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The Cyprus Economy
www.icpac.org.cy No100SEPTEMBER2010 A RADICAL REFORM OF EUROPEAN FINANCIAL SUPERVISION The Journal of the Institute of Certified Public Accountants of Cyprus CONTENT NÔ. 100 8-10-2010 07.30 ™ÂÏ›‰· 1 September 2010 - No. 100 ISSN 1450-2380 Editor Ninos Hadjirousos, FCA Deputy Editor T. Anastasiades, B.Sc., M.A. (Econ.) Editorial & Institute Offices 11 µyron Avenue, CY-1096 Nicosia P.O.Box 24935 1355 Nicosia - Cyprus Tel. 22870030 Telefax 22766360 E-mail: info@icpac.org.cy URL:http/www.icpac.org.cy Accountancy Cyprus is published quarterly by the Institute of Certified Public Accountants of Cyprus and is sent free to all members of the Institute as well as to a large number of other persons, companies, and organizations. The Institute can accept no responsibility for the accuracy of contributed statements or articles appearing in this publication, and any views or opinions expressed are not necessarity endorsed by the Institute, its Council or by the Editors The Institute Council Members President: Vice President: Secretary: Treasurer: Michael Antoniades, BA(Hons), ACA Panicos Charalambous, FCCA Christis Christoforou, BA(Econ.), FCA, MBIM Demetris Demetriou, FCCA * Demetris Halios, BSc (Acc), CPA George Kourris, BSc, FCA * Christodoulos Papas, BA (Hons), MBA, FCCA Panikos Tsiailis, FCCA * Nicos Syrimis, FCA * Kyriakos Iordanou, FCCA, MBA, ACIM, CIA * Theodoros Parperis, BSc (Econ), ACA * Marios Skandalis, FCCA, FIFC, CFC, CFE * Denotes member not in practice Contents Institute News ............................................................................................................................................................ 2 Professional Briefing .................................................. ............................................................................................... 9 Fiscal Consolidation: The only Path to Economic Prosperity...................................................................................... 15 “The Energy Policy in Cyprus”.................................................................................................................................... 16 The European Parliament gives green light to new financial supervision architecture.................... ........................... 19 Interview with the Chairman of the Employers & Industrialists Federation (OEB), Mr. Philios Zachariades to Ninos Hadjirousos, Editor, Accountancy Cyprus Journal..................................................................................... 21 Interview of Mr Bernard Musyck, Advisor for Foreign Trade, Ministry of Foreign Affairs, Kingdom of Belgium, attached to the Belgian Embassy in Nicosia................ .......................................................... 26 Cyprus: Political Unification and Economic Integration............................................................................................... 31 “Cyprus - the state of price ceilings” ........................................................................................................................... 33 Recommendations and sanctions: New Commission proposals to enhance economic surveillance........................... 34 The structural problems of the Cyprus Economy........................................................................................................ 38 Internal Audit Service of the Republic of Cyprus: The Consultant of the Public Sector and Partner of the European Commission .................................................................................................................................. 39 Corporate Social Responsibility .................................................................................................................................. 43 The cost of the Turkish Occupation in Cyprus ............................................................................................................ 44 IASB and FASB propose significant changes to lease accounting ................................................................................... 45 Human Resources and Work Environment as a motivating force for the achievement of high objectives............................ 49 Stepping out of the crisis; Things to do ...................................................................................................................... 51 The Bank Positive Stress-Tests Results And The Economy................ ...................................................................... 52 The problem with the Cyprus Economy...................................................................................................................... 55 Digital economy; a key to exit from the crisis ............................................................................................................. 56 Limassol’s Golden Year?............................................................................................................................................ 57 The Excel Wizard ....................................................................................................................................................... 58 The role of Cyprus in the Mediterranean solar plan.................................................................................................... 62 Initial assessment of Basel III ..................................................................................................................................... 64 Economic restructuring is urgently needed in the European Union......... ................................................................... 67 Cyprus displays the highest reliance on indirect taxes in the EU - results of the edition ......... .................................. “Taxation trends in the European Union”................................................................................................................. 69 The 8 biggest mistakes in promoting your audit firm ...and how to avoid them! ......................................................... 74 What investment professionals say about financial instrument reporting ................................................................... 79 XBRL explained: A crash course ................................................................................................................................ 82 IASB proposes to fundamentally change accounting for insurance contracts............................................................. 88 Perspectives on mergers & acquisitions in the banking sector ................................................................................... 92 On LIFO and Opera .................................................................................................................................................... 94 Fundamental changes in accounting for insurance contracts ..................................................................................... 99 Economic Bulletin ....................................................................................................................................................... 104 Banks will keep lucrative business ............................................................................................................................. 106 Institute News Institute News COUNCILãS ACTIVITIES Koulla Theocharous-Protopapa Pangkratios Vanezis During the third quarter of 2010 the Council of the Institute met four times and considered matters of interest to the ICPAC and to the profession at large. Other issues dealt with were, among others, the following: On 4 September 2010, Mr Ninos Hadjirousos, former president of ICPAC, attended the meeting of the Federation of Mediterranean Accountants in Bucharest. Auditing Standards Committee Andreas Philippou - Chairman Panikos Constantinou Andreas Georgiou George Georgiou Xenia Georgiou Michalis Hadjipantelas On 23 September 2010 Ms Lina Lemesiou, Senior Officer of ICPAC, attended the FEE Audit Working Party in Brussels. Panos Kourouyiannis Charalambos Kyprianou Milis Christodoulos Loulloupis On 29 September 2010, Mr. Christos Kyriakides, Senior Officer of the Institute, attended the meeting of the Cyprus Stock Exchange Consultative Committee for Corporate Governance Code. Maria Nicolaou Maria Papacosta Souzana Poyiadji George Pouros Nicos Stavrou ICPAC COMMITTEES On 31 August 2010 the Council decided on the appointment of the Chairmen and members of the Committees and the disciplinacy Committee, as follows: Accounting Standards Committee Christos Tsissios Corporate Governance and Internal Audit Committee Panikos Papamichael - Chairman Ioanna Antoniou Marios Agathaggelou - Chairman Nicholas Ayiomamites Andreas Andreou John Diola Christoforos Constantinou George Hadjineophytou Ioannis Efthymiou Charis Kakoullis Maria Karantoni Vasilis Koufaris Marios Kashioulis Tryfonas Kyriakou George Kazamias Eleni Markitsi Antonis Logides Christos Miamiliotis George Nicolaides Chrysis Pegasiou Panos Prodromitis Thea Sofroniou Irene Psalti Michalis Stavrides Constantinos Schizas Andreas Yiasemides Apostolena Theodosiou Stelios Vasiliou 2 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Institute News Education Committee Michalis Poulladofonos Maria Pastellopoulou - Chairwoman Sergios Savvides Achilleas Achilleos Costas Seraphim Myrto Adamidou Nicolas Shiakallis Alexis Avakian Mikaella Sofroniou Andreas Avraam Agis Taramides Costas Constantinou Andreas Theofanous Maro Constantinou Froso Yiagkoulli Georgia Gregoriou-Iordanou Akis Kolokotronis Financial Services Committee Iosif Korelis Toulla Kyrou Marios Cosma - Chairman Olga Michael Alexis Agathocleous Michais Mitas Marios Anastasiou Marios Ppasias Demetra Ellina Costas Tsierkezos Popi Hadjiioannou Constantinos Kallis European Union Matters Committee Michalis Kanellas Marios Lazarou Maria Kaffa - Chairwoman Eliza Livadiotou Panikos Antoniades George Neophytou Michalis Avraam Antonios Paschalis Maria Christofidou Panayiotis Peleties Maria Demetriou Savvas Pentaris Constantina Gergiou Loukis Skaliotis Costas Kalias Kyriakos Volis Kyriakos Karaolis Charalambos Kasapis Information Technology and Business Consulting Michalis Makris Committee Demetris Nicolaides Varnavas Nicolaou Marina Pieri Christos Tavelis Aristides Trimintis Nicholas Shiakallis - Chairman Ersi Costea Melina Demetriou Constantinos Ekkeshies Nicos Ioannou Michalis Panayiotou Ethics & Institutions Committee Andreas Pittakas Nicholas Rousos Antonis Siammoutis - Chairman Christos Demetriou Spyros Yiasemides Rovertos Yousellis Efstathios Efstathiou Christos Ierodiaconou International Andis Karlettides Investment Committee Business, Shipping and Foreign Stella Panayidou Polyvios Polyviou ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Costas Mavrokordatos - Chairman 3 Institute News Costas Christoforou Neophytos Neophytou Petros Economides Ioanna Nicolaidou Andreas Georgiou Marina Nicolaou Antonis Kasapis Marios Panayiotou Marios Klitou Myria Saparilla Stefanos Michaelides Demetris Sazeides Christos Odysseos Gabriel Onisiforou Public Relations Committee Panos Papadopoulos Marios Paraskeva Aggela Georgiou Yiakoumi - Chairman Phidias Phidia Maria Antoniou George Savva Niki Christofi Petros Yiakoumi Ivi Hadjioannou Maria Zavrou Demetrios Hioureas Christakis Katsikides Larnaca - Famagusta Coordinating Committee Christos Kirkos Iordanis Kliriotis Panayiota Vayianou - Chairwoman Ioanna Kountouri Andri Andreou Chrystalla Lambrou Christos Antoniou Andreas Loizou George Charalambous Avgousta Papadopoulou Kleovoulos Christodoulou Savvas Polyviou Michalis Gregoriou Aggelos Stavrou Nicos Hadjilambrou Panayiotis Thrasyvoulou Eleftherios Kassianos Michalis Lambrianides Public Sector Committee Tasos Michael Marios Nicolaides Maria Saouri George Skapoullaros Stavrinos Stavrinou Paris Theophanous Rea Georgiou - Chairwoman Andreas Antoniades Chloe Charalambous Evanthis Hadjiliasis Stylianos Ioannides Alexandra Ioannidou Limassol - Paphos Coordinating Committee Mary Ioannou Stella Kaimakliotou Kyriakos Neocli Panayiotou - Chairman Nicholas Agathocleous Emilios Ayiomamitis Christos Christodoulou Mary Christodoulou Maria Markitsi Iacovos Papaiacovou Stelios Pittakas Kyriakos Savva Michalis Tsaggaris Phivi Karayianni Eleftherios Kasianos Stock Exchange and Capital Markets Committee Popi Koufari Demetris Taxitaris - Chairman Charis Metaxas Christoforos Anayiotos 4 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Institute News Katerina Antoniou Chrysilios Pelekanos Michalis Constantinides Philippos Philippou Marios Demetriades Soteroula Rossidou Andreas Ioannou Aggelos Stylianou Natali Koufari Alexis Tsielepis Antonis Lazarides Katerina Papanicolaou Economic Crime and Forensic Accounting Committee Socrates Paschalis George Philippides Maria Krambia-Kapardi - Chairwoman George Prodromou Chrystalla Asimenou Charalambos Sergiou Marios Constantouras Demetris Shiakallis Charalambos Efstratiou Nicos Theodoulou Leonidas Ieronymides Elena Kalaitzi Taxation Committee Aggelos Loizou George Mylona Aggelos Gregoriades - Chairman Ioanna Papanastasiou Nicos Chimarides Antonis Partzilis Stelios Gregoriou Nicholas Pavlou Michalis Halios Silia Philippou Panicos Kaouris Stelios Savvides Constantinos Kapsalis Christos Skapoulis Andreas Karaolis Tasos Yiasemides Petros Liasides Pavlos Mallis Disciplinary Committee George Markides Pieris Markou Non members Neophytos Neophytou George Stavrinakis - Chairman Andreas Pifanis Christos Mavrellis Savvas Savvides George Charalambides Antonis Taliotis Christoforos Christofi Kyriakos Christofi VAT Committee Nicos Papaefstathiou Leandros Papafilippou Christos Christodoulou - Chairman Charalambos Charalambous Members Ioannis Demetriades Andreas Charitou Christakis Economou Stelios Christodoulou Christakis Ioannou Michalakis Christoforou George Karavis Maria Kapardi Polina Kouvarou Nicos Nicolaides Florentia Kyriakidou-Teloni Leontios Savvides Therapon Mavkas Loizos Shiakallis Christos Papamarkides Yiannakis Theoklitou ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 7 Institute News 3091 Evangelos Pteroudes ACA 3092 Yiannis Peslikas ACA During the period July - September 2010 the following 3093 Neophytos Christodoulou ACCA persons have been accepted as new members of the 3094 Michalis Michael ACA Institute: 3095 Aggeliki Papanidou ACCA 3096 Elpiniki Iosif ACCA NEW MEMBERS 3053 Niki Vontitsianou Beales ACCA 3097 Marinos Kartapanis ACCA 3054 Demetra Constantinou ACCA 3098 Andreas Kimishies ACA 3055 Nicholas Trikkis ACCA 3099 Theotokis Yiannakkaras CPA-USA 3056 Andreas Charalambous ACCA 3100 Melpomeni Konnari ACCA 3057 Theofylaktos Nikolaides ACCA 3101 Maria Kyriakou ACCA 3058 Irenoulla Aggelidou Aristou ACCA 3102 Eleni Papoui ACCA 3059 Panayiotis Chrysostomou ACCA 3103 Michael Melifronides ACCA 3060 Nicholas Dragatsis ACA 3104 Alina Makarian ACCA 3061 Rodoulla Nicolaou ACA 3105 Andreas Papanisiforou ACCA 3062 Andreas Argyrou ACA 3106 Charalambos Charalambous ACCA 3063 Andreas Petrides ACA 3107 Albena Rahneva ACCA 3064 Stefani Nicolaou ACA 3108 George Parpoulis ACCA 3065 Evgeny Tarakanov ACA 3109 Michalis Ioannides ACA 3066 Iacovos Kounnamas ACA 3110 Eleni Manti ACA 3067 Panayiotis Artemi ACA 3111 Petros Papadouris ACA 3068 Marios Athanasiou CPA-USA 3112 Evripides Themistocleous ACA 3069 Andreas Evangelou CPA-USA 3113 Laoura Michael ICAS 3070 John Joseph Youselli FCCA 3114 Nandia Gregoriou CPA-USA 3071 Alexandros Nicolaides ACCA 3115 Silia Panayi ACA 3072 Korinna Ilona Revesz ACCA 3116 Andreas Michael ACA 3073 George Papadopoulos ACA 3117 Irene Theocharous ACA 3074 Spyros Thrasyvoulou ACA 3118 Maria Koubari ACCA 3075 Christoforos Photiou ACCA 3119 Emily Diola Kirmizi ACA 3076 Constantinos Theodosiou ACA 3077 Frixos Zempylas ACCA 3078 Mari-Elena Floride ACCA 3079 Polina Papantoniou ACCA 1452 Marios Kasinos CPA-USA 3080 Emilios Tannousis ACCA 2016 Constantina Constantinou ACCA 3081 Georgia Tofini ACCA 3082 Victoria Papalinskaya ACCA 3083 Chrysostomos Stylianou ACCA 3084 Veronika Kofterou ACCA 2340 Nicos Komodromos CPA-USA 3085 Popi Koufari ACA 2062 Ierotheos Dagres FCCA 3086 Irene Tziakouris ACA 3087 Antigone Alexandrou ACA 3088 Lambros Teklos ACA 3089 Georgia Prastitis ACA 94 Andreas Christodoulides FCCA 3090 George Theofilou ACA 2549 Demetris Georgiades ACCA 8 RE-REGISTERED ASKED TO BE REMOVED PASSED AWAY ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Professional Briefing Professional Briefing RECOGNITION OF SERVICES Ninos Hadjirousos is honoured On 31 August 2010 the Council offered a dinner in honour of Mr Ninos Hadjirousos, in recognition of his services to the Institute for 41 years. During this period, Mr Hadjirousos served the Institute from many posts as member and president of committees and as member of the Council for 21 consecutive years (1989-2010) acting as treasurer, vice president and President of the Institute in the period 1997-1999. Mr Hadjirousos served also on the Committee of past presidents of the Institute and is the editor of the Accountancy Cyprus journal since 1997. At the dinner, the President of the Institute Mr Syrimis thanked Mr Hadjirousos for his service to the Institute and the profession and concluded with the hope that his example will be followed by others and mostly his sons, who are also in the profession. After receiving a comemorable plaque, Mr Hadjirousos thanked the President and the Institute for the honour extended to him and stated that he did no more than what was expected of him and is proud for the present state of the Institute and the profession. Mr Hadjirousos also said that he may have given a lot to the Institute and the profession in Cyprus but certainly he received more than he gave. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Mr Hadjirousos concluded by saying that he still has a lot to offer and will continue his service to the Institute as past president and editor of the Institute journal. Mr. Lazaros Lazarou reelected as a Council member of ACCA Mr. Lazaros Lazarou, Accountant - General of the Republic of Cyprus was reelected on 9 September 2010 for a third three - year term as a Council member of the Association of Chartered Certified Accountants. Mr. Demetris Taxitaris appointed to the Consultative Working Group of CESR Mr. Demetiris Taxitaris, member of ICPAC and an officer of CISCO, has been appointed for a term of two years member of the Consultative Working Group of CESR (Committee of European Securities Regulators) to support the work of the Standing Committee on Corporate Reporting of CESR. The meetings of the Committee are held in Paris. Mr. Taxitaris was proposed for this Office by ICPAC and nominated in the Cyprus Securities and Exchange Commission. Mr. Athos Stylianou appointed Honorary Consul Mr. Athos Stylianou, member of ICPAC, has been appointed Honorary Consul of Guyana in Cyprus. Athos is the Managing Partner of RSM Stylianou, the member firm of RSM International. 