IRA Publishes Commentary by AEI's Peter Wallison

Will the Slow Pace of Adoption of XBRL in the US Allow the EU to Assert Dominance in Global Finance?

XBRL: Give Them the Tools and They Will Finish the Job
February 21, 2006

By Peter J. Wallison

In December, the London Stock Market celebrated a record year for foreign company new issues, with 129 new offerings by companies from 29 different countries. According to a press report on this success, "about 38 per cent of the international companies surveyed said they had considered floating in the US. Of those, 90 per cent said the onerous demands of the new Sarbanes-Oxley corporate governance law had made London listing more attractive."

By now, it's well-known what harm Sarbanes-Oxley has done to the attractiveness of the US securities markets, but what isn't well-known is that lack of resources available to a relatively obscure accounting group-engaged in the development of a technical-sounding disclosure system called XBRL-may also threaten not only the current primacy of the US financial markets but also the future competitiveness of US companies.

Since 1998, the American Institute of Certified Public Accountants ("AICPA") and a few other organizations have sponsored the development of a taxonomy for eXtensible Business Reporting Language ("XBRL"), a derivation of the computer language XML that has the ability to tag individual words and numbers so that they can be understood in a particular context. The tagging facility permits financial statements, and even text such as footnotes, to be translated into a common language that can be read by computer applications. Thus, an analyst or investor who is interested in comparing the oil reserves of all publicly-reporting energy companies would be able, using XBRL, to do a computer search of a database containing the financial statements of these companies and pull out the relevant data in seconds. XBRL allows the search engine to ignore "reserves" for bad debts or other purposes and to extract only the data on oil reserves. Without this facility, the same information would have to be developed through a time-consuming page-by-page search through the disclosure materials filed by energy companies with the SEC.

XBRL represents a huge advance in the information potentially available to investors and analysts, and its significance has not been lost on the new Chairman of the SEC, Christopher Cox. Since taking office, Cox has made the implementation of XBRL-which he calls "interactive data" in order to avoid the techie connotation of XBRL-one of his key priorities, devoting attention to it in almost a third of all his public speeches. Under his prodding, the SEC is doing what it can to encourage the use of XBRL by public companies, including most recently offering expedited review of securities registrations for those companies that file in the interactive data format as part of the XBRL Voluntary Program for EDGAR.

But there's a problem. The development of the XBRL taxonomy-the definitions and classifications that enable contextual tags to be applied to every item in a company's financial statements-is going slowly. As Cox explains, "the development of taxonomies lacks resources. Believe it or not, the awesome global challenge of fashioning a new way for billions of people to exchange financial data is currently dependent on the success of one solitary man who labors in anonymity at XBRL-US." Indeed, only one person is currently employed full-time on this task; the other volunteers who are assisting in this effort are employed elsewhere and help out when they can.

And why is this a problem? For the same reason that the growth of the London Stock Market is a problem. The EU is also aware of the power and significance of XBRL, but its officials haven't relegated it to a private, voluntary initiative. Before Chairman Cox, the SEC would not even acknowledge the significance of XBRL, and its development has been slow and uneven. Meanwhile, the countries of the EU were busily developing the taxonomies necessary to state their new common financial reporting system-known as International Financial Reporting Standards, or IFRS-in XBRL. In the future, then, companies that want their financial statements to be more accessible to investors and analysts will have another reason, apart from Sarbanes-Oxley, to offer their securities in the EU, particularly London, and to report their financial results in IFRS. And, even worse, in the globalized capital market of today, capital will flow to the companies whose financial statements are most easily analyzed and understood, giving the companies that state their financials in IFRS an important competitive advantage over those that use US-GAAP.

To be sure, at the moment, the US financial reporting system-Generally Accepted Accounting Principles, or "US-GAAP"-is the preferred financial reporting system for most businesses, but IFRS is not far behind. According to the latest data available, US-GAAP is used by companies comprising 53 percent of the capitalization of all markets, while IFRS is used by 35 percent. The balance, 12 percent, use other financial reporting systems but will likely convert to either GAAP or IFRS as the capital markets continue to globalize. But, as shown by the growth of the London Stock Market, and the corresponding decline in foreign listings on the US markets, IFRS is closing the gap.

So what we have is a competition in two distinct areas, all revolving around the development of XBRL. The first is competition between the US and EU securities markets for dominance in the global financial markets of the future. The EU, which has now put in place the XBRL taxonomies that are necessary to make financial reports stated in IFRS more accessible to investors and analysts than those stated in US-GAAP, is in a position to take advantage of this resource in attracting new listings and encouraging the use of IFRS. But the second area of competition may be even more important in the long run. Unless the XBRL taxonomies can be completed soon, US companies that report in US-GAAP may find themselves at a disadvantage in attracting capital vis-à-vis foreign competitors that use IFRS. The long-run consequences for the competitiveness of the US economy as a whole could thus be adversely affected.

What to do? Now that XBRL has the full endorsement of the SEC, there can be no reason for US companies to hold back. XBRL is coming-the only question is whether it will be sooner or later. The competition between the US and the EU for financial dominance, and the competition among companies for scarce capital, argues strongly for the US financial and industrial communities to get behind the XBRL effort. This means providing the financial resources to increase the personnel available to the XBRL consortium. There's a lot at stake.

Peter J. Wallison is a resident fellow at the American Enterprise Institute

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