Can our current systems of accounting, which are so expensive and murky, be replaced by a system that produces genuine financial transparency without being even more expensive?
I did not think so, till I read this book.
With increasing astonishment, I realised that if, as a result of the current crisis, there actually is increased regulation, and companies are simply respond in their usual way –"each regulatory request triggers new projects inside each bank, lasting for many man years" – then increasing regulation will increasingly strangle all companies, whether financial or non-financial. But the good news is that there is a way through.
It starts, as does the book, with understanding how and why we have such an "expensively produced mess" of a system in all companies around the world, because of which everyone from Chairmen and Chief Executives to Treasurers, Auditors and CFOs is doomed to have an insufficient idea of what is in their own accounts. (If that seems an extreme statement, consider that that was the precise defence offered by such officials when summoned as a result of the current crisis to legislative leaders around the world to explain why they should not be thrown in jail – and consider further that that explanation was accepted as valid by the legislators).
In any case, Brammertz and his colleagues take us through the history of the development of our world's costly, complicated, confusing and unclear system of accounting, which has been at least one contributor to the creation of the current crisis – and which now calls for taxpayers to rescue financial and manufacturing companies even though no one can quantify anything like the scale of either the risks or indeed even the full costs.
What we need is not more information, argue the authors. What we need is higher quality information. And it is quality not quantity of information which will be demanded in order to increase regulatory effectiveness.
That is why it is imperative to find a way of providing the information by means that do not increase the financial and management burden on companies.
The enormous merit of this book is that it shows not only how it might be possible but indeed has been possible in hundreds of cases with which the authors have been quietly involved over the last 20 years.
The solution proposed in this book "could become an opportunity, since it would trigger a common unified financial language" which could be understood by any and all of the principals involved, be they treasurers, bookkeepers, actuaries, investment officers, controllers, ALM managers or the individuals responsible for budgeting. No longer would such parties be at loggerheads with each other, living in their own silos.
Additionally, the language would enable genuine dialogue between banks, insurance and reinsurance companies (in my view, perhaps making bancassurance really possible for the first time).
Most attractively, this language would be all that is needed to bring together the interests of the whole of the financial community with that of its regulators.
The result would be improved information content for all participants at reduced cost, well-ordered, thought-out and efficiently displayed.
Starting with the actual situation of financial institutions today, the authors analyse the elements involved in each individual financial transaction and then build up to the level of the system as a whole, taking in liquidity, value and income, risk and sensitivity analysis, combining all that with detailed considerations of market risk, counterparty risk, behaviour and cost accounting, as well as issues of natural time, valuation concepts and risk groups. The authors show how easily (and incontrovertibly) the elements can be computed to derive virtually any static financial information of interest. They expand the scope to dynamic simulation, and follow it up by extending it to insurance and reinsurance, and indeed to non-financial industries. Aggregation should not be allowed at the level of individual deals, argue the authors. However, as the chain from there to the global level is very long, aggregation needs to be allowed by means of rules that are agreed with regulators for the purpose of being able to drill down or helicopter up to any level, from single deal to the whole economy.
Here is an illustrative quote from the discussion of risk: "Depending on which of the elements fluctuate, the system produces the corresponding risk results. If only market risk factors are (changed), then only market risk will be produced; if only credit ratings are (changed), credit risk will be produced, and so on. If two or more of these risk factors are (changed), a combined, consistent and fully integrated risk figure will be produced. If all risk factors are allowed to (change), then the integration of all risk categories is complete" (brackets mine).
In other words, the authors propose "a unified financial language that merges all financial concepts in a fully consistent and natural manner". The "language" is based on financial events seen in terms of cash flows, value and income - of any flavour, sensitivity and risk – providing the
power to ask any defined financial instrument what its value or income or anything of financial interest would be under all market conditions.
This is breathtaking by itself.
Further, the system provides for spot checks as well as continuing analysis of liquidity, value, income, sensitivity and risk of any part of a company, of a whole company, of an industry, of a region, of a nation, of a group of nations or indeed of the whole of the world – if we all followed this elegant system which is based on a fresh fundamental analysis of the elements that go to make up finance, industry and commerce.
The most important advantage of the proposed system, however, is that entrepreneurs and managers can save all the energy which they invest at present in addressing problems of data quality. Instead, they can devote their energies to the key task of making, on the basis of the best quality of information, much better business decisions.
The same applies to administrators and politicians, who no longer need to tear their hair out at all the uncertainties and obfuscations created by the present systems, and can focus their attention on the question of what is the wisest decision.
It is the strength of the system that it can provide not only all the known ratios, but also any new ratios and reports (such as environmental or social ones) that are thought necessary or useful in future, so that the system becomes a sort of "financial laboratory where new things can be discovered or invented, and accordingly expressed and presented".
While the book does not include current “hot issues” such as the practicalities of counter-cyclical provisioning, the venality of leveraged betting or the practical issues around complementary currencies, I’m sure that all those can be integrated in the system, and the consequences clearly mapped.
The time for such a system has come, and Brammertz and his colleagues provide here a book that is carefully argued from step to step, thoroughly thought-through, simple, elegant, and comprehensive.
There is simply no way of avoiding taking this book and its proposed system seriously.
It is essential reading for everyone, lay person or expert, interested in the issues of the entire industry, since it addresses the cost and quality issues involved at every level, from global governance to individual deals.
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