9 Professional Briefing MEMBER FIRMS OF ICPAC WHICH QUALIFIED FOR QUALITY CHECKED ICPAC Quality Checked is a quality assurance scheme introduced by ICPAC as from 1 July 2006 to promote best practice and to help improve standards across the profession in Cyprus. The scheme is available to all ICPAC member firms and the quality assurance reviews of non-audit services are carried out alongside the routine statutory audit monitoring visits undertaken by ACCA on behalf of ICPAC. Under the scheme, ICPAC member firms can qualify for the ICPAC Quality Checked certificate and mark if they are able to demonstrate that they follow best practice standards, in addition to having a satisfactory outcome on audit monitoring and on compliance with ICPAC’s rules and regulations. In previous issues of this journal, reference was made to nine firms that have been awarded the ICPAC Quality Checked certificate and mark. In the meantime, one additional firm has been awarded the ICPAC Quality Checked certificate and mark, namely PKF/ATCO Limited. accountability regarding those plans by reporting periodically on our progress. Our first report, dated 31 March 2010, described the progress we had made to date, explained some of the challenges we face in improving and converging our standards in certain areas, and reported changes made to certain project-specific milestone targets. As noted in our March 2010 progress report, we recognise the challenges that arise from seeking effective global stakeholder engagement on a large number of projects. Since publishing the March progress report, stakeholders have voiced concerns about their ability to provide highquality input on the large number of major Exposure Drafts planned for publication in the second quarter of this year. The IASB and the FASB are in the process of developing a modified strategy to take account of these concerns that would: ñ prioritise the major projects in the MoU to permit a sharper focus on issues and projects that we believe will bring about significant improvement and convergence between IFRS and US GAAP. ñ stagger the publication of Exposure Drafts and related It is noted that about 220 ICPAC member firms have not yet been subject to quality assurance reviews by ACCA on behalf of ICPAC. IASB AND FASB ISSUE STATEMENT ON THEIR CONVERGENCE WORK The IASB and the FASB today announced their intention to prioritise the major convergence projects to permit a sharper focus on issues and projects that they believe will bring about significant improvement and convergence between IFRSs and US GAAP. Their joint statement is as follows: In our November 2009 joint statement, we, the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) again reaffirmed our commitment to improving International Financial Reporting Standards (IFRSs) and US generally accepted accounting principles (GAAP) and achieving their convergence. That Statement affirmed June 2011 as the target date for completing the major projects in the 2006 Memorandum of Understanding (MoU), as updated in 2008, described project-specific milestone targets, and acknowledged the need to intensify our standards-setting efforts to meet those targets. We committed 10 to providing transparency and consultations (such as public round table meetings) to enable the broad-based and effective stakeholder participation in due process that is critically important to the quality of their standards. We are limiting to four the number of significant or complex Exposure Drafts issued in any one quarter. ñ issue a separate consultation document seeking stakeholder input about effective dates and transition methods. The modified strategy retains the target completion date of June 2011 for many of the projects identified by the original MoU, including those projects, as well as other issues not in the MoU, where a converged solution is urgently required. The target completion dates for a few projects have extended into the second half of 2011. The nature of the comments received on the Exposure Drafts will determine the extent of the redeliberations necessary and the timeline required to arrive at high quality, converged standards. The IASB and the FASB have begun discussions on this proposed strategy with their respective oversight bodies and regulators, including members of the IASC Foundation Monitoring Board. It is expected that this action by the FASB and IASB will ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Professional Briefing not negatively impact the Securities and Exchange Commission’s work plan, announced in February, to consider in 2011 whether and how to incorporate IFRS into the US financial system. The boards expect to publish shortly a progress report that includes a revised work plan. IAASB PROPOSES ENHANCED STANDARD ON USING THE WORK OF INTERNAL AUDITORS Recognizing developments in the internal auditing environment and the evolving relationship between internal and external auditors, the International Auditing and Assurance Standards Board (IAASB) today released an exposure draft on a proposed revised standard that addresses the external auditor’s responsibilities relating to using internal auditors’ work during an audit. The proposed International Standard on Auditing (ISA) 610 (Revised), Using the Work of Internal Auditors, aims to enhance the external auditor’s performance by providing a stronger framework for evaluating and using the work and assistance of an entity’s internal auditors. Related enhancements to the external auditor’s required considerations of the internal audit function are also proposed in ISA 315 (Revised), Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment. IFAC SMP COMMITTEE PUBLISHES QUALITY CONTROL IMPLEMENTATION GUIDE The Small and Medium Practices (SMP) Committee of the International Federation of Accountants (IFAC) today issued the second edition of its Guide to Quality Control for Small- and Medium-Sized Practices (QC Guide) The implementation guide is intended to help SMPs understand and efficiently apply the redrafted International Standard on Quality Control (ISQC) 1, Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements. Note related to accounting Auditing and relevant issues By Tassos Anastasiades, Deputy Editor ACCOUNTING STANDARDS DIVIDE SET TO WIDEN US banks will have to value more assets at market prices under radical proposals recently unveiled by accounting ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 standard-setters. The proposals would widen a growing divide with rules for non-US banks, which are moving in the opposite direction, delivering a blow to efforts to create a single set of global accounting standards. While the proposals, which critics argue will lead to more volatility in bank earnings, are intended to increase the transparency of accounts for investors, they are also expected to trigger a backlash from some in the financial services industry. Bob Herz, chairman of the US Financial Accounting Standards Board, said the reaction from US retail banks and regulators “will not be very warm”. He said the proposals would see US banks adopt more fair value accounting, which requires companies to report financial holdings at current market prices. This approach was one of the most divisive issues of the crisis, blamed by critics for exacerbating the losses reported by banks during the market turmoil. ACCOUNTING STANDARDS DELAYS CRITICISED Michel Barnier, European Union internal market commissioner, has criticised the way in which the world’s top accounting rule makers have handled their decision to delay the deadline for creating a single global accounting standard. The International Accounting Standards Board and the US Financial Accounting Standards Board were earlier forced to issue a statement confirming they would not meet the deadline of June 2011 set by the Group of 20 industrialised nations for global accounting harmonisation. Relations between the EU and the IASB have been fractious in the past, and any sign of deterioration is closely watched as it could further damage the already fragile convergence process. While it is not unusual for accounting rulemakers to revise deadlines during their standard-setting process, the G20 ministers had pushed for June 2011 in part because it is seen as particularly important in moving US companies to international standards. Mr Barnier said he was “disappointed” by the way the decision by the US FASB and the IASB had been taken and called for the matter to be discussed urgently by the Monitoring Board, which oversees the operations of the IASB. Mr Barnier sits on the board, as does Mary Schapiro, chairman of the US Securities and Exchange Commission, which oversees the US accounting rule maker. “All jurisdictions represented in the monitoring board need to work closely together and that’s where the important decisions should be discussed and taken. That’s why the Commissioner would like the issue to be discussed as quickly as possible at the Monitoring Board,” the European Commission said. Mr Barnier added that he “strongly supported and believed in” the creation of single high-quality global accounting standards by June 2011. It was a “shared commitment from all G20 members which had to be respected”. 13 Professional Briefing TO FASB OR NOT TO FASB? HEARD the joke about a businessman who asks his accountant what two plus two is? The accountant draws the blinds, leans over the desk and whispers: “What would you like it to be?” The crafting of accounting rules is more art than science, thanks to the need to balance the interests of companies, their investors and-especially in banking-their regulators. No great surprise, then, that the world’s two big standard-setting bodies-America’s Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), which covers most other countries-are on very different tracks in their treatment of financial instruments. Investors are still digesting the 214 pages of proposals released by FASB on May 26th. But if adopted, these would shake up banking by greatly expanding the impact of fair-value (or mark-to-market) accounting, in which assets are valued at market prices rather than on an historic-cost basis that reflects the price banks paid for them. In both America and Europe, instruments held for sale are marked to market, whereas loans intended to be kept on the books are held at cost. Although fair-value adjustments for the latter are already disclosed in banks’ accounts, FASB now wants them to be reflected in income. By contrast, IASB, which unveiled its own proposals last November, wants to spare loans held to maturity by banks from the vagaries of the market. The two also differ on how banks should reserve for deteriorating credit, with FASB again putting forward the more radical proposals. BASEL RULES THREATEN GROWTH, SAY BANKERS Economic growth in the eurozone, the US and Japan will be cut by three percentage points between now and 2015 if current proposals to force banks to hold more capital and liquid assets go forward unchanged, the world’s leading banking industry group has warned. As a result, 9.7m fewer jobs would be created in those areas over the period, according to an impact assessment issued by the Institute of International Finance at a meeting in Vienna.The group is pushing hard for the Basel Committee on Banking Supervision to rewrite or at least delay implementation of the proposals, known as Basel III, which are expected to be voted on later this year. According to the IIF, the eurozone would feel the largest impact from the new Basel proposals, with growth cut by 0.9 percentage points per year, resulting in a cumulative reduction in gross domestic product of $920bn by 2015. The US would see a cumulative reduction of 2.6 per cent, or $951bn, and Japan would see a 1.9 per cent or $130bn cut. “We all need a betterregulated banking system, but there is a price to pay . . . The question is how can you design the reforms for 14 maximum benefit at minimum cost,” said Peter Sands, chief executive of Standard Chartered. ERNST & YOUNG FACES UK INQUIRY OVER AUDIT OF LEHMAN BROTHERS A British investigation has been launched into whether Ernst & Young properly audited Lehman Brothers accounts in the months leading up to the US investment banks collapse. The Accountancy and Actuarial Disciplinary Board, which regulates the profession in Britain, has launches a probe into E&Yãs accounting treatment of controversial transactions known as “Repo 105s” and “Repo 108s”, which Lehman regularly used in its quarter-end balance sheets. The US investment bank collapsed in September 2008 at the height of the glopal financial crisis. The AADBãs probe into E&Y, one of the worldãs “Big Four” industry firms, intensifies the scrutiny of the accounting professionãs actions in the lead-up to the crisis. SWISS TO GIVE US NAMES OF TAX DODGE SUSPECTS Switzerland ended months of uncertainty over the diluting of bank secrecy when parliament finally approved legislation allowing the transfer of the names of thousands of American clients of UBS suspected of evading tax owed to the US authorities. The decision followed days of parliamentary wrangling that had threatened to delay a crucial treaty between Bern and Washington authorising the transfer. This could have triggered a crisis in bilateral relations and threatened the future of UBS, Switzerlandãs largest bank. DANES URGE BASEL III CHANGES Denmarkãs banks, some of the worlds biggest issuers of covered bonds, are frantically lobbying European regulators to avert proposed funding rules that threaten the structure of the country’s mortgage market. Two of the biggest mortgage lenders, Nykredit and Realkredit Danmark, were in London this week to ask British regulators to take up their case in the Basel committee on banking supervision, which is drafting the Basel III for glopal bank regulation. Danish banks have lobbied Swedish authorities and will take their case to other countries with representation on the Basel committee. Denmark has no seat on the committee. Under Basel III proposals, due to be finalized by November, banks will be encouraged to hold the most liquid and historically reliable assets, such as government bonds, and discouraged from other assets including covered bonds. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Fiscal consolidation and growth Fiscal Consolidation: The only Path to Economic Prosperity Despite the major impact that the international economic crisis has had on the real economy of Cyprus, some positive signs have been recently observed during the first half of 2010. This shows that the Cyprus economy is gradually exiting from the economic crisis. Economic growth in the second quarter of the year reached 0.2% on a yearly By Charilaos Stavrakis, basis and 0.6% on a Minister of Finance quarterly basis. It is anticipated that this trend will continue for the rest of the year. If this is the case, then growth for 2010 will be in positive territory, probably around 0.5%. However, I would like to emphasise that there are still risks for the economy, therefore there is no room for complacency. Apart from the challenge of securing a sustainable economic recovery, Cyprus must, as a matter of priority, also consolidate its public finances which have deteriorated, due to the expansionary fiscal policy, but also due to the reduction of public revenues, both reasons stemming from the economic slowdown. We must, at the same time, address the structural problems of the economy, exposed and magnified by the crisis. As known, an Excessive Deficit Procedure has started for Cyprus, decided by ECOFIN on the 13th of July 2010. Among other, ECOFIN requires that Cyprus achieves a fiscal deficit of at most 6% for 2010, and less than 3% of GDP by 2012. In order to attain the target for 2012, the aim for 2011 is a deficit of around 4.5% of GDP. I would like to note that Cyprus was in the last group of E.U countries that entered the Excessive Deficit Procedure and this was due to Cyprus` comparatively better state of public finances in relation with the other Member States. Currently, out of the 27 E.U. countries, 24 of them have excessive budget deficits, a fact that shows the common fiscal challenges faced by Europe as a whole. Given the economic environment, the Government of the Republic of Cyprus, acting decisively, prepared a broad policy framework for fiscal consolidation. We have continuously emphasised the importance of healthy public ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 finances in order to achieve higher growth and prosperity. Quoting Mr Baroso, President of the European Commission, in his speech in the European Parliament on the 7th of September “Sound public finances are a means to an end: growth for jobs. This is our overarching priority. This is where we need to invest”. The framework for fiscal consolidation was intensively discussed with social partners and political parties in order to reach a broad consensus, which is considered essential for a successful reform. Unfortunately, some of the proposed measures, namely, the temporary increase of the corporation tax by 1% for two years and the adjustment of immovable property taxes have been rejected by the House of Representatives. Still pending are the equally significant proposals for amnesty on the issuance of title deeds for buildings with minor irregularities, specific actions to tackle tax evasion and tax avoidance and the reform of the system of social transfers in order to target better benefits and help more those in greater need. Moreover, there is an ongoing attempt to curtail current expenditures and conduct public sector reforms which will address the growing size of civil service. The recent decision of the Council of Ministers for the abolition of 400 permanent positions in the public sector has been taken in this context. We are determined to continue with the necessary reforms, through the Budget drafted for 2011. Based on the tight budget approved by the Council of Ministers and taking into consideration policy measures already adopted, the fiscal deficit in 2011 is expected to reach around 5,4% of GDP. The Government is determined to take additional measures, necessary to contain the fiscal deficit to 4,5% of GDP, in line with the Council Recommendations, issued in the context of the Excessive Deficit Procedure for Cyprus. In this context, we are planning to discuss once more the pending proposed measures with the political parties and social partners in order to reach a common ground. We are also considering other socially fair measures that can contribute to this effort. To conclude, I would like to express my wish that all involved stakeholders, will realize how important the next months are in terms of adopting the necessary measures so that fiscal consolidation can be attained and bring the Cyprus economy back to a path of economic prosperity. 15 The Energy Policy in Cyprus “The Energy Policy in Cyprus” The provision of a secure, competitive and affordable, as well as environmentally and financially sustainable, energy supply has always been a big challenge for Cyprus. This stems from the fact that Cyprus is an isolated island state both geographically and infrastructurally. Given that our economy and the By Antonis Paschalides competitiveness of our Minister of Commerce, country are very much Industry and Tourism dependent on investments in the energy sector, one of the principal duties of the Government is to safeguard a secure, competitively priced, and environmentally sound energy supply. In addressing the country’s energy challenge, Cyprus’ energy policy is significantly influenced by a number of EU energy and environmental policies. Our international commitments are leading us not only towards ambitious targets for energy efficiency, renewable energy and greenhouse gas emission reduction, but are also offering us new opportunities for growth. The importance of security of supply can be realized by considering the cost of energy not being available when required by an end-user. Interruption of the energy supply, or threats of interruption, could lead to widespread disruption. Better security can be achieved by ensuring that energy sources are reliable, that markets are designed and regulated appropriately, and that energy systems are resilient to shocks through a combination of diversity and flexibility. The availability of competitively priced high quality energy services has a significant effect on the Cypriot economy. Prices have an impact on the competitiveness of industry and services and on the economic growth indicators. They also have a direct impact on the life of the individual citizen. Competition in the electricity generation sector is promoted and 65% of the market has 16 been liberalized. Likewise, since 2004 the full opening of the competition of the inland petroleum fuel market has already taken place. Given that Cyprus is an isolated and fully dependent on the import of fossil fuels system, the implementation of strategies for exceptional contingencies outside its control are sought. Our objective is to diversify the current reliance on oil products while ensuring that contingency plans are in place to cater for short-term disruption in oil supply. In view of that, the establishment of an onshore LNG import, storage and regasification terminal and the integration of the liquefied natural gas into the country’s energy mix is a strategic target. No doubt, the import and use of natural gas as an alternative fuel in Cyprus’ energy mix will contribute to the improvement of the country’s security of energy supply and diversification of energy sources, to the reduction of the county’s energy dependence on fossil fuels, to the achievement of a secure and cost-effective, long-term, energy supply and to the protection of the environment through the reduction of carbon dioxide emissions. Moreover, the construction of an oil products import, storage and distribution terminal with the facilities to maintain strategic oil stocks for 90 days will promote competition in the oil sector and allow for a fair