ANALYSIS: Accounting changes will impact both funds and their administrators

By Clint Egenes, LaCrosse Global Fund Services The movement toward adopting a single set of globally accepted accounting standards has gained significant momentum.

Driven by the globalisation of today's markets, the movement toward adopting a single set of high quality, globally accepted accounting standards has gained significant momentum in the US and internationally.

Led by other global capital markets, US acceptance of International Financial Reporting Standards as the global accounting language of the future continues to grow. The progression toward IFRS implementation in the US, assuming it continues, would likely impact public and private entities.

Globally there is a significant trend toward full IFRS conversion. Over 12,000 public companies in nearly 100 countries use IFRS accounting standards. Canada, India, Japan and a number of other countries will complete their transition to IFRS by 2011. Nine of the top 10 global capital markets are in the process of or have already transitioned to IFRS. Only the US still uses US Generally Accepted Accounting Principles (GAAP) as its approved set of accounting standards. This appears likely to change, given developments over the last few years.

Regulatory bodies in the US have begun pushing forward in an effort to promote IFRS as the preferred set of standards for domestic companies. Within the next few years the US Securities and Exchange Commission (SEC) could mandate a timeline in which all US public companies must transition to IFRS.

The SEC has already enacted rules that allow foreign private issuers to list securities in the US using IFRS without performing reconciliation to US GAAP. The SEC has recently approved a roadmap for conversion to IFRS, including elective adoption by large public companies in the US in 2009 and a 2011 deadline to determine if a phased transition for US public companies should begin in 2014.

As the regulatory bodies in the US set the table for IFRS conversion, recent developments have focused on public companies. However, private entities, including non-registered investment companies, may be impacted as well. Internationally, the International Accounting Standards Board (IASB) has taken steps to provide guidance on the impact of IFRS to private entities by initiating an IFRS for Private Entities project.

The Private Company Financial Reporting Committee (PCFRC) in the US has been monitoring this project and has suggested that field tests by private entities in the US would be beneficial in assessing the impact of the IASB's project and IFRS in general. The PCFRC seems to support a parallel IFRS track for private entities if the SEC's initiatives for public companies continue to move forward.

Advisers looking to launch new funds are faced with the decision regarding which set of accounting standards to use: US GAAP or IFRS. For non-registered investment companies such as hedge funds that are not subject to regulatory filing requirements, that decision can be driven by significant seed investors or future marketing plans for a fund.

Seed investors subject to IFRS are likely look for funds to adopt IFRS standards and vice versa for seed investors subject to US GAAP. In the absence of strong preferences by significant seed investors, an adviser may consider future marketing plans and the geographic location of potential investors as factors in choosing a set of standards.

Some advisers use multiple sets of standards when they manage stand-alone funds domiciled in different countries. This allows them to market US domiciled funds to US investors under US GAAP while marketing foreign funds to foreign investors under IFRS.

Impact of IFRS
Through clarification and convergence on existing standards, as well as co-operation on new standards, joint efforts between the Financial Accounting Standards Board (FASB) and the IASB are expected to have addressed the more significant accounting and reporting differences between US GAAP and IFRS by the time the SEC considers mandating IFRS conversion. Doing this in such a short timeframe will be a tall order, given the magnitude of the differences in accounting and financial reporting requirements between the two sets of standards.

This is especially true for investment companies and other industries that apply industry-specific guidance under US GAAP. No specialised industry requirements exist under IFRS.

This could leave many advisers asking how and when a potential transition to IFRS will impact them. Steps taken by the SEC to mandate conversion need to be watched together with convergence efforts between the FASB and IASB.

Progress in the IASB's IFRS for private entities project and developments in the PCFRC's interpretation and guidance regarding IFRS should be monitored. These organisations will help drive conversion requirements and timelines for private companies.

The move toward IFRS seems inevitable for private entities, especially if investors start to demand its use based on the conversion efforts of public companies.

The efforts needed to move from US GAAP to IFRS for investment companies should not be taken lightly. It would be unwise to try to switch for the first time at year-end during the audit and financial reporting process. A significant effort is needed as well as careful planning for several reasons.

Technical knowledge
IFRS is a principle-based set of standards intended to address all industries rather than the rules-based approach of US GAAP which was tailored to specific industries. IFRS requires significant use of professional judgment when applying principles to an investment company. Developing an IFRS framework to apply the standards and support accounting and reporting positions needs to be done taking into consideration many elements and should not be rushed..

Operational processes
There are a number of accounting and financial reporting differences between US GAAP and IFRS specific to investment companies. On the accounting side potential differences include valuation methodologies, consolidation, amortisation approach and treatment of brokerage commissions.

Even more significant are the reporting requirements that can vary regarding comparative data, financial statement classification, statement of cash flows, schedule of investments, financial highlights information and extensive disclosures such as IFRS 7.

System readiness
These differences could substantially impact accounting and financial reporting systems. A thorough understanding of the requirements and areas open to interpretation is critical to ensure system capabilities are aligned with IFRS requirements in a controlled manner.

Fund administrator capabilities
Investments made by proactive administrators to develop their processes and systems internally to accommodate IFRS standards can pay dividends to advisers. An administrator proficient in IFRS allows advisers to be proactive in a US GAAP-to-IFRS conversion, whether related to FASB/IASB convergence efforts or potential mandatory conversion requirements.

Advisers will have flexibility when selecting a set of accounting standards based on new funds, clients or international marketing.

Given the likelihood that non-registered investment companies will be impacted eventually by a conversion to IFRS and the complexities involved with managing a transition from US GAAP to IFRS, it is important for advisers to consider an administrator's IFRS capabilities and experience when selecting its hedge fund administrator.

The administrator will need to be competent in both US GAAP and IFRS and have controlled processes and systems in place to lead advisers through a conversion to IFRS.