Following E. Faber's nomination to the ISSB - or the need for an analysis of the controversies in sustainable finance/accounting (3)

Continuation of the second part. To the second part.

Let us now turn to a central controversy, which has opposed continental European approaches and IAS/IFRS from the outset: that of Fair Value defended by IFRS (and therefore by the ISSB).

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Fair Value and Sustainability

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Let's already recall that in 2018, the EU's introductory report for a Sustainable Finance Action Plan stated that:

"There is considerable disagreement among interested parties on the appropriate accounting treatment for long-term investments, in particular on whether long-term assets on investors' balance sheets should be valued based on the currently prevailing (daily) market prices - also known as 'mark-to-market' valuation or 'fair value' accounting [...]

In this context, the accounting standard IFRS 9 is seen by many companies as having negative impact on long-term finance, including both investment and lending [...].

Investigate alternative accounting approaches to fair value/mark-to-market valuation for long-term investment portfolios of equity and equity-type instruments.

Thus, Fair Value seems difficult to reconcile with long-term investments, which are essential for sustainability issues, as recognised by the EU. There is therefore a divergence with the ISSB.

To go further, let's take the example of the first version of IAS 41.

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IAS 41

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IAS 41, on biological assets, led to the use of Fair Value for the valuation of the plantations themselves. Figure 1 shows the consequences of implementing IAS 41 in (actual/model) tests on plantations in Malaysia, just before the official introduction of IAS 41 in that country.

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Fig. 1

Source: Hanim, A. (2010). Planters concerned over new accounting standard. Thestar.Com.My.

(MPOA: Malaysian Palm Oil Association)

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Fair Value allows huge profits to be made (for shareholders) at the beginning of the plantation's operation, when the plantations are not mature enough to guarantee real profits (it takes an average of 5 years before the palm trees reach maturity).

In these conditions, there is a total disconnect between the material reality of profit creation and the desire for "quick" profits, whereas Historical Cost Accounting respects this reality.

This case has been studied in depth by T. Suzuki, including interviews conducted in 2010. He concludes that "IAS 41 [...] negatively affects the sustainable development of the most important industry [palm oil] in the [South East Asian]".

Prior to that, in 2010, T. Suzuki and J. Jaypal submitted a report to the Institute of Chartered Accountants of India (ICAI) on the socio-economic impacts of IFRS on stakeholders in India.

In all these studies, they severely criticised the implementation of IAS 41. From several interviews on the impacts of this standard, they concluded that "96% of the respondents believe that IAS 41 was significantly damaging to the sustainable development of the plantation industries" (reported by (Hanim, 2010) - see above).

For example, in 2010, the CEO of the MPOA said of IAS 41: "this accounting makes our industry unsustainable [… The consequences] are like what happened to Enron" (reported by (Suzuki, 2012)).

The Malaysian Prime Minister of Plantation Industries and Commodities used the same comparison: "This is Enron Accounting for Agriculture... The only difference is that it was a scandal at that time; now it is mandatory" (reported by (Suzuki, 2012)).

Enron-style accounting! This is more or less what is in store for the use of Fair Value in the case of the environment...

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Finally, "the AOSSG [Asian-Oceanian Standard Setters Group] noted that concerns had been raised by investors (as well as preparers) [and, as explained, by Malaysian government and other stakeholders] about the relevance and usefulness of information provided to users for certain biological assets accounted for at fair value. Specifically the paper included a survey performed by the Malaysian Accounting Standards Board (MASB) in 2010 that found that a group of analysts specialising in plantation did not find fair value information for BBAs [bearer biological assets] useful, particularly the presentation of changes in fair value within the profit or loss - which in some instances can be large an d distort profits" (Site IASplus).

As a result, the IASB amended IAS 41 in 2014, proposing to bring biological assets that meet the definition of a "bearer plant" (including plantations) within the scope of IAS 16 (allowing for a possible reversion to Historical Cost), rather than using the Fair Value measurement approach prescribed by the first version of IAS 41. These amendments are effective for annual periods beginning on or after 1 January 2016.

Thus, we have a concrete case showing that the use of Fair Value is in contradiction with a sustainable management of a company and of ecosystems.

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Fair value, shareholders & sustainable investments

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In addition, there are many articles documenting the fact that Fair Value privileges a single actor, the shareholder, to the detriment of other stakeholders.

Ultimately, the targeting of investments for sustainability can only be done by showing the real costs of environment-related investments and activities. It seems impossible to achieve an ambitious, credible and controllable sustainability financing policy without accounting based on the real costs of related activities. Green finance" should be based on the sequence:

"Objectives [of ecosystem preservation] (in scientific terms) / Action plans / Budgets [thus costs attached to the action plan] / Reporting of these costs [including linkage to costs actually incurred in the balance sheet and income statement each year] / Targeting of funding towards these objectives based on these budgets and monitoring".

Fair Value can only encourage the development of secondary markets for green financial products, and thus the non-operationalisation of sustainability actions. On these issues, I refer to the paper we have just written with Hugues Chenet and published in "Bankers, Markets & Investors": https://www.journaleska.com/index.php/bmi/article/view/3366

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Finally, what do we get back in the end? The fact that it is necessary, in the debates/work on sustainable accounting, to go beyond appearances (mobilising concepts, charismatic personalities, etc.), to couple theory/practice, research/application, to integrate ecological sciences, bio-economical models, etc. in these reflections, and, above all, not to run away from, refuse or ignore controversies.

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It will never be possible to reconcile European approaches and IFRS/ISSB... So what? The only problem is that these questions should be:

• the subject of a citizen debate and democratically accepted societal choices (choices that are incompatible with each other) and
• not a work presented as technical and in the hands of a few experts, conveying false consensus (taken up by the players) but imposing real choices that will determine the future of the planet and our societies.

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