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The value of interdisciplinary work is on display in this article by two Dutch policy scholars: the subject matter is accounting rules for financial instruments, but it spans public policy and regulation in a way that is also of interest to scholars of law and regulation. (Full disclosure: I am an editor of Regulation & Governance, though I was not involved in this article’s editorial process.)

Mügge and Stellinga discuss the choice between the two main accounting standards (fair value accounting, or FVA, and historical cost accounting, or HCA), across three policy-making moments between 1997 and 2013, in terms of two dominant explanatory theories for policy change—neither of which turns out to be convincing. What emerges is a sense of how accounting regulators, specifically the EU’s Accounting and Regulatory Committee (ARC), put in place unstable sets of accounting standards for financial instruments that were neither exactly what banks wanted, nor what the International Accounting Standards Board (IASB) as standard-setter wanted. Nor is this simply a case of a regulator ‘splitting the baby’ between competing interest groups.

FVA is a useful accounting method because it can produce the best estimate of an asset’s present ‘value’. In accounting terms, assets do not have an inherent, fixed value beyond what the market’s current, aggregated preferences generate, and that is what FVA records. On the other hand, FVA can be volatile and have procyclical effects, can exacerbate herding behavior, and can be highly subjective in valuing illiquid assets. HCA’s advantages are the flip side of FVA’s: HCA is effective in tempering market volatility and tamping down herding, since assets are recorded at historical acquisition cost. However, HCA can also imperceptibly allow vulnerability and risk to build up. This can produce distrust, and is especially unhelpful with respect to contingent, hard-to-price instruments such as derivatives. Across time, as the authors show, one accounting standard has often been the solution to the other’s problems.

The authors look at EU accounting standard policy through three time periods: the Full Fair Value proposal in 1997-2001, the IAS 39 controversies from 2002-2005, and the financial crisis and IFRS 9 from 2008-2013. Throughout, the IASB as standard setter maintained an unambiguous preference for a clear, stringent FVA standard. Banks preferred FVA in good times, but HCA in bad times—that is, they had no consistent accounting standard preference but a clear preference for flexibility and their own autonomy. If an expertise-based causal account had been operating, the IASB would have prevailed in establishing the regulatory standard. If regulatory capture were dictating outcomes, presumably the banks would have prevailed. The result was neither. Instead, the ARC as regulator waffled between FVA and HCA, producing temporary fixes, policy reversals and hybrid positions, and clashing with both banks and standard-setter at different times.

What was ARC doing? Was its response simply incoherent, perhaps because of internecine disagreements? (No, though it might have looked that way sometimes.) Was it pursuing a separate agenda? (Not really.) Banking regulators were unified in their action, but “without a clear and consistent preference for a specific accounting treatment for financial instruments, or for allowing banks to choose one themselves.”

Why could ARC not identify a stable preference for a general rule? Because its preference might change later. Regulators need reliable data to promote fair and efficient capital markets, so FVA is a good method—but not if it actually causes banks to fail. In a crisis, needing to consider systemic safety and soundness, the regulator will avoid loss and side with the banks in favor of HCA. Recognizing this, ARC avoided committing completely to a single standard, while also not giving banks free rein. The result is that accounting standards—ostensibly stable, common concepts—“offer no solid fundament” and “remain temporary fixes.” In this way, the simple but puzzling question of differential accounting treatment over time unspools into a narrative about the drivers of, and tensions within, regulation.

Mügge and Stellinga note that the dynamic they describe is “rooted in the reflexivity of financial markets, in which future expectations, which are translated into valuations, shape the future they seek to describe.” They wonder whether “an apparent ‘lack of progress’ in global financial governance is not solely owed to its global nature, but more importantly to the inherent limits of governing reflexive financial markets.” They make policy recommendations for improving regulation (including a Twin Peaks regulator). Another thing that emerges from their account, however, is a more persistent tension that will bedevil regulation no matter its form: the tension between the stability law provides, and the pragmatic and dynamic capability the modern world seems to demand.

Mügge and Stellinga’s work invites us to think further about why FVA rules are the solution to HCA rules’ problems, and vice versa. It is because ultimately, the problem is temporality, and the difference between FVA and HCA is temporal: the accounting method modifies the moment at which an asset is valued. The relationship between effective regulation and time demands more study. We value good timing in regulation: the Federal Reserve needs to know when to take the punchbowl away (just when the party starts going). After a crisis we want to avoid ‘building another Maginot line’, or ‘closing the barn door after the horse has left’, or engaging in “quack corporate governance” (per Roberta Romano) for the sake of being seen to be doing something. Very often, however, we remain hostage to our times. We like our party, and our punchbowl, even if after a crisis we are struck with hindsight righteousness and, sometimes excessively or ill advisedly, demand a response. Mügge and Stellinga show how in this case, ARC’s regulatory choice has been to fail to commit to one accounting standard for financial instruments, even though this leaves the structure of accounting standards resting on the shifting sands of temporal preference. Given the policy tensions in ARCs’ mandate and its sensitivity to the pros and cons of each accounting method, at least this shows pragmatic attention to trying to do what needs to be done to discharge its mandate. At the times in question, it is not obvious that a single consistent position would have been wiser. All the same, leaving the choice of accounting standards in a state of perpetual uncertainty seems a high price to pay.

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Cite as: Cristie Ford, Drama and Consequence in Accounting Standards Choice (Seriously), JOTWELL (June 20, 2014) (reviewing Daniel Mügge & Bart Stellinga, The unstable core of global finance: Contingent valuation and governance of international accounting standardsReg. & Governance (forthcoming, 2014)),