and transparent pricing policy that will benefit the Cypriot consumer. Furthermore, it is expected to contribute positively to the environment. Another way of reducing reliance on imported fuels is the promotion and increase of the use of renewable energy sources. The RES roadmap by the EU sets the objective to increase the proportion of RES in the overall EU energy mix to 20% by 2020. Cyprus’ share, recognising the country’s gross domestic product, its potential and its starting point, is set at 13%. Technically, Cyprus can exploit renewable energy through wind farms, solar thermal power plants, energy production units from biomass and biogas, solar thermal and photovoltaic systems. It is worth mentioning that diachronically the Cypriot citizens are very much familiarized with the solar water heaters, with Cyprus being the leader in thermal ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The Energy Policy in Cyprus solar energy applications per capita. Similarly, energy conservation is a key objective in the national energy policy, helping the economy to achieve its social and environmental objectives. It can have a significant impact on the energy sector and can arguably be the lowest cost option in reducing dependence on energy imports (security of energy supply) and the impact on the environment. Cyprus’ energy policy promotes investments in renewable sources of energy and energy efficiency and through attractive incentives draws investors in setting up both the manufacturing and the operation of equipment harvesting energy from RES and energy conservation. Much effort has been devoted in expediting the procedures and facilitating the materialization of investments for the promotion of alternative energy sources and energy conservation technologies. The set of fair, non discriminatory and transparent terms for connection of an electricity producer from RES to the national grid, as well as the existence of energy market rules which eliminate distortions, are the necessary requirements for the expansion of renewable energy technologies. Apart from the implementation of various measures to tap renewable energy and diversify the energy mix, concurrently sustained efforts are being made to seek opportunities in oil exploration in order to further decrease the country’s reliance on imported fuels. Although the exploration activities for hydrocarbon are relatively recent, numerous leads and even some prospects have been already identified, making sound the possibility for a commercial discovery in the future. We continue to develop all the necessary legislative, infrastructural and regulatory structures, reaping the benefits of the implementation of a comprehensive energy policy, which covers the whole energy spectrum with specific objectives, options and alternative scenarios and specific tasks for the public and private sectors. Financial Supervision in the EU The European Parliament gives green light to new financial supervision architecture Having fought for more than a year in favour of a radical reform of European financial supervision, the European Parliament on 22 September 2010, at its plenary session in Strasbourg, gave the final seal of approval to a package of reforms which will see a fundamental shift in the way banks, stock markets and insurance companies are policed as of 2011. Tassos Georgiou, Head European Parliament Office in Cyprus Three European supervisory authorities (ESAs) will be established to replace the current supervisory committees. Their powers will stretch much further than the advisory nature of the current system and their potential to gain further competences will be considerable thanks to a strong review clause. A European Systemic Risk Board (ESRB) will also be established with the task of ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 monitoring and warning about the general build-up of risk in the EU economy. This new system should be able to provide better protection from events such as the Fortis bank crisis weekend, Germany’s unilateral naked short-selling ban and the losses faced by life insurance policyholders in the UK, Ireland and Germany with the collapse of Equitable Life. It should at the same time strengthen the EU single market for financial services and provide much better investor protection. COSMETIC OR ROOT AND BRANCH REFORM A number of Member States, particularly those with large 19 Financial Supervision in the EU financial centres, favoured the limited reform approach. This led to a significant reduction in the scope of the Commission proposals, themselves considered by the EP as not going far enough. Parliament’s rapporteurs from the beginning argued that the system needed serious reform so that risk would be better understood, primarily through much improved communication between national supervisors. The final deal sees the transformation of advisory committees into watchdogs with a bite. The ESAs are set to get tough new powers to settle disputes among national financial supervisors and to impose temporary bans on risky financial products and activities. If national supervisors fail to act, then the authorities may also impose decisions directly on financial institutions, such as banks, so as to remedy breaches of EU law. The daily work of the ESAs will see them drive coordination within the current system of colleges of national supervisors set up to watch over cross-border financial institutions. prohibit such activities or products permanently. ESRB: FASTER AND BETTER WARNING ABOUT RISK MEPs inserted provisions to enable the ESRB to communicate rapidly and clearly. The ESRB will develop a common set of indicators to permit uniform ratings of the riskiness of specific cross-border financial institutions and make it easier to identify the types of risks they carry. The ESRB will also be responsible for establishing colourcoded grades to reflect different risk levels. When making warnings or recommendations on risk build-up, the ESRB is to use the colour-grade to indicate the level of risk. To enhance the ESRB’s ability to predict risk build-up, a broader range of skills and experience, including academics, will be represented on its Advisory Scientific Committee. Finally, to improve visibility and credibility from the outset, the ECB President will preside over the ESRB for the first five years. ESA FIREFIGHTING POWERS In the event of disagreements between national supervisors, ESAs will be able to impose legally-binding mediation and, if no agreement can be reached within the relevant college of supervisors, to impose supervisory decisions on the financial institution concerned ESAs will be able to intervene as mediators at their own discretion, rather than only at the request of one of the national supervisors. The ESAs will be able to monitor how national supervisors implement their obligations under EU law. If these obligations are implemented incorrectly, the ESAs may issue instructions to the national supervisor concerned and, if these go unheeded, directly instruct the financial institution to remedy any breach of EU law. CONSUMER PROTECTION A CENTRAL GOAL In response to the ever more complex world of financial services, MEPs successfully pushed for consumer protection to be at the very heart of the ESAs’ work. ESAs will have the power to investigate specific types of financial institution, or financial products such as “toxic” products, or financial activities such as naked short selling, to assess what risks they pose to a financial market and issue warnings where necessary. Where specific financial legislation so provides, ESAs may temporarily prohibit or restrict harmful financial activities or products and may also ask the Commission to introduce legislative acts to 20 POWERS THAT MAY GROW Both the ESAs and the ESRB will be able to grow as events require. Particularly for the ESAs, MEPs ensured that the Commission will report back every three years on whether it is desirable to combine the separate supervision of banking, securities, and insurance on the benefits of having all the ESAs headquartered in one city and on whether the ESAs should be entrusted with further supervisory powers, notably over financial institutions with pan-European reach. ROLE OF THE EUROPEAN PARLIAMENT MEPs also succeeded in improving democratic oversight of the whole supervisory system. The EP will be able to veto the appointment of ESA chairpersons and will have a say in the development of the technical standards and implementing measures. Moreover, the ESRB President will keep the chair and vice-chairs of the EP’s Economic Affairs Committee updated on ESRB activities through confidential discussions. The legislative texts empower the Commission, the ESAs and the ESRB to ask the Council to declare an emergency. But the Parliament will also be able to ask the Council to declare an emergency through resolutions and questions, in the same way as it has a right to make requests to the Council and the Commission in any other matter. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Interview - The Cyprus Economy Interview with the Chairman of the Employers & Industrialists Federation (OEB), Mr. Philios Zachariades to Ninos Hadjirousos, Editor, Accountancy Cyprus Journal In the interview we had with the Chairman of the Employers and Industrialists Federation, Mr. Philios Zachariades, we have been informed, inter alia, that the Federation remains adamant that the only way out of the crisis is through economic growth and containment of the state’s non-productive expenditure. “It is only Mr. Philios Zachariades through growth that new job opportunities will be created and unemployment reduced and it is only through growth that businesses will expand and materially contribute to the state’s finances”, Mr. Zachariades stated. He also stated that the members of the Federation already contribute to the combating of the economic recession by trying to conduct their business as usual and retaining their employees, within a very harsh economic environment. In relation to the fiscal deficit Mr. Zachariades stated that the Government has done little to contain non - productive public expenditure and that what needs to be done is apparent: non - productive state expenditure should be reduced. At the same time Mr. Zachariades strongly opposes any increase of the corporate tax, mainly because our most significant - competitive advantage for foreign owned companies is our corporate tax rate. The full interview with Mr. Zachariades follows: 1. Mr. Zachariades, you have undertaken the presidency of the Employers & Industrialists Federation in difficult times. What is your vision for the Federation? The Federation is the main advocate and a highly respected representative of the enterpreneurial community of Cyprus, and it is my vision that it continues to act as a ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 dynamic force development. in the island’s socio-economic I am fully committed towards working to enhance the Federation’s role as the main promoter of innovation, progress and professionalism in Cyprus. Our financial independence and apolitical character will support our leading role as a quality services provider whose reputation, status and reliability are respected in Cyprus and abroad. 2. How would you comment to the measures taken by the Government in facing the economic crisis? In general terms, the Government has delayed in the implementation of measures that would be effective in overcoming the problems created or brought to the surface by the economic crisis. It has attempted to balance the deficit by focusing on revenue increase, at the expense of businesses and the taxpayer, while doing very little towards containing expenses. The official figures show that the measures that have been taken until today have brought little benefit, unemployment has increased significantly and growth has stagnated since the outbreak of the crisis. The proposed increase of corporate and property taxes has been rejected and we are now hoping for the Government’s new propositions for combating the effects of the financial crisis. 3. What measures would you suggest to combat economic recession and reduce the fiscal deficit? How can your members contribute? The Federation was among the first institutions to have made responsible and constructive proposals well in advance of the outbreak of the economic crisis in Cyprus, but unfortunately these were not heard. We remain adamant that the only way out of the crisis is through economic growth and containment of the state’s nonproductive expenditure. 21 Interview - The Cyprus Economy expenditure and is largely responsible for the deficit. The proposed and recently approved newly created 1080 positions in the civil service must be recalled and civil service should be reduced by 5% overall. The practice of interchange ability between government posts must be introduced, departments that need support should be able to derive it from other overstuffed departments. Furthermore, entry salary scales for the newly employed in the civil service must be reduced. Finally, civil servants must start contributing towards their pension funds, as their private sector colleagues do. These are only some of the measures we have suggested. It is only through growth that new job opportunities will be created and unemployment reduced and it is only through growth that businesses will expand and materially contribute to the state’s finances. Our members already contribute to the combating of the economic recession by trying to conduct their business as usual and retaining their employees, within a very harsh economic environment. Any steps or measures that can be taken to assist them in conducting their business smoothly, efficiently and expeditiously will have a positive value added effect to the economy. In relation to the fiscal deficit, we regret to note that the Government has done little to contain non-productive public expenditure. For us, what needs to be done is apparent: non-productive state expenditure should be reduced. 4. What are the main structural problems facing the Cyprus economy and what are your suggestions for dealing with them? The structural problems facing Cyprus are neither new nor have they come about as a result of the economic crisis. If anything, the crisis has helped to bring those problems to the surface and to the public’s attention. The problems fall in three categories: the unsustainable state payroll and pensions, government bureaucracy, and the lack of proper incentives, where needed, to help the economy pull itself out of the crisis and into positive growth. I would like to elaborate a little more on that. The state payroll constitutes the biggest part of state 22 Unfortunately once more, political considerations have averted the introduction of much needed measures to reduce the state payroll. This increase in cost, which is not accompanied by a proportional increase in productivity or improvement of the services provided, is paid out of the pocket of the taxpayer. Bureaucracy is another important problem that stifles growth, investment and job creation, bringing many negative consequences to the economy. Measures must be taken to expedite the approval of building permits and issuing of property title deeds. This will help boost the construction sector, which could contribute significantly to GDP. Given its greater efficiency and lower costs, the delegation of government services to the private sector can greatly reduce bureaucracy and boost business activity. At the same time, such delegation will allow government employees to assume new duties, decreasing costs and increasing available manpower to be used elsewhere without employing new civil servants. The current state of our economy highlights the need of incentives to businesses to expand, grow and create new job positions. Some sectors of the Cypriot economy, which contribute significantsly to our GDP and employ thousands, could be seriously affected if proper measures are not taken. The tourism industry is in need of modernisation, and building and tax incentives could help those businesses upgrade and compete in the global market with value added benefits to the economy. The construction industry is another example of an industry ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Interview - The Cyprus Economy that contributes a lot to our GDP but is unfortunately smothered by the inefficiencies of our bureaucracy and the lack of foresight. There are many things we can do to add value to our economy, create new and increasing sources of income and new quality job positions. The expertise and willingness of the entrepreneurial community is here and waiting for the political will to take Cyprus out of the crisis. Incentives and subsidies offered to the renewable energy industry would reduce unemployment and create a sustainable source of income for the government. This would also establish a new dynamic industry sector in Cyprus and diversify the basis of our economy even further, shielding it better from future economic turmoil, in addition to the direct environmental benefits. Finally, we suggest that the government extends even further the Built-Operate-Transfer (BOT) practice which has already proved successful and to the benefit of public finances. The new ultra-modern Larnaca airport, a source of pride and enjoyment for all of us, was built on the BOT method without costing the taxpayer a single euro. 5. What are your views to the suggestion by the Government to increase the corporate tax rate by one percentage point? We strongly oppose any increase to the corporate tax rate. Given the problems and uncertainty our economy is facing as a result of the financial crisis, this has been a most unfortunate time to raise the issue. An increase in the corporate tax rate would be counterproductive for many reasons. One of our most significant competitive advantages, if not the most significant, especially for foreign- owned companies, is our corporate tax rate. An increase in the corporate tax rate, no matter how small, creates an uncertainty as to our tax regime. Furthermore, the way the government decided to increase the tax rate without consulting those affected, i.e. the businesses, created even greater uncertainty as to its intentions. If the government decides unilaterally and with no consultation to increase the corporate tax rate, then what will happen if the economy for any reason takes a turn for the worse? Lastly, we have grounds for concern for further inflationary pressures since an increase in corporate tax may be shifted to the end user, the consumer. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 6. Both the IMF and the European Union are suggesting either amending or abolishing the wage indexation system. What are your views about this system? We share to a large extent the views expressed by the IMF and the European Union but we believe that this discussion should be put on hold until our economy is out of the crisis. There are far more urgent issues to consider for the time being. 7. Cyprus, as all other industrial countries, has to deal with an ageing population because of low fertility rates and high life expectancy. What are your views? Can any measures be taken to face this serious problem? The increase in life expectancy is a sign of the advancement of our society, the progress of our economy and the subsequent improvement of our quality of life. The numbers do show that our social welfare system is not sustainable as it is. It was designed when birth rates were higher, life expectancy was lower and socioeconomic conditions were different from today. The first and most efficient measure that needs to be urgently introduced is the gradual increase of the retirement age, a measure that will have immediate positive effect on both the social insurance fund and public finances. Furthermore, for the Federation, as well as for the European Union, it is important that the private sector can be involved in a contributory, but significant role, in the area of pension benefits, through private insurance companies. The consequences of the ageing population for the public finances and especially the state social security systems, are so dire that the private sector cannot be excluded from the effort to mitigate them. Examples from other European countries have confirmed that the insurance industry can successfully assume part of the enormous cost of satisfactory and viable pension plan provisions. Further, the supplementary pension that can be provided by the private sector can guarantee a respectable quality of life for aging citizens, thereby satisfying a common goal of both the state and the industries. Rest assured that the Employers and Industrialists’ Federation will be in the forefront of the discussions that will follow and we will contribute constructively and responsibly towards a sustainable and prosperous future for Cyprus. 25 The Belgium Economy & Belgium Presidency Interview of Mr Bernard Musyck, Advisor for Foreign Trade, Ministry of Foreign Affairs, Kingdom of Belgium, attached to the Belgian Embassy in Nicosia To Ninos Hadjirousos, Editor and Tassos Anastasiades, Deputy Editor, Accountancy - Cyprus Journal At the interview H.E. the ambassador of Belgium, Mr. Guy Servin was also present. In an interview we had with Mr. Bernard Musyck, Advisor for Foreign Trade attached to the Belgian Embassy in Nicosia, we were informed that it is the 12th time that Belgium is Mr. Bernard Musyck having the EU Presidency and the country will use all its experience to continue in a pragmatic way its tradition of honest broker in the European interest. In times of crisis and institutional changes, Belgium will conduct a sober and pragmatic Presidency with the strong will to keep the EU going and to strengthen the relations with all EU-institutions, with special attention to the European Parliament. should be contained. Possible measures to reduce public spending include an immediate increase of the pensionable age; substantial cuts in civil servants’ pension benefits and salaries, reduction in the size of public employment; measures to contain costs of the social security and health care systems; Also when new government revenues are proposed, individual and company taxation remain unchanged and indirect taxes are adopted such as VAT, special taxes on tobacco and alcohol, specific taxes affecting banks as well as taxation on energy consumption. Referring to our question about the wage indexation system in Belgium, Mr. Bernard stated that the automatic wage indexation is annual and is closely monitored by the state in order to prevent an upsurge in relative labour costs, which could threaten competitiveness. More precisely, the forecast of increases in foreign hourly labour costs among Belgium’s main trading partners (that is France, Germany and the Netherlands) serves as an upper limit to wage increases. The interview with Mr. Musyck follows: As regards the Cyprus issue, the Belgian Presidency will further encourage and stimulate the two sides in working out a just, viable and durable agreement in the interest of all the Cypriots and of the region as a whole. With regard to our question about how the Belgian government plans to tackle the current economic crisis, Mr. Bernard informed us that Belgium wants to subscribe to the latest decision of the European Council (17 June 2010) regarding the way to tackle the crisis. The guidelines are clear: strategies should support growth and spending 26 Dear Mr Musyck, could we start off by asking you to tell us in a few words what are the priorities of the Belgian presidency? Well, this is the 12th time Belgium is having a rotating EU Presidency and the country will use all its experience to continue in a pragmatic way its tradition of honest broker in the European interest. The Belgian Presidency will concentrate on 5 clusters of ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The Belgium Economy & Belgium Presidency major importance: 1. Combating the economic and financial crisis 2. Reinforcing the social dimension of the EU 3. Implementing the Stockholm Program Action Plan in matters of Justice and home affairs. 4. Environment and Climate 5. Enlargement Belgium will also have to continue the important and urgent work of further implementing the Treaty of Lisbon. In times of crisis and institutional changes, Belgium will conduct a sober and pragmatic Presidency with the strong will to keep the EU going and to strengthen the relations with all EU-institutions, with special attention to the European Parliament. As regards the Cyprus issue, the Belgian Presidency will further encourage and stimulate the two sides in working out a just, viable and durable agreement in the interest of all the Cypriots and of the region as a whole. How does the Belgian government plan to tackle the current economic crisis? Belgium wants to subscribe to the latest decision of the European Council (17 June 2010) regarding the way to tackle the crisis. The guidelines are clear; strategies should support growth and spending should be contained. The Belgian Employers’ Federation believes that 80% from the fiscal consolidation’s effort will have to come from reduced spending. The Belgian state needs to find 25 billion euros by 2015 to balance public finances. Because Belgium is already a very high tax environment, only about 5 billion euro could be financed through new taxation, mainly indirect taxes. government revenues are proposed, individual and company taxation remain unchanged and indirect taxes are adopted such as VAT, special taxes on tobacco and alcohol, specific taxes affecting banks as well as the taxation affecting energy consumption. Does Belgium also face the challenge of a relatively over-sized civil service? Yes definitely; in Belgium, the government’s payroll represents 25% of total government spending. If we look at Eurostat numbers, we see that in Belgium (compared to neighbouring countries) we have 0.7 civil servants more per 100 inhabitants. If you look at the country as a whole this means that we have an excess of 70.000 civil servants. Translated in costs, this means an excess in the cost of public services of about 1.6% of GDP (about 5 billion euros). Between now and 2020 it will be possible to automatically “trim” the public payroll by about 196.000 civil servants who will retire. Having said this, it is also a matter of changing mentalities; we have to prepare citizens to start changing their expectations of the public service. Each time issues and problems are identified; lobbying groups start demanding higher public spending and expanded employment in the service. This situation is not tenable in the long run; the State cannot be expected to solve all the problems faced by the citizens. The government needs to start distinguishing between what are essential needs of the citizens as opposed to “desired policies” to improve welfare. Moreover, the nature of the services provided by the State is also changing, and increased number of tasks can now be contracted to the private sector which is often more cost effective. What other related issues are relevant at the moment ? What are possible measures to reduce public spending? Proposals to reduce public spending have been inspired from other European states and can be summarised in five points: First, an immediate increase of the pensionable age; second, substantial cuts in civil servants’ pension benefits and salaries (it seems that all European countries are now following this line); third, reduction in the size of public employment; fourth, measures to contain costs of the social security and health care systems; fifth, when new ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Our second most important challenge is reducing social spending; social spending has been increasing faster than economic growth and this is not sustainable in the long term. If this trend continues, the State will be forced to cut pensions, unemployment and social benefits and/or health care outlays. Can tax collection be improved to help balancing the budget? 27 The Belgium Economy & Belgium Presidency national cross-sectoral agreements scheduling pay increases. Wage bargaining is considered to be rather centralised in Belgium because lowerlevel agreements always need to respect higher-level agreements (employers cannot offer less than what has been agreed at the collective bargaining table). On the income side, there is little else that the government can do since direct taxation already yields 36 billion euros and nobody sees how this figure could be pushed-up. We Belgians are already the champions of high taxation; nobody actually understands the large spread that exists between the cost to the employer and the net pay received by the employee. Our marginal taxation rate is extremely high and currently stands at 45%. What makes Belgium particularly special is that this marginal tax rate already applies for an annual income just above 20,000 euros. In France for example, such a high marginal tax rate is only applicable for incomes higher than 50,000 euros. Are there any other types of income sources that the government could access? Belgium needs to review taxes on properties. At the moment, taxation of properties relies on data that were last updated in 1975. This creates situations that are not equitable. Regarding VAT, our margin of manoeuvring is quite narrow but the Belgian government sees new promising opportunities in the field of green taxation. Belgium, together with Cyprus, Luxembourg and Malta uses a wage indexation system; could you tell us about your countries’ experience? In Belgium, collective wage bargaining and wage indexation play a central role in wage setting. Wage bargaining takes place every two years and results in 28 Regarding the indexing system, Belgium uses an automatic index-linking system which offers upper and lower bounds to wage growth. The idea is to link pay and social benefits to an index in order to prevent the erosion of purchasing power by inflation. It is important to note that prices of tobacco, alcohol and transport fuel are excluded from the calculation. Automatic wage indexation is annual and concerns private and public sector employees as well as beneficiaries of the legal minimum salary. It is mandatory for all employers to adjust wages according to the index. Do you actually suffer from cost inflation problems? Only to a certain extent; the state closely monitors the automatic indexing of wages in order to prevent an upsurge in relative labour costs, which could threaten competitiveness. To this effect, two laws were voted in 1989 and 1996 to allow the government to intervene in the wage-setting process. Concretely, this means that the forecast of increases in foreign hourly labour costs among Belgium’s main trading partners (that is France, Germany and the Netherlands) serves as an upper limit to wage increases. Are all social partners satisfied with the current system? One of the problems that has been identified with the system is its lack of flexibility in facing economic shocks as well as its inability to adapt to changes in regional employment growth. Employers also believe that the system leads to increases in wage costs that in turn threaten the competitiveness of the country and limit employment growth. Thus they are calling for a revision of the system. The trade unions disagree, fearing losses in the purchasing power of their members. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Political and Economy Integration of Cyprus Cyprus: Political Unification and Economic Integration 1 INTRODUCTION In the GC economy the fundamentals are strong and there is high standard of living. Despite the relatively mild impact of the world economic crisis, large economic imbalances were brought to the surface: a big budget deficit (may stabilize around 7% of GDP without By Michalis Sarris, difficult spending cuts) and Former Minister of Finance an unsustainable external current account deficit (18% of GDP in 2008 and 8% this year despite zero growth). There is a need for fiscal consolidation and bold structural reforms, to improve competitiveness. In the TC economy the fast growth after 2004, was based largely on real estate development, and was clearly unsustainable. There is now low economic growth, high unemployment, large deficits, heavy dependence of Turkey, structural problems and an economic system largely dependent on the state. A far reaching and politically challenging reform program is badly needed. Without a solution the two economies’ standard of living will diverge further. Economic prospects for the two economies, but especially for the TC economy are full of challenges. Therefore, a good solution with the expected positive economic impact is now particularly important. framework conducive to fast economic development and a socially sensitive society which should offer all Cypriots opportunities for progress and fulfillment of their expectations. A positive and friendly climate facilitated the discussions among TC and GC technocrats during the recent deliberations on economic matters. Membership of the European Union and the Eurozone is a very positive element in arriving to sensible economic arrangements. Further, it is generally recognized that the cost of bad economic arrangements would be great and could threaten the viability of the political solution. POSITIVE PROSPECTS OF A SOLUTION Reunification will have a positive impact on the economy: a faster rate of economic growth for the whole island, a significant “peace divident”, reconstruction expenditures, and fulfillment of the potential of the northern part of the island. Political stability will help improve the climate for private sector development, encourage investment by both Cypriots and foreigners and stimulate job creation. There will be a better utilization and distribution of limited resources, a reduction of wasteful expenditures, avoidance of infrastructure duplication, and important savings in military expenditures. Normalization of relations with Turkey will also have a positive impact as partnerships between Turkish and Greek Cypriots will make possible access to a large and growing economy in important sectors. CHALLENGES OF THE TRANSITIONAL PERIOD ECONOMIC ASPECTS OF A SOLUTION Economic and financial issues play a key role for a viable and workable solution: a strong economy is a basic precondition for the economic and social welfare of all Cypriots and for the creation of a common future. Our common vision should be to create together an economic Irrespective of the specific characteristics of a solution, for a transitional period, there will be pressure on the gap between savings and investment manifested in larger budget and current account deficits and inflationary pressures. For this reason, it is crucial to avoid excessive burdening of public finances with large expenditures for 1 Notes for a presentation at an Economic Journalism Workshop for Turkish Cypriot Journalists, Sept. 14-15, 2010. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 31 Political and Economy Integration of Cyprus reconstruction, resettlement and possible support for the banking system. Naturally there will be a need for transitional arrangements as economic agents adjust to open markets, but these arrangements will have to be such as to provide a balance between giving time to adjust but not inhibiting market forces from supporting fast economic development, thereby delaying social and economic convergence . throughout Cyprus (ii) free movement of goods and services and (iii) free movement of capital and investments and (iv) encouragement of foreign investment. It would be essential to implement a ten-year Economic Development program with emphasis on infrastructure in the north of Cyprus financed by EU structural funds, international development lending institutions and the Federal Budget. International experience shows that policies that rely on the transfer of resources to achieve economic convergence are not effective. PRECONDITIONS FOR REALIZING BENEFITS The solution must be based on solid grounds: the European Union framework provides such a basis especially in the areas of fiscal and monetary policy, regulation and supervision of the financial system, free movement of goods, services, labor and capital, trade expansion and competition. The appropriate institutional arrangements should be adopted to help deal with the transitional challenges and realize the positive prospects for rapid and sustainable development and convergence in living standards. A key priority is the adoption of an effective framework for the regulation and supervision of the banking system to ensure the efficient provision of credit to business and households. It would also be essential to ensure the necessary institutional arrangements for the viability of public finances both in the medium and long run. It goes without saying that a solution should include the adoption of the European Acquis throughout Cyprus and handling any transitional arrangements with sensitivity and effectiveness: deviations from the acquis should be welljustified, be time-bound and be for technical reasons. Finally, it would be in the interest of all Cypriots to agree on the adoption at the federal level of common minimum social norms for application throughout Cyprus in such important areas as employment, safety in the workplace, social insurance and medical care - recognizing of course, the co-responsibility of the constituent states in formulating and implementing social policy. ECONOMIC DEVELOPMENT AND CONVERGENCE The adoption of the principles summarized in the previous section will strengthen the prospects for economic development and will promote the convergence of living standards between Turkish and Greek Cypriots. The key instruments to support economic development and convergence are (i) ensuring without obstacles the pursuit of entrepreneurial activity and employment creation 32 PUBLIC FINANCES Macroeconomic stability is essential for sustainable development and sound public finances are a key to macroeconomic stability. The EU framework provides the correct basis for the design and implementation of public finances. There is a need for an Internal Stability Pact to ensure that the budget of all fiscal entities follows EU rules to avoid excessive deficits and the build up of too much debt. SOCIAL DEVELOPMENT AND LABOR MARKET ISSUES It is important to give emphasis to social policy so that citizens feel that the authorities are approaching with sensitivity their welfare. Workers rights should be protected while at the same time businesses are given sufficient flexibility to implement their enterprise plans. It would be desirable to have minimum social standards which apply throughout Cyprus. FINANCIAL SECTOR The euro, a strong and reliable currency, will serve the economic needs of all Cypriots. Effective regulation and supervision of the banking system throughout Cyprus is essential to ensure the soundness of the financial system so it can serve effectively households and businesses. CONCLUSION A successful reunification of the Cyprus economy will benefit all Cypriots in tangible ways. We have a unique opportunity to create the conditions for a prosperous and just society, to adopt sound policies and institutions, while at the same time avoiding costly mistakes. Membership of the European Union and the entrepreneurship of all Cypriots are key allies in this endeavor. We must not miss this opportunity. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The imposition of price ceilings ‘Cyprus - the state of price ceilings’ By Averof Neophytou Deputy President Democratic Rally The imposition of price ceilings is the refuge of those who can not manage the market economy. AKEL and the government are trying to promote the introduction of price ceilings in various products and services as a solution to address higher prices. Unfortunately, the government and AKEL do not realize that such practices not only do not address profiteering phenomena but hide the real problems. The question that should trouble us in the issue of the tuition fees of private secondary schools is the problem of the quality of the public education offered by the state and not the amount of tuition. If you think that more and more parents choose private education for their children, then it shows that parents no longer have confidence in the system of public education. And that is the question that should trouble the government and all of us, not the fees of private schools. In addition, private schools do not impose a burden on the state budget and the Cypriot taxpayer does not have to pay for these fees. It is a personal choice of every parent to send their children in a private school, while the state provides free education, and to bear the costs involved. What should the government ensure is the quality of the curriculum and the state of the buildings and teaching facilities and in addition that every parent should know in advance how much the cost of private education will be to complete, so that he or she should be in a position to calculate his budget and decide on their available options. It would be unreasonable to require the state to cap the fees when public education is costing the Cypriot taxpayer much more. The average cost per pupil in Primary education was m6,082 in 2008 while the average education cost per student in secondary education was m9,805 and ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 the cost of Technical Education was m13,791 per student. University education was costing m23,714 per student in 2008. From the numbers alone we can observe that public education involves much higher costs than private education. And of course not only nobody addresses the issue of the cost of public education, but calls are made by almost everyone to increase public spending on education. If we just compare numbers, we see that the cost of private education is much lower than the burden on citizens from public education. Private universities cost students approximately m9,000 per academic year in 2010. This is in contrast to the State University of Cyprus, where the cost per student (in 2008 prices) was m23,714. The same goes for private secondary education. On average tuition at a private secondary school for 2010 is approximately m6,500 for each year of schooling, while the cost per pupil in public education is m9,350 for high schools, m9,645 for lyceums and m13,791 for technical schools and professional education. So we are just being hypocritical by supporting the introduction of a cap on fees in private schools, while the cost of public education is much higher. After all, those who choose private education do so consciously rejecting the free public education provided by the state. It is clear that the problems we must confront are the quality of public education and its cost, which is significantly higher than the private sector. Our economy should be driven by free market rules and the state should provide conditions for fair competition to thrive. This can only be done through the shielding of institutions and the strengthening the role of the Commission for the Protection of Competition. The imposition of the cap only creates additional distortions in the market which will be paid by the Cypriot consumer. AKEL should not forget that the only thing they managed to achieve in the recent imposition of a ceiling on retail fuel prices was to create huge queues at petrol stations and the only result had been the suffering of the Cypriot consumer, while purchasing oil and gasoline at the highest price. 33 Economic surveillance in the EU Recommendations and sanctions: New Commission proposals to enhance economic surveillance Androulla Kaminara Head of Representation of The European Commission All European Union countries combat economic deficits, in various ways depending on the nature and extent of the problems they have to face, with measures for reducing expenses, i.e. proposals to freeze in remuneration in the public sector in Cyprus or to reduce them by 5% in Spain or even by 15% in Hungary; measures to increase revenue generation, i.e. VAT increase in Britain to 20% and in Greece to 23%. The economic crisis and the threats against the Euro, and the EU response in May through the m500 billion package, have shown the interdependence between European economies. They have also shown that with respect to surveillance, coordination and ultimately adherence to the agreed standards, the existing mechanisms contain gaps. It is precisely these gaps that the new Commission proposals intend to cover, proposals that incorporate preventive as well as corrective measures. With respect to prevention, the key is the new European Semester mechanism, an analysis, and information and coordination cycle. Every January, the Commission will submit to the European Parliament the annual report for development with estimates for the following year. In April, Member States will submit their own stability and convergence programmes as well as structural change 34 programmes. In the beginning of July, after having examined the programmes, the Commission will make specific recommendations to every country. However, this does not mean that governments will have to send their budgets to the Commission before submitting them to their national parliaments. During the second semester of each year, Member States will have to finalise their national budgets. These proposals were discussed at the recent meeting of the EU Task Force on Economic Governance headed by President of the EU Council Herman van Rompuy on July 12. The Task Force agreed that the Commission proposals, in particular the concept of the European Semester will result in better, more co-ordinated surveillance efforts. The ECOFIN Council, meeting in Brussels on the next day, July 13, concurred and asked for the adoption of the necessary modifications to the code of conduct on the implementation of the Stability and Growth Pact as soon as possible so that the Commission proposals can be introduced in practice as of 2011. Beyond this annual cycle, the proposals foresee surveillance mechanisms to deal also with longer term problems with a view to locate in time excessive macroeconomic imbalances, e.g. in fields such as competitiveness, balance of payments etc., but also likely structural impediments in achieving the objectives of Europe 2020 strategy, and to deal with them again through a set of preventive and corrective measures. The Commission proposes the introduction of new, simple indices illustrating the overall progress of every economy. These indices would be in advance based on clear objectives with respect to the pace of deficit and debt ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Economic surveillance in the EU reduction on one hand; on the other hand, there would be surveillance and, should it be decided that the pace needs to be accelerated, new recommendations will be made. These proposals are also reflected in the Broad Economic Policy Guidelines adopted by ECOFIN on July 13. These guidelines are considered an important step in the implementation of the Europe 2020 strategy for jobs and growth. On the corrective part, the Commission proposals foresee sanctions to countries that do not comply with the recommendations with regard to fiscal policy or the control of macro-economic aggregates. One basic sanction is the partial suspension of financing from the EU budget, in particular from the Cohesion Fund, Agricultural Funds and the Fisheries Fund. The amount of sanctions will be known in advance and will be proportionate to the size of the country’s economy. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 During a first phase, there will be a warning issued that, that in programmes extending over a period of several years, some payments will be suspended. To prevent this, Member Stated should adopt Commission recommendations. Taking into account that programmes are of a multiannual nature, Member States will have plenty of time to comply. In case a country does not comply with the recommendations, disbursements to that country may be annulled, and unlike in the past, permanently lost. These sanctions do not affect the final beneficiaries of the funds, e.g. the farmers. Member States will continue to pay the subsidies to the beneficiaries but, and this is what sanctions are all about, they will do so from their own resources, without being reimbursed from the EU budget. 37 The Cyprus Economy The structural problems of the Cyprus Economy Economic crises usually offer challenges but also opportunities to introduce economic reform so as to face structural problems. So this economic crisis is an opportunity to introduce such reform as Greece is now doing. The main economic problem that Cyprus faces now is competitiveness. According to a survey of 139 countries By Tassos Anastasiades, by the International Deputy Editor Economic Forum, Cyprus lost six places in comparison to 2009. It may be noted that while the average per capita income of the 27 EU members is 96% the average productivity is 87%. The main reason for this is that the wage rates are rising at a faster rate than the rise in productivity. For example in 2006 while wages rose by 5.7%, productivity increased by 1.8%, in 2007 wages increased by 4.7%, productivity increased by 2.0%. In 2008 the increase in wages was 7.5% and productivity 0.8% and in 2009 the increase in wages was 4.0% while productivity dropped by 0.5%. To improve competitiveness either wages should be reduced or productivity should be increased by the taking of various measures by the social partners (such as by the introduction of new products and services as well as new procedures) or by a combination of both. Towards this end the decrease of bureaucracy, specifically with regard to the construction industry and the registration of new companies, mainly foreign companies, will also help. It might be advisable to follow the same procedures for the Cypriot investors as those which have been followed for the Qatar investment. And there are many private projects which are waiting for approval to start, something which will reduce both unemployment and increase the tax revenue of the Government. Productivity can also increase with the partial privatization of state companies because it will induce the new public companies to become more competitive and productive. And with the sale of part of the share capital, perhaps 30%, the revenue will be used to reduce the public debt and even the fiscal deficit in cases where the Government pays the losses of the companies, as for the Cyprus Airways and Eurocyprea. It is not expected that the merging of these two companies will render them profitable. The new 38 company must seek alliances with other airlines. It may be noted that even British Airways - Iberia are seeking alliances or even mergers with 12 other smaller airlines. The civil service can also become more productive by making it easy for the civil servants to move from one department to another and introducing computerization of all the services in the public sector. The administrative cost of the businesses when dealing with the Government should also be reduced, something which is pursued by KPMG to which this project has been awarded, after official tendering. In Cyprus, whereas company - level collective agreements exist, sectoral agreements cover a larger proportion of the work force which renders the labour market inflexible. And this because if a certain percentage increase is decided for the industry as a whole it may be possible for some of the companies not to be in a position to pay the wage increase and will be forced to fold up. So the solution lies in conducting negotiations separately with each company. So companies with higher productivity will be offering more than the average increase in productivity. In combination with collective bargaining in Cyprus there is also the inflexible institution of wage indexation, an institution which also exists in some form in Malta, Luxembourg and Belgium. Among countries which had this system and abolished it were Denmark, France, Italy, Netherlands and Spain. In Cyprus it may not have to be abolished but at least amended so that it is offered once instead of twice yearly while the cost of living allowance should not to be affected by temporary and seasonal factors as it happened this year with the vegetable prices due to the very hot august. Also due to the fluctuating prices of oil. Another amendment which should be introduced is to exclude any changes in VAT to affect cost of living allowance. Generally speaking wage indexation is a factor for pushing up wage costs thus leading to loss of competitiveness. For the civil and educational service but also for the semiGovernment and local Government services new reduced scales should be introduced so that not only the wage-bill will be reduced but also the disparity in the remuneration between the private and private sector will be reduced. This is especially necessary for the public education service where the teachers’ salaries are three times the average per capita income as related to 1 - 11/2 time the average per capita income in the EU countries. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Internal Audit Service Internal Audit Service of the Republic of Cyprus: The Consultant of the Public Sector and Partner of the European Commission BACKGROUND By Andreas M. Lambrianou, Commissioner of Internal Audit of the Republic of Cyprus. In July 2003 the Republic of Cyprus recognizing the necessity for the modernisation of the Public Sector and the new requirements imposed by the principles of good public governance, established the Internal Audit Service as an Independent central internal audit Authority for the Public Sector, with the Internal Audit Law of 2003 [N 114 (I)/2003]. Following that, the Council of Ministers appointed the Internal Audit Service as the Responsible Audit Authority for the audit of Programs cofinanced by the European Union in Cyprus, as its structure and expertise satisfied the relevant requirements set by the European Commission. The Internal Audit Service is headed by the Commissioner of Internal Audit, appointed by the Council of Ministers. His duties and responsibilities are determined by the relevant legislation and he is responsible for the strict and effective application of its provisions. The Internal Audit Board comprises of five members and is chaired by the Minister of Finance. It acts as the conduit between the Council of Ministers and the Internal Audit Service and its duties and responsibilities are also determined by the Legislation. THE DUAL ROLE In order for the Internal Audit Service to comply effectively with its dual role, it has been organised in two Directorates: the Internal Audit Directorate and the Audit of Co-financed Programs Directorate. INTERNAL AUDIT - THE CONSULTANT OF THE PUBLIC SECTOR The Internal Audit Directorate acts as the internal auditor for the entire public sector. The role of the Internal Audit Service is to act as a consultant to the management of Public Sector Organisations helping them improve their ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 effectiveness and efficiency. The audit objectives are set taking into consideration the public interest, good public governance, the need to safeguard the use of public resources in an effective, efficient and economic manner, the provision of high quality and cost effective services as well as the need to safeguard Government revenue. In accordance with article 10 of the Law, the Internal Audit Service is functionally and administratively independent from auditees. Audits by this Directorate are performed in accordance with its audit manual which is based on the International Standards for the Professional Practice of Internal Auditing of the International Institute of Internal Auditors. Upon the completion of each audit, a report is prepared which includes audit findings as well as recommended actions that should be taken by the auditee in order to address the weaknesses identified. Following discussions with the auditee this report takes the form of an Agreed Action Plan with specific implementation timetables. Based on these timetables, follow-up audits are carried out thereby monitoring the implementation of corrective measures (value added) and their results are communicated to the Internal Audit Board. AUDIT OF CO-FINANCED PROGRAMS - THE PARTNER OF THE EUROPEAN COMMISSION The Audit of Co-financed Programs Directorate audits the various Programs co-financed by the European Union in Cyprus. In accordance to the established Management and Control system operating in Cyprus, the Internal Audit Service is responsible for the performance of systems audits of the institutions that are involved in the management of such programs, such as the Planning Bureau (as Managing Authority) and the Treasury of the Republic (as Certifying Authority), as well as for the performance of sample-based audits of institutions that are involved in the implementation of the programs (Beneficiaries) in order to verify the correctness and legality of the expenses that are being certified to the European Commission. The audit methodology is set by the Directorate’s audit manual which is based on a number of handbooks, questionnaires and instructions that are published from time to time by the European Commission. Our recommendations aim at the continuous improvement and strengthening of the management and control systems 39 Internal Audit Service of the organisations involved. Upon the completion of each audit and the receipt and evaluation of any comments from the auditee, the Directorate issues the Final Audit Report which instructs the auditee to take any measures necessary to remedy the problems identified. In its Annual Audit Reports to the European Commission, our Service expresses its professional opinion as to whether the management and control system has functioned effectively in order to ensure the regularity and legality of expenses that have been claimed for co-financing by the European Commission. TRAINING AND PROFESSIONALISM STRATEGIC PLANNING The work of the Internal Audit Service and its personnel are governed by the Code of Professional Contact which describes the values that an Internal Auditor should comply with which include independence, integrity, objectivity, impartiality, confidentiality and competency. In accordance with its above responsibilities, the Internal Audit Service has adopted a process of short-term and long-term strategic planning. The outcome of this process is the five-year Strategic Plan of the Internal Audit Service which now covers the period up to 2015 and includes -in summary- the following objectives: i. Provision of an effective and efficient Internal Audit Service ii. Evaluation and improvement of the existing internal audit model of the Public and the wider Public Sector iii. Fulfilment of the obligations of the Internal Audit Service towards the European Commission as an Audit Authority iv. Utilisation of all experiences gained from the audit of co-financed Programs for the benefit of the public interest. The annual audit activities of the Internal Audit Service which emanate from its strategic plan are included in its Annual Audit Program and they are set by the Commissioner of Internal Audit taking into consideration a large and diversified number of factors. An innovation in the annual audit program of 2010 for the Internal Audit Directorate is the inclusion of Horizontal audits i.e. those relating to issues that affect more than one government department or even the entire Public Sector such us the ability of the Republic to achieve environmental or energy objectives and targets set by the European Union and also the evaluation of the current housing policies of government departments. Audits and other assignments are also carried out for a number of Ministries/ Departments/Services such as the current assessment of the major factors contributing to the increase of the cost of purchasing medicines from 2000 to 2009, and specialised computer and information security audits on Government computer systems. The selection of audits of the Audit of Co-financed Programs Directorate is made in accordance with the regulatory framework that applies to the co-financed programs and the respective Audit Strategies which were agreed with the European Commission. 40 The Internal Audit Service follows a specific training strategy and takes measures aimed at the continuous training and professional development of its personnel. Moreover, at the center of its strategy for efficiency, economy, effectiveness and continuous improvement and minimisation of bureaucracy lies the continuous upgrading of its computerised information systems. It should be pointed out that the performance of audits is completely computerised through specially tailored software. SOCIAL ACTIVITIES The human side of our professionals is evident through our participation in social activities which demonstrate our social sensitivities such as: (a) On June 2009, our Service co-organised a charitable futsal game against the team of the Hostel for Teenage Boys in order to support them both morally and financially to the maximum possible extend (b) On October 2009, our Service participated in a Pancyprian charitable futsal tournament for the purchase of an analyser of thyroid hormones for the General Hospital of Famagusta and (c) On May 2010, the Centre for Study of Haematological Malignances of Cyprus ([KEMAK]) co-organised with our Service, a Charitable futsal tournament under the aegis of the First Lady of the Republic of Cyprus, Mrs Elsi Christofia in order to establish a modern Scientific Centre in the field of tumour-haematology in Cyprus. VISION The last year signals the beginning of the revision and modernisation of our strategy. My Vision for the Internal Audit Service is to establish it as one of the central pylons for the reformation of the Public Sector and its operation in the competitive environment of the European Union and the globalised economy. By setting the Mission, Role, Objectives and the framework of values that underlie our Service, as stated above, I feel, at this moment, the need to publicly express my warm thanks to all my colleagues in the Internal Audit Service, who work tirelessly and continuously for achieving our goals and making our Vision a reality. Thus -like a big family- we are working hard, responsibly and productively, with particular zeal, methodology and planning, whilst maintaining a wonderful and genuine personal relationship with a spirit of collaboration in order for our mutual goals to be achieved in their entirety and crown our efforts with success. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Corporate Social Responsibility Corporate Social Responsibility Corporate Social Responsibility spans from the prÔvision of better welfare for the employees of a company, to the offering of financial assistance for philanthropic, educational, athletic and environmental purposes in the area the company operates and even internationally. It may be noted that in spite of the fact that one of the major objectives of a company is By Maria A. Papacosta the maximization of profit, Board Member in many instances big public KPMG Limited companies are not interested in having the maximum possible profit because they consider themselves responsible for the welfare of the area they operate and that they should contribute to the welfare of the people in general. Thus, from their profits they allocate big amounts for the public benefit, mainly for social and environmental matters. supported with various functions which are performed for the purpose of promoting the culture heritage of each member - country that KPMG operates internationally. In the environmental field the company participates in various recycling programmes and energy conservation. KPMG recycles paper, it reduces publications and as far as possible the use of ink. It also recycles its electronic and electrical effluent either through its suppliers or through certified recycling companies. In 1996 KPMG allowed its staff in Britain to spend two hours a month of their paid for time on work for the community. Later on the programme expanded to half a day a month and now adds up to 40,000 donated hours a year. Corporate Social Responsibility (“CSR”) is of essential importance for KPMG globally. With regards to donations and sponsorship, KPMG in Cyprus offers inter alia: ñ sponsorships for music concerts, operas, dance shows, theatre plays and various cultural activitie for the benefit of society in general ñ sponsorship of young football teams ñ donates money for people in need KPMG in Cyprus, conducts non-profit academic research on environment - economic interactions in collaboration with top US universities. KPMG is a value-driven firm whose aim is to turn knowledge into value for the benefit of its clients, its people and its communities. We believe that our responsibilities to society go beyond legal obligations and that KPMG people should play a full role in the communities in which they live and work. One of our Global Values is the following: WE ARE COMMITTED TO OUR COMMUNITIES. Our values describe who we are, what we do, and how we do it. We aim to incorporate them into our relationships with our clients and colleagues so that they are reflected in the work we do everyday and in the relationships we have with each other and our clients. Our Corporate Social Responsibility activities are divided into three sections: Education, Culture and Environment. KPMG being sensitive and recognizing the responsibility that it has for the environment systemically tries for the promotion of better management of the environmental effects which emanate from its activities. In the educational field KPMG supports young people and their research with grants and scholarships. Society is ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 In the field of education, KPMG in Cyprus supports our universities and colleges by: ñ sponsoring various Universities and Cyprus and in UK ñ offering money prizes for top students ñ sponsoring various accounting and economic publications KPMG Academy in Cyprus was created in the frame of the organization’s wider strategy for social responsibility with a goal to turn knowledge into value. KPMG International launched the Global Green Initiative in 2008 which amongst other progressive strategies, includes the ambition to reduce our global carbon footprint by 25 percent by 2010. This move is supported by KPMG Cyprus. We are also committed to having a wider positive impact on the environment and addressing local environmental challenges. KPMG member firms are investing in responsible energy use, education, working on environmental protection projects and joining forces with leading groups and other businesses to address impacts. In February 2010, KPMG in Cyprus in cooperation with the Cyprus Chamber of Commence and Industry signed the Environmental Charter. In addition, our growing Global Sustainability Service 43 Corporate Social Responsibility Network, with more than 15 years’ sustainability experience, provides services to help our clients deal with the impact of climate change on their businesses. Of course the donations and contributions made by companies towards various philanthropic and social purposes are very important, but the welfare which is created in the form of new places of work, new products, new innovations and new inventions is much more important than any contributions made by companies in the form of CSR. Poverty in various countries will be faced by investment made by multinational companies on the basis of globalization. If markets remain open, CSR will expand. Thus to - day one company after another specifically the multinationals are adopting the CSR. To day it is inconceivable for a big international company not to have adopted CSR. Globalisation has been the driving force both for the growth of the world economy and the adoption of CSR. As KPMG Cyprus, we recognize our responsibility towards the community we live in and we constantly strive to achieve what is best for it in terms of social, cultural and environmental well-being. The cost of the Turkish occupation in Cyprus The cost of the Turkish Occupation in Cyprus The recent “white” strike of the employees of the Civil Aviation in Greece, has revealed that the national air-transport companies of Cyprus are losing of millions of euros every year, due to the embargo that Turkey is imposing on flights of Cypriot planes over its airspace. Similar costs are inflicted on ships carrying the Cyprus flag due to the fact that Turkey By Marios Mavrides doesn’t allow them to use Associate Professor Turkish ports. The above Economics, European costs and many others, are University of Cyprus due to the Turkish Occupation of part of Cyprus for the past 36 years and which continues to date. The Republic of Cyprus suffers a huge amount of costs each year which is related to the occupation, some of these costs are direct and others are indirect, meaning that they affect public finances in an indirect way. There is also an opportunity cost involved which as a consequence of the occupation. The direct costs include housing subsidies for displaced persons (refugees), national security expenditures as well as expenditures for the maintenance of the green line, expenditures for the maintenance of United Nations peace-keeping force in Cyprus, expenditures for the promotion of the Cyprus problem, relieving measures for the enclaved persons, and many others. All these amounts are listed in the annual budget of the republic, but they are too many, and it is very difficult to identify all of them. In this article, we are going to mention some of the largest expenditures of the Republic of Cyprus which are related to the Turkish occupation. 44 DIRECT EXPENDITURES Housing subsidies for the displaced persons amount to m86 million a year. These subsidies are likely to continue for as long as occupation continues to exist. The refugee identity is transferable to the next generations. However, the amount spent would begin to decrease after a certain point into the future, since low fertility in Cyprus will start to affect the number of the applicants. Housing subsidies include cash subsidies only. But there are also housing units provided to displaced persons in housing projects built by the government as well as land subsidies for those who would like to build on their own. It should be noted that amount of housing subsidies reported in the budgets is understated since housing projects and land subsidies are not included. In addition to the above housing expenditures, the government is also providing cash subsidies for rent to 3,800 refugee families. The budget of the Ministry of Defence for 2010 amounted to m361 million. Of that amount, only m7 million were needed for the operation of the ministry. The rest of the money was related to the national security, like the Cyprus Army which spends around m134 million in salaries and operational expenses and the National Guard, which spends around m105 million. In addition to the above, the expenditures for the purchase of military equipment and weapons for 2010 is about m115 million. It would be naïve to assume that all that money would not be spent if the Turkish occupation did not exist. After all, most countries, including the Vatican, have an Army. It is however, logical and realistic to assume that the budget of the Ministry of Defence would be much lower without the existence of Turkish occupation. There is a list of other expenses listed in the budget reports, which are related to the occupation. The expenditures for the maintenance of the UN Peacekeeping force in Cyprus are around m15 million a year, the funds for the promotion of the Cyprus problem amount to ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The cost of the Turkish occupation in Cyprus m3.2 million a year, and the maintenance expenditures for the government built housing projects are around m14 million a year. It would be difficult and time-consuming for someone to identify all expenditures related to the occupation in the budgets. What is certain however, is that the republic of Cyprus is spending hundreds of millions of euros every year in direct expenses, due to the Turkish occupation. Perhaps a graduate student would like to investigate this subject further for his/her Masters’ thesis. and we are not trying to do that. With regards to the economy, it is rather simple and easy to understand that the value of the foregone opportunities is enormous and it could have benefited both communities on the island. With all resources available for use, the Cyprus economy would have been able to grow much faster during the past 36 years and the standard of living of the Cypriots would have been much higher. CYPRUS WOULD HAVE BEEN A PARADISE INDIRECT EXPENDITURES The indirect costs of the Turkish occupation are probably more significant than the direct expenditures. The indirect costs have to do with the forgone benefits that property owners could have if they were able to exploit their properties as well as the benefits to the Cyprus economy from taking advantage of all its resources in a more stable and fertile economic environment. The forgone opportunity from not using a property is based on a logical annual rate of return, which is compounded over the years. For example, if someone had a property which was worth m100,000 in 1974 and was able to earn 4% net return on his property every year, then his property would have doubled in value in 18 years and double again in another 18 years (Rule of 72). So after 36 years, the value of his property would have been m400,000. There are however, many other factors that can affect the value of a property over the years, such as the regional development, the ability of the owner as a businessman, the financial environment etc. It would be impossible for someone to calculate the value of the forgone opportunities of the lost properties, without making strong assumptions, Most of the Cypriots must have wondered at least once during their lifetimes, how would Cyprus be had the tragic events of 1974 did not take place. How would Cyprus be today if the economy was united and operating under conditions of piece, security and political stability, and being able to take full advantage of its strategic geographical position? Like the President of the Republic of Cyprus said recently during an interview,” Cyprus would have been a paradise”. The economy would have had excellent prospects for growth and prosperity. By taking advantage of all its resources, the economy would produce high growth rates, more jobs, and higher standard of living for the people of Cyprus. Cyprus would have become an international financial center with huge capital inflows, as many multinational companies would have wanted to have their headquarters in Cyprus. The service sector, which includes tourism, banking services, accounting, education, health etc, would have formed a strong base for our economy. It is a well known fact that Cyprus is the bridge between North and South, East and West. It is about time we realize that and do something about it. Lease accounting IASB and FASB propose significant changes to lease accounting Because almost all companies enter into lease arrangements, the proposed model explained below will have a pervasive impact for IFRS and US GAAP preparers. Some entities will be affected more than others, depending on the number and type of leases in existence at the transition date. By Tasos Nolas* The proposal applies to all ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 entities, but certain types of leases are excluded from its scope. The boards propose that the scope of the leasing standard includes leases of property, plant and equipment but does not include leases of intangible assets. The boards also propose to exclude from the scope: leases to explore for or use natural resources (such as minerals, oil, and natural gas); leases of biological assets; and leases of investment property measured at fair value. The comment letter period ends on 15 December 2010; a final standard is expected mid-2011. Management should begin to assess the implications of the proposal on their existing contracts and current business practices. 45 Lease accounting Management should also consider commenting on the exposure draft to ensure their views on the proposed changes are considered. THE PROPOSALS The IASB and FASB have proposed a new approach to lease accounting that would significantly change the way entities account for leases. Their exposure drafts, both entitled ‘Leases’, will result in a converged standard that aims to address the weaknesses of existing standards. The key objective is to ensure assets and liabilities arising from lease contracts are recognised in the balance sheet. KEY PROVISIONS LESSEE ACCOUNTING The proposed model will eliminate off-balance sheet accounting. All assets currently leased under operating leases will be brought onto the balance sheet, removing the distinction between finance and operating leases. The new asset _ representing the right to use the leased item for the lease term _ and liability _ representing the obligation to pay rentals _ will be recognised and carried at amortised cost, based on the present value of payments to be made over the term of the lease. The lease term will include optional renewal periods that are ‘more likely than not’ to be exercised. Lease payments used to measure the initial value of the asset and liability will include ‘contingent’ amounts, such as rents based on a percentage of a retailer’s sales or rent increases linked to variables such as the Consumer Price Index (CPI). The proposed model will require lease renewal and contingent rents to be continually reassessed, and the related estimates to be trued up as facts and circumstances change. Income statement ‘geography’ and timing of recognition will change. Straight-line rent expense will be replaced by depreciation, which will be recognised on a basis similar to similar owned assets, and interest expense, which will be recognised on a basis similar to a loan. LESSOR ACCOUNTING The boards were unable to agree upon a single lessor accounting model and decided that concerns about the application of each of the two approaches in certain fact patterns could only be addressed through a dual model. 46 For leases where the lessor retains exposure to significant risks or benefits associated with the leased asset either during the term of the contract or subsequent to the term of the contract, the ‘performance obligation’ approach would be followed. The lessor recognises the underlying asset and a lease receivable, representing the right to receive rental payments from the lessee, with a corresponding performance obligation, representing the obligation to permit the lessee to use the leased asset. For all other leases, the ‘derecognition approach’ would be followed. The lessor recognises a receivable, representing the right to receive rental payments from the lessee and records revenue. In addition, a portion of the carrying value of the leased asset is viewed as having transferred to the lessee and is derecognised and recorded as cost of sales. Similar to lessee accounting, lessors under either approach would also need to estimate the lease term and contingent payments and true-up these estimates as facts and circumstances change. DISCLOSURES The proposed model will require more extensive disclosures than are currently required under IFRS and US GAAP. The disclosures focus on qualitative and quantitative information, and on the significant judgements and assumptions made in measuring and recognising lease assets and obligations. TRANSITION Pre-existing leases are not expected to be grandfathered. The boards are proposing the new leasing approach to be applied by lessees and lessors by recognising assets and liabilities for all outstanding leases at the date of the earliest period presented using a simplified retrospective approach. The exposure draft does not propose an effective date. We anticipate the final standard to have an effective date no earlier than 2012. * Partner Assurance Services PricewaterhouseCoopers Member of the Global PricewaterhouseCoopers Consulting Services (ACS) and ACS leader on the Global PricewaterhouseCoopers Real Estate Industry Accounting Group ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Labour Relations Human Resources and Work Environment as a motivating force for the achievement of high objectives The CSE, as a modern and dynamic organisation, places particular importance to the issues of labour relations, the productivity and in the efficiency of its personnel as well as to its corporate social responsibility. In this framework, the CSE has established effective mechanisms of operation By Mr. Nondas Cl. Metaxas that promote a collective Director General spirit, hard work and high CEO of the Cyprus output. Functioning as a Stock Exchange team and in a spirit of mutual understanding, the management, the executives and the personnel of the CSE seek to attain new objectives, plan the future and create value for their work and their organisation. the most developed stock exchanges of Europe and in our region. Its recognition by international and European institutions, its modern technological infrastructures, its collaborations with other stock exchanges and in general the structure and its operation, confirm the comprehensive work that is carried out internally in the CSE. The close and harmonious collaboration of the Council and personnel, the responsibility of those who manage, the executives and its personnel, the completion of projects within the set timeframes and the continuous effort of all in order for the organisation to advance, have brought the CSE in an enviable place regarding productivity and efficiency. A fact that should be pointed out is the collective participation to the organisation’s planning. The preparation of strategic plan begins from below and “it moves up”, until the final proposal that will be discussed by the Council is prepared, again with the attendance of the responsible executives. Today, the CSE is characterised by an excellent climate of labour relations which is evidenced by the zero loss of work time due to internal labour friction. Everybody who works at the CSE enjoys a healthy work environment, ideal for producing results that require high output and attaining difficult objectives. By implementing the Code of Governance and the hierarchy of organisation, everybody works for the ultimate result that is none other than the reinforcement and credibility of the CSE, both inland and abroad. The effort of costs reduction is once again collective. Also each member of the personnel feels that he/she is being utilized and participates within the CSE. The CSE applies, even if this is not required by its legislation, the provisions that itself imposes on its Members and the listed companies. A factual proof is the application of the Code of Corporate Governance to the extent that it is able to, based on its legal status. What does this mean? It means an independent Internal Controller and Audit Committee with explicit operation rules. It means in the final analysis the most explicit application of fair administration. ñ From 29 March the E.C.M. Market (Emerging Companies) that enriches our market. ñ The listing in the Derivatives Market of the Athens Exchange (AthEx) of a banking product based on the joint index AthEx - CSE. ñ The introduction of new tools aiming to the increase of liquidity of the market, such as the institution of Market Makers, the Over the Counter Trades, as well as the Securities Lending. The most excellent labour relations have brought about important results for the CSE, which today is included in ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 For this reasons, the CSE has the advantage to promote continuously new development objectives, which with systematic and hard work the executives and personnel bring to materialisation. Indicative of this is that just for the period 2009-10 (up to date) the CSE has accomplished and promoted: 49 Labour Relations ñ The simplification of internal processes in order to minimise bureaucracy and to strengthen the technological infrastructure of its services. ñ The widening of its relations with other stock exchanges (Greece, Russia, Romania, Egypt, etc). ñ Its approval, in 2009, as a recognized stock exchange by the tax authorities of the United Kingdom. ñ Its approval from June 2010 as a recognized stock exchange by the competent authority for capital markets issues of the Russian Federation (FFMS). ñ The reinforcement of its recognition in international level through its upgrade by the FTSE in country category (FTSE Global Index Series) and specifically to the category of Frontier Markets. ñ Its linking, in November 2009, to the consortium Link Up Markets that began with the participation of a number European Depositories - Exchanges, including the CSE. ñ The signing in 2009 of the Memorandum of Understanding (MOU) for its participation to the Target 2 Securities project promoted by the European Central Bank for the unification of transactions clearing by a unified pan European platform. ñ The development of bonds market in the CSE. ñ The recent taking over, within particularly difficult and pressing conditions, functions relating to Government Listed Bonds and Treasury Bills, due to the transfer of the Public Debt administration from the Central Bank to the Ministry of Finance. ñ The preparation of regulations on the promotion of Global Depository Receipts (known as GDR’S). At the same time, with all these objectives that the CSE achieved, its personnel: ñ Organises regularly informative presentations “road shows” in markets abroad for the promotion of the CSE and its Member companies. ñ It strengthens the investors’s information. In addition to the monthly electronic review of the market with the publication (e-briefing CSE) and the annual publications Fact Book and Annual Reports, it published recently the “Glossary of the CSE” that 50 includes in simplified language terminologies of the stock market and the publication “Articles & Opinions of executives of the CSE” that covers specialised subjects from technocrats of the CSE. ñ It organises educational presentations for all the participants of the capital market. As it can be deduced from above recently, the central axis of all actions of the CSE is the promotion of new products and services that serve the needs of market, its participants as well as investors. Also the CSE gives particular importance to the management of its resources, so that it remains a robust and financially strong organisation. It achieves this with particular policies that aim to the proper control of expenses and to the increase of revenues. Above all it should be stressed once again that the decisive factor is that the formulation of relevant policy is carried out with the participation of all personnel. As a modern organisation, the CSE could not close its eyes to the needs of society. For this, within the framework of its Corporate Social Responsibility, it participates, within the framework of its abilities, to philanthropic events, organises blood donations of its personnel, supports institutions of social benefit and in general it participates actively in our society. Remarkable also is the activity of the CSE in events that concern the entertainment of its personnel. As such they are the common social events of its personnel, while now it undertook also the organisation of the pan European athletic tournament for 2011. The remarkable work that is being done at the CSE is due to the proper organisation, the hard work and the healthy work environment in the organisation. These guarantees strengthen the efforts of the personnel, which is called to handle difficult problems and to carry out a very important mission. The correct operation of the CSE, its international credibility and its further growth have direct repercussion to the development and the course of the Cypriot economy, a dimension that has been comprehended completely by all that work today at the CSE. The executives and the personnel of the CSE will continue with the same zeal their work and their mission. A mission that creates large benefits for the economy and for Cyprus generally. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Structural problems of the Cyprus Economy Stepping out of the crisis; Things to do The end of the crisis has started being visible in the horizon. constructive way and be willing to accept waiving certain absurd benefits they have been so far enjoying, at the expense of the rest of the economy. Nevertheless not all economies will step out of the crisis at the same time and not all economies can do it following the same ‘recipe’. Additionally the remuneration system of the civil servants needs to be modernized and become related to the productivity of each civil servant, individually, or where this is practically not possible, become related to a group’s productivity. (Such as the case is with the police force members or those of the fire brigade). When, and how, an economy will step out of the crisis will depend on its structural possibilities and on the discipline its citizens will show during these difficult times of adjustment. Moreover the economic system needs to truly become competitive because there is no other viable way of achieving sustainable control over prices and quality. By Dr Ioannis Violaris Associate Professor of Economics Frederick University Our economy is unfortunately facing many structural problems for many years and unfortunately its only now, because the EU authorities have imposed it on us, that we are, even reluctantly, willing to face them. Even so it is perhaps a unique opportunity to do the things that, mainly for political reasons, have not been done in the past. We are a tiny country and yet most agricultural products, for being transported a few kilometers, ad up on their prices more than double of their original cost. Additionally the farmers themselves need to realize that to achieve economies of scale they too need to accept merging, if not their businesses, at least some of their activities, such as the promotion of their products. Merging and cooperation should also become the norm for many other small to medium sized enterprises (SME’s) that are the vast majority of local businesses, as otherwise most of them will keep facing serious problems. The things to do, almost, touch all sectors of the economy: Primarily we need to contain the public sector’s both elastic and inelastic expenses and at the same time enhance this sector’s productivity. To do that the public sector’s trade unions, and of course the civil servants themselves, need to cooperate in a ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Finally, both the government and the banking system need to stand by the side of the SME’s in supporting their operations and it is at least odd that they have not done so for the last two years. In fact though the government has generously supported the banking system, little to nothing has ended up to the SME’s. Probably most of it ended up to businesses that the banks consider more reliable! 51 Bank positive stress tests The Bank Positive StressTests Results And The Economy The very encouraging news for the two largest banks in Cyprus that succeeded in the relevant test definitely created an air of optimism. It is evident that the Cypriot banks will continue to maintain a high capitalization and play a significant rôle in the institutional changes in the area. ñ The strengthening of the large-scale construction sector Besides, the statements made by Mr. Athanassios Orphanides, Governor of the Central Bank of Cyprus, are indicative of the climate created. Apart from the above, we should make reference to the fact By George A. Mavreas B.BA. (R.E.), Registered Surveyor It is a certainty that the fact that the two largest banks in Cyprus succeeded the specific test, and that they did so quite effortlessly, shall mark the end of the scaremongering that has been developing lately, resulting in grave consequences for the economy of Cyprus. in all towns and particularly in Nicosia and Limassol, where there are universities -therefore there is a need for such properties. ñ The promotion of productive units, such as technological parks, power production units, etc. from which multiple benefits result. ñ The provision of building loans, so that the market may progress. that the favourable results of the tests not only had a positive impact but also sent a strong message across Europe regarding Cyprus, a fact that shall contribute to more investors approaching Cyprus. It is evident that the banks have the ability to proceed with an expansion of lending therefore we consider that they should amend their lending policy as soon as possible. The loans and deposits indices during the last few months Given these facts, we consider that the two banks, along with the banking sector in general, do not have the right to put up barriers to bank lending. are quite encouraging. Deposits rose by 10%, whereas an It is the duty of the leadership of the banks, both towards the business world and the people of Cyprus, to promote a courageous policy aiming at the expansion of their lending policy, particularly focusing on those sectors affected by the crisis - real estate and tourism. Accordingly, it is our conviction that there is still space for More specifically, regarding the real estate industry, we believe that the banks are obliged to aid and direct their concern towards: 52 increase of 13% was shown in building loans in comparison to last year which was a really bad year. further improvement. This is also a sector in which the banks should play an extremely significant role for the continuation of this gradual and stable growth. This may particularly apply to the real estate sector in order for the industry to be assisted, so that it recovers and, consequently, the economy of Cyprus will recover. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The Cyprus Economy The problem with the Cyprus Economy In my opinion the biggest problem the Cyprus economy faces, ever since the establishment of the Republic, are the politicians themselves. This may sound extreme to some readers, but this is my honest conviction. The problem with our politicians is not lack of intelligence. The real By Frixos Kyprianou problem behind our troubles Manager is that these people instead MK KYPRIANOU LTD of looking at the economy as a service to the nation they look at it as a service to their own ambitions. A good example of this it’s the way the public sector is managed. In the early 1990s for example, the public sector payroll was around m500million. This year the payroll is expected to be in excess of m2.2billion. What more does the public sector offer to the people today, as compared with the 1990s, which can justify such an increase? The increase in the payroll is in excess of 400%. I am sure that if the economy was run in a businesslike manner the payroll cost would have probably increased by 30% or 50% or even 100% but never 400%. If the economy was run in a businesslike manner the effort would have been to simplify public sector procedures and use of automation to minimise the government costs. Unfortunately, our politicians over the years were in the business of inventing new procedures, in order to justify new positions and do favours in exchange for votes. I am sure all of us have had dealings with public sector servants at some time in our life. Some of them were actually very good and willing to help. Some couldn’t care less and some were unable to help not because they did not want to help but because of lack of ability. My question to our politicians making telephone calls pushing that Mr X is employed by the government, would they employ Mr X ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 if the government was their own business? Or even more importantly if Mr X, after he is hired, proves to be incompetent for one reason or another would they keep him if the government was their own business? I think not. There are numerous examples that anyone can draw on relating to the mismanagement of the economy. The real point however is what can actually be done to put a stop to this problem. A general idea that exists is that there should be a system in place to move away from the customer type relationships that exists between politicians and voters. The problem here is how it can actually be implemented such an idea on a small island with a closed society like ours. In my opinion the best way to minimise bad decision making and mismanagement would be to impose a penalty for the politicians that act irresponsibly. Tough parameters could be imposed and if exceeded to bare some kind of penalty. For example the payroll of the state should not be allowed to exceed a certain percentage of the GDP. Another example is the national debt, where the parameters already exist, but they could be accompanied with a penalty. A more specific idea that comes to mind is in relation to the office of the President. If for example at the end of the presidential term the set parameters are exceeded then he or she should not be allowed to run for president again. The same could be applied to all the ministers where if the set targets for their ministries are exceeded they should not be allowed to run for public office again. Living in Cyprus and seeing how our political system operates suggestions such as the one above will always remain exactly that, suggestions. Even though it might be a good idea to try to limit the scope of action of the political leaders when it comes to the economy, most likely any suggestions that will force them to act more responsibly will never be voted in. If such suggestions are ever to be considered I will be extremely shocked. I just hope we do not end up copying our neighbours in Greece. 55 Investing in Technology Digital economy; a key to exit from the crisis Investing in technology is a basic development condition By Andreas Kashiouris President of the Cyprus Information Technology Enterprises Association (CITEA). Reinforcing and utilizing competitiveness and even to further losses regarding the digital economy constitutes efficiency indicator. In addition, only a mere 0.48% of the key in tackling the effects Cyprus’ GDP is absorbed in research and technology, of global financial crisis. whereas the average of the European Union reaches 1.9%. This is due to the fact that It is unacceptable that Cyprus, a country with the highest investing in digital economy rates worldwide in recent university graduates, to be may job placed last among the 27 EU member states on research opportunities by increasing and technology. Furthermore, ICT professions in Cyprus productivity and economic do not demonstrate the importance of their role yet mainly performance in all domains. due to the lack of a timely strategic plan on behalf of the According to a European State for the implementation and promotion of the Commission report, even Information Society. though create the new field of Information and Communi- The State has to formulate and preserve a favorable cations Technology (ICT) environment within which the Information Society may be accounts only for 4.8% of the European Gross Domestic developed and expanded; this should be an ongoing Product, it leads the way in private investments in research process. Digital Recovery is the key not only to the exit and development sectors, with 25% of total investments from the crisis, but also for creating the national and 32% of researches in private sector for the year 2007. infrastructures which could support a long-term According to the objectives of the Digital Agenda, one of sustainable development policy for the benefit of the the seven key strategic initiatives of Europe 2020 for economy. The advantages in respect to the employees’ sophisticated and sustainable development, ICT stand as productivity stemming from the money dedicated to the leading corporate investment in research and information technology outweigh those of other development. As Digital Agenda Commissioner, Mrs. investments. Reinforcing ICT could turn them into a Neelie Kroes, stated: “To help achieve our goal of development tool for our country and a key to exit from investing 3% of GDP in research and development, Europe stagnation and financial crisis. needs to double its public spending on ICT R&D by 2020 and also create the best conditions for the private sector to It is important to realize that investing in technology is a do the same.” necessity. It is a precondition of development; therefore, it is probably the only expense that should not be tucked into Cyprus ranks among the last EU member states in the area constraints, budgetary or other, mainly due to the fact that of ICT. This results to the enlargement of the gap with the technology increases productivity and consequently our rest of Europe in the specific field, to reduced losses in future potential to achieve better results. 56 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Development projects in Limassol Limassol’s Golden Year? It seems that Limassol has all going for it and the town is fast changing from an ordinary Cyprus town to one which will have major attractions over the next 2-3 years. The town has been fortunate enough to have a most successful Mayor who, he seems, he knows the “ins and outs” of the Government By Antonis Loizou F.R.I.C.S. and is “an artist” in attracting - Antonis Loizou & E.U. funds. The Associates Ltd - Real Estate Municipality together with Valuers & Estate Agents the local Chamber of Commerce are acting as one and are demanding more and more for this town and Limassol is one or more steps ahead from the other towns. ñ ñ ñ ñ ñ ñ ñ The Limassol marina is under way and out of the total 4 marinas to be build it has gained ground, ahead of the Larnaca Marina and port project of at least 2 years. The published promenade plan, which includes “over the sea” footpaths and added parking is also prepared to commence works within the year (now out to tender). The Limassol Zoo will be upgraded through contribution of the offshore Cos and works are under way. The beach works have been completed as well as the numerous beach cafes, which are a major source of income for the Municipality. The Garillis “river” bed will become over next year a linear park extending for over 5 kms and tenders are out. The old city has secured millions of Euros to have its infrastructure improved. The town is the first to undertake multi storey buildings of 15-30 storey height and one of the first projects (Olympic Tower) is under way, whereas Pafilia with its 35 storey project across the beach is expected to commence next year. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 ñ Plans are under way to construct a new seaside road from the old harbor to the new one and the area west, where most of the factories are, will be rezoned for office uses of a high rise nature, expecting to become a kind of Manhattan for Cyprus. Already there are modern offices built. ñ The old port is out to tender for its conversion into a Greek island style fishing harbor with entertainment and restaurant/bar facilities. ñ Etc etc So the town is changing and these and other projects will have a wider affect in its property market and value. The town has now the highest property values in terms of offices (approximately m7.000/sq.m.) and apartments (approximately m10.000/ sq.m.) both relating to beach properties and it has retained over the years its no.1 position favorite of the offshore Cos. Foreign language schools are full up and at the moment there is a sort of shortage of accommodation in order to satisfy demand. A new college is programmed to be developed north of Limassol (along the Platres road) and it is noticeable that foreign permanent home seekers find Limassol as the most attractive city. Limassol east is the favorite location (Ayios Tychonas, Pareklisha etc villages) in terms of housing, whereas north of the town areas such as Paramytha etc are growing in interest. Values for not on the beach villas have a range of around m3.500/sq.m., depending on quality and garden size (as well as the sea views offered). This cosmopolitan development will show “its teeth” and affects on the town shortly and that will help the local property market, making, as the Mayor says, the new cosmopolitan Beirut of the Middle East. What we must also consider is the increase in traffic and the problem of congested roads as well as the lack of within the town parking, because if this is not resolved, the old town will come to a halt. We often compare the old city of Limassol with that of Nicosia and although we understand that nothing can beat the sea views and the beach, copying to an extent Limassol’s Municipality by that of Nicosia, will help the latter tremendously. 57 The Excel Wizard The Excel Wizard By Stratos Panayides, BA(Econ), ACA Training Consultant at AKTINA 58 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The Excel Wizard ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 61 Solar Energy in the Mediterranean The role of Cyprus in the Mediterranean solar plan It is generally accepted that climate change is the result of the rapid growth of new economies around the world, since conventional fuels are used in order to meet their energy demand. Thus, the future environmental, economic and social challenges for the Medi-terranean countries are very important and directly related to sustainability. The economic By Dr. Andreas Poullikkas and social development in Assistant Manager, combination with the enviElectricity Authority of ronmental protection of the Cyprus Mediterranean region, constitute the basic ingredients for the viability of the area. the positive effects of renewable energy sources (RES) technologies towards achieving this goal, the EU has taken a range of specific actions in the direction of enhancing the integration of RES in the existing European power generation system as a major step towards the reduction of global warming and climate change phenomena. Specifically, an action plan in the form of an EU Directive (2009/28/EC) on the promotion of the use of energy from RES has been introduced by the EU whereby a target of RES share of 20% out of the gross final energy consumption of the EU has been set to be reached by the year 2020. The RES Directive sets out specific national targets to be achieved by each individual member state, regarding the share of RES generated in each member state by the year 2020. For Cyprus, the national target states that the share of energy produced from RES must be at least 13% out of the gross national final consumption of energy in 2020. THE MEDITERRANEAN SOLAR PLAN THE MEDITERRANEAN REGION The Mediterranean region is already highly polluted region with serious problems, such as, desertation, potable water shortage, and excessive pollution, from industrial activities as well as form marine activities. Based on recent studies, during the end of this century, the average temperature of the earth is expected to rise between 2,2 and 5,1 degrees Celsius. It is, therefore, expected that the rise of sea water level will flood large land areas, imposing, thus, movement of population in higher altitudes. Demographic increase and the continuous increased economic activities of South Mediterranean countries are expected to change considerably the current energy demand profile of the Mediterranean region. In particular, it has been estimated that by 2020 South Mediterranean countries energy needs will be doubled and that by 2050 their power needs will reach that of the European level. On the other hand the European Union (EU) has already tuned its energy policy into achieving maximum reduction of carbon dioxide emissions from power generation plants. In this context, it has already set out a strategic objective of achieving at least a 20% reduction of greenhouse gases by 2020 compared to 1990. This strategic objective represents the core of the new European energy policy. Recognizing 62 On the 13th of July 2008, forty three leaders from EU and Mediterranean countries, in a common statement, adopted a new framework of collaboration for the Mediterranean region. The Union for the Mediterranean. This has been, already, integrated within the EU policy, in which, among the 6 thematic priorities that were indicated for collaboration in the framework of Union for the Mediterranean, solar energy has a leading role. Mediterranean region offers an ideal natural resource for the production of energy from RES and mainly from the sun. For example in desert conditions within a period of six hours the energy absorbed from the sun is by far greater than the world annual energy consumption. Furthermore, EU high technological achievements and know-how in solar energy production can provide the appropriate transmission system upgrades and connections in order to satisfy the energy needs for both the Mediterranean countries as well as the EU member states. The main objective of the Mediterranean solar plan is the installation of solar power generation plants with a capacity of 20GW between the years of 2011 - 2020. In order to achieve this, a detailed roadmap has, already, been agreed providing all relevant activities as well as time ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Solar Energy in the Mediterranean schedules, such as, (a) the choice of installation areas, (b) the potential of local industry for the development of the Mediterranean energy market, (c) initiatives for the production and efficiency of energy (solar energy or other RES technologies), (d) the progress that has taken place in the legislative and regulating reforms, (e) the available financing mechanisms, (f) the development of appropriate infrastructure for the transmission of the produced power in EU member states, etc. FUTURE CHALLENGES The Mediterranean solar plan constitutes an ambitious attempt for the exploitation of the Mediterranean region natural resource in order to offer green energy and security of supply to the Mediterranean countries, as well as, to the EU member states. The plan will contribute catalytically in the economic and social growth of countries involved and will create advance know-how and new places of work. However, the success of this undertaking will depend mainly upon two factors, the financing as well as the political will for collaboration on national and on country to country level. Concerning financing it is estimated that the Mediterranean solar plan will cost approximately 80 billion Euros. EU financing mechanisms are not big enough to finance such ambitious project. Currently, discussions with various private initiatives, outside the framework of the Union for the Mediterranean, exist, that could undertake the cost for the realization of this investment. Also, it is generally accepted that the private character of the initiative will be more flexible in order to overcome the political issues that may emerge. Regarding political will, already in national level, some participating countries, such as, Spain, Italy, Morocco and Algeria have made enough steps, faster than the other countries, and have shaped national plans for the exploitation of solar energy. THE CASE OF CYPRUS Our country possesses the most important prerequisite for success towards the sustainable economic development which is the existence of capable, multi-discipline and ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 university educated human resources. Nevertheless, the common characteristic of the scientific activities relating to detail analysis and long-term planning is the absence of the State as well as the absence of political parties. Cyprus society is highly dependent on the political parties, and as such, the only “experts” allowed for speaking and for analyzing any subject, even scientific issues, are considered to be the representatives of the political parties. Cypriot technocrats with the relevant expertise and serious scientific background on the issue under discussion are only allowed to speak and provide their knowledge and expert views when they are politicized or become as candidate members of the Parliament. The above situation cannot continue any longer. The existing energy situation and the existing economic development model need to be revised in order for Cyprus to shift to a more sustainable development model by using green technologies and implementing energy efficiency policies. With the creation by the State, for example, of a National Energy Policy Council it will be possible to implement a long-term energy strategy for the island. Also, with the creation of a Centre of Renewable Energy Sources it will be possible to study and to implement the most appropriate RES technologies for Cyprus. By this way the passage of Cyprus to the sustainable development will be achieved with the least economic cost. Finally, the benefit and the know-how that Cyprus will gain from collaborating in projects aiming to the design and application of high technologies that are to be implement in Mediterranean region, show the way for a more active participation of Cyprus in the Mediterranean solar plan. Suitable planning and organization will help our country, to fully test and integrate RES technologies and in particular solar energy technologies into the island energy system. These can be later used in a larger scale in other EU member states. 63 Basel III Initial assessment of Basel III While the term Basel 2 is widely used as the unofficial term of the EU banking regulations with title Capital Requirement Directive (CRD), currently all efforts made for creating a more secure banking system and overcoming the effects of the current financial crisis centre around new measures now called CRD 2, CRD 3 and CRD 4 which will form part of the new Basel 3 framework. CRD 2 will be incorporated into national law until 31.10.2010 under Guideline 2009/111/EC of the European parliament and will be applicable after 01.01.2011. Additional to the advice/ recommendations of the Committee of European Banking Supervisors (CEBS) on EU regulations (passed through European and individual EU country national parliament), the Financial Stability Board (FSB) advises on a worldwide scale the G20 countries which in turn will decide on helpful regulatory banking reforms during the coming November meeting in Seoul, South Korea. These measures come as a response to the financial crisis where current regulation failed to capture and banks misinterpreted the real risk in the trading activities. However raising the replacement risk to stress levels or the capital requirement on open trading positions will in turn reduce dramatically the returns of the trading book affecting directly bank results. CRD 2 measures focus on improving the quality and transparency of bank equity and in particular: The European Commission prepared a bill (dated 13.07.2009) that has passed it to the European Parliament for implementation. By Anastasios Fikardos Group Internal Audit, Hellenic Bank ñ Management of Large Exposures ñ Eligibility criteria for Hybrid Capital to be treated as part of Tier 1 Capital (permanence, flexibility of payments, loss absorption) ñ Requirement to retain at least 5% of the risk in originator’s books in securitizations (“skin in the game”) With such measures under way each Bank is gauging the consequences on the level of their equity, on how their ratios (rises on Tier 1 ratio, total equity ratio) are affected and how equity buffer needs will need to be prudently assessed to avoid restrictions in dividends and bonus payments. Overall this is expected to increase loan margins in an attempt by the Banks to maintain the same profitability ratios as before the proposed changes. 64 CRD 3 measures focus on the trading book and how additional capital must be held by banks during stressful periods. In particular it focuses on: ñ Raising the equity requirement for complex structured products ñ Disclosure requirements of securitization risks ñ Regulators performing checks in remuneration policies CRD 4 measures focus on the general stability of the financial system and consists of the following seven hot topics: ñ Liquidity standards recommendations) (already under CEBS ñ Definition of capital ñ Leverage ratio (complementary to risk-based capital requirements to restrict the build-up of excessive debt in the banking system) ñ Counterparty credit risk (derivatives, repos, securities financing) ñ Counter-cyclical measures (buffers, forward looking provisions) ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Basel III ñ Treatment of financial institutions deemed “too big to fail” (systemically important) ñ Removal of options and national discretions Much of the controversial discussions in the adequate level of liquidity in stressful periods and the management of contingency funding strategies additional to the normal liquidity process (transforming deposits into loans) lies around the types of assets banks can use for their liquidity buffer scenario. CEBS for example is understandably not willing to accept any more uncovered financial assets (bonds) to be part of the banks liquidity reserve as in the event of systemic crisis all banks will be looking to dispose the same assets at the same time, driving prices down exacerbating thereby the crisis. For CRD 4 a bill has not been passed yet to the European Parliament by the European Commission (expected second half of 2010) however Public Consultations (closed 16.04.2010) and a Public Hearing (closed 26.04.2010) have already been concluded. Conclusively three major issues will puzzle banks and regulators alike in the near future from the above measures: ñ CRD 2: The statutes of the various forms of equity have to change in order to sustain the supply of going concern capital through capital conservation, that is, encouraging banks to retain earnings (through reduced dividend payouts and payouts to staff) to build their reserves ñ CRD 3: Measures to raise the safety of the banking system puts pressure on bank results from trading activities which in turn raises questions on the wide applicability of Basel 3 rules to all banks (large international as opposed to regional banks). The US in contrast to the Basel Committee has not applied even Basel 2 to all banks. ñ CRD 4: Will the liquidity transfer between banks work again in the future without Central Bank intervention? At what cost will banks refinance their funding needs in the future? Will the more expensive cost of financing companies (especially SMEs) bring about a decrease in economic growth? Economic restructuring in the EU Economic restructuring is urgently needed in the European Union By KPMG Limited The European citizens have been boasting about their social model, their generous vacations, low retirement ages, the national health systems and their welfare benefits. However, low growth rate, low fertility rates and high life expectation will not help the population within the EU to maintain the quality of life which is accustomed to it, at least not without the taking measures and significant economic restructuring. Thus the countries of the EU reduce salaries, increase retirement age, increase working hours and reduce welfare benefits and pensions in ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 order to reassure investors, ,. Restructuring is now necessary since the EU is facing an ageing population and the fertility rates are falling. Unemployment is rising since traditional industries move to Asian countries and the area’s competitiveness is downgraded in relation to the world markets. Economist Robert Mundell, Nobel prize winner, has stated that debt restructuring may be “inevitable” for one or two 67 Economic restructuring in the EU euro nations within five years. What is more, Professor Steve Hanke of Johns Hopkins University has stated that the economic crisis of Greece will end up in default if debt obligations are not restructured. Mr. Mundell, who won the economics prize in 1999, said that the EU needs greater fiscal centralization, including the creation of Euro - Zone Treasury notes and bonds “There is no area bill like a US Treasury bill. A Euro - Zone bill will greatly improve the ascent of the Euro as the reserve currency along the US dollar.” As Peter Sutherland, former EU commissioner, said, Europe would have if it hadn’t been for the Euro. After the financial crisis of 2008 there would have been competitive currency devaluations of the national currencies which would lead to economic chaos. As Mr. Sutherland argues, the initial administration system of the European currency was schizophrenic. On the one hand, it represents the achievements of consolidation of 40 years based on the obvious inadequacies of national procedures to face the European and world crises. On the other hand, efforts were exerted to maintain absolute sovereignty in fiscal and macroeconomic matters. The current recession is the result of the existing management of the Euro which reflects to a large extent, the national economic sovereignty. It is for this reason that Mr. Sutherland suggests that there must be a common management in regards to fiscal issues. In this respect it may be noted that Mr. Herman Van Rompuy, president of the European Council, has been asked to submit suggestions for the reform of the Eurozone management by next October. According to forecasts of the European Commission, the Eurozone economy is expected to expand by 1% in 2010 after a decrease of 4.1% in 2009. The Cyprus economy which contracted by 1.7% in 2009 is expected to expand by 0.5% in 2010 and by a further 1.5% in 2011. The Greek economy, which faces serious economic problems, is expected to contract by 3% in 2010 and by a further 0.5% in 2011. Professor Hanke has stated that the Greek economy might be substantially improved if the contributions of the employers to the wage bill were abolished and instead introduce a uniform value added tax. In this way the competitiveness of the Greek economy would be enhanced to the same extent as a devaluation of 40 - 45%, prof. Hannke states. Of course the EU continues to be the most important economic power internationally. Europeans are afraid about their work and their savings, when the Governments 68 and their companies cannot borrