of accounting and
auditing standards. Under the EU Regulation on
international accounting standards, all EU companies listed
on exchanges will have to have their accounts prepared
according to IAS, as endorsed by the European Commission, as
of financial year 2005. CESR's initial consultation
document implied that accounts would have to be prepared
using IAS and International Standards of Audit (ISA), but
was not clear.
15.(SBU) CESR issued a new consultation document at the end
of July that is more explicit. It proposes including "two
years of audited historic financial information prepared and
presented in accordance with the accounting standards which
will be adopted in the issuer's next annual financial
statements." That would mean re-stating two years of
information according to IAS. CESR considered and rejected
other options: re-statement of three years of accounts;
reconciliation between local Generally Accepted Accounting
Principles (GAAP) and IAS, and no restatement or
reconciliation. CESR has invited comments on this
consultation document by October 30 and will hold hearings
on October 9 in Paris. It will provide its final advice to
the Commission by 31 December.
16.(SBU) On auditing standards CESR acknowledges that the
absence of comprehensive rules at the EU level could result
in differing levels of audit scrutiny of accounts. CESR
declared, however, that it shares the European Commission's
objective to implement International Standards of Audit
(ISA) as of 2005.
Issuers from Third Countries: The Meaning of Equivalence
--------------------------------------------- ------------
17.(SBU) Issuers from third countries were among the most
outspoken critics of CESR's initial consultation paper. One
such critic was the American Financial Services Association
(AFSA). AFSA is a trade association that represents 400
firms involved in the financial services industry including
Ford Motor Credit Company, GMAC Financial Services, CIT
Group Inc., Household International and Toyota Motor Credit.
AFSA states that these borrowers have debt outstanding
totaling approximately $224 billion listed in the EU. These
companies issued $37 billion of corporate securities listed
on an EU exchange in 2002, and $71 billion in 2001.
18.(SBU) AFSA argues that US GAAP should be considered to
be international accounting standards since they are
prevalent in the international market place and require
comparable disclosure as EU rules. Therefore, U.S. GAAP
accounts "should be acceptable under the Directive."
"Requiring issuers to restate US GAAP numbers to a different
international accounting standard on an ongoing basis would
impose costs so prohibitively high as to drive many issuers
out of the European debt capital market." AFSA made the
same case for the use of auditing standards and "invited"
CESR and the Commission "to make clear that U.S. audit
standards represent equivalent standards" to those in the
19.(SBU) In July CESR issued a new consultation paper in
July regarding (a) minimum information requirements for
sovereign government securities issues, should
authorities decide to issue one (non-equity issues and
guarantees by such governments are not required to draw
up a prospectus); (b) historical financial information of
EU and non-EU issuers to be included in a prospectus; and
(c) advertising. With respect to (b) CESR proposes that
non-EU issuers be subject to the same minimum information
requirements as EU issuers. Non-EU issuers that prepare
financial statements according to a GAAP "equivalent" to
IAS Regulation need not submit additional information.
20.(SBU) CESR acknowledges that their proposal raises
the question of "equivalence." Article 20 of the
Prospectus Directive specifies that a competent authority
in a member state may approve a prospectus from a third
country issuer provided that the prospectus has been
drawn up in accordance with international standards (e.g.
IOSCO Disclosure Standards) and the information
requirements, including information of a financial
nature, are "equivalent" to the requirements under this
Directive. The Commission is authorized to adopt
implementing measures stating that a third country
ensures such equivalence.
21.(SBU) CESR states in its July consultation document
that it is working with the European Commission in order
to devise the best procedure to "manage the question of
equivalence." A German securities official suggests that
EU securities regulators tend to believe that accounts
prepared under U.S. GAAP should be considered equivalent
to IAS accounts. This official points out that all major
European exchanges do so now. The European Commission,
according to this official, is in a dilemma: they want
companies to abide by the new regulation on international
accounting standards rather than use US GAAP, as some
firms now do. Resolution of this issue is not a
technical matter but a political one, in official's
22.(SBU) DG Internal Market officials have not made a
clear public statement on this issue. They have declared
that an overall goal should be to achieve convergence
between U.S. GAAP and IAS. They would like EU issuers to
be able to use accounts prepared using IAS for listing in
the United States. USG officials have raised the use of
accounts prepared under U.S. GAAP in the informal US-EU
financial market dialogue. In response, DG Internal
Market officials conceded that not accepting US GAAP
would damage the EU capital market should US issuers
leave. "We would shoot ourselves in the foot," quipped
one. They reportedly made the same comment to
representatives of AFSA.
23.(SBU) Some members of the finance industry, however,
believe that the Commission is using this issue as a
bargaining lever to extract concessions from the US, such
as on implementation of Sarbanes-Oxley legislation or
placement of European trading screens in the United
States, a "tit-for-tat" approach to regulation.
The Power of an Exemption
24.(SBU) In its July consultation paper CESR proposes
some exemptions for wholesale issuers from having to meet
an "equivalence" standard. CESR reasons that the
different nature of the investors concerned justifies
different treatment. This exemption would apply to both
accounting and auditing standards for wholesale debt
issues and issuers of high denomination asset backed
securities or depository receipts (e.g. issues having
denominations of at least euro 50,000).
25.(SBU) Specifically CESR proposes that issuers are to
use accounts prepared under IAS or a non-Member state
local GAAP equivalent to IAS, "otherwise" the following
information shall be included in the registration
document: (a) "a prominent statement that the financial
information included in the registration document has not
been prepared in accordance with IAS Regulations and that
there may be material differences in the financial
information had IAS Regulation been applied to the
historical financial information; (b) immediately
following the historical financial information a
narrative description of the differences between IAS
Regulation and the accounting principles adopted by the
issuer in preparing its annual financial statements.
Similarly, if different auditing standards were used than
those applicable in a member state, information shall be
included would be (a) a prominent statement disclosing
which auditing standards have been applied; and (b) an
explanation of any significant departures from ISA.
CESR Information Gathering
26.(SBU) In January the Commission gave CESR a mandate
to provide factual information and legislative and
practices of Member States regarding the treatment of
third county issuers with respect to drawing up and
approval of prospectuses. This information is due to the
Commission at the same time CESR provides its advice on
the July consultation document, that is, 31 December. On
the basis of the information gathered the Commission will
decide whether an additional mandate asking CESR to
provide technical advice on possible draft implementing
rules will be granted in the future.
An Observation
27.(SBU) Accounts prepared under U.S. GAAP were once
considered the world standard. EU firms listed on US
exchanges had to use U.S. GAAP accounts or reconcile them
to it. Even EU firms listed on US exchanges could use
their U.S. GAAP accounts to satisfy home country
requirements. The EU Regulation on international
accounting standards is changing all that. By forcing
uniformity of accounting standards for all 7,000 EU
listed firms, it raises the prevalence of IAS usage.
This has the potential to divide the world in two: IAS
and U.S. GAAP. In August the Swiss Stock Exchange
announced that as of 2005 only IAS or U.S. GAAP accounts
would be accepted for Swiss listed firms on its exchange:
Swiss GAAP will no longer be accepted. In July the German
Accounting Standards Board made cooperation with the
International Accounting Standards Board (IASB) its
primary objective.
28.(SBU) Bringing these two accounting standards worlds
together is noble aim of the convergence project of the
U.S. Financial Accounting Standards Board and the
International Accounting Standards Board. Former SEC
Chairman Pitt stated that if there were sufficient
progress in convergence and a process for consistent
interpretation and enforcement of IAS, then it may be
appropriate for the SEC to reconsider the need for
private issuers from the EU firms to continue to
reconcile from IAS to U.S. GAAP. A Commission statement
to the same effect would go a long way toward relieving
market uncertainties its current ambiguous position is
29.(SBU) By keeping the issue vague of whether US firms
can continue to use U.S. GAAP in Europe, the Commission
thinks it keeps up the pressure for firms in the EU to
use Commission-endorsed IAS and convergence, the latter
seen as an ultimate objective by Commissioner Bolkestein.
There are other views of the Commission's objectives.
One is that it would like to assert the primacy of EU
standards world wide - a counterweight to the role of the
U.S. SEC. Another is that, as noted above, the
Commission wants to use the acceptance of U.S. GAAP
accounts as leverage for other concessions.
30.(SBU) If convergence truly were the Commission's
goal, it could enlist the firms represented by AFSA to
push for such convergence. Such convergence would unite
two major capital markets. If the other two views more
accurately reflect reality, then the outcome depends on
politics. This may or may not be at all helpful for
financial markets. What is less uncertain, is that by
maintaining uncertainty, the Commission is needlessly
creating uncertainties for non-EU global firms that may
take their business elsewhere. It wouldn't be the first
time that financial markets, provoked by policy changes,
created new instruments and markets were none had existed
31.(U) This cable coordinated with Embassies Berlin,
Rome, The Hague and USEU Brussels.
32.(U) POC: James Wallar, Treasury Representative, e-
mail; tel. 49-(69)-7535-2431, fax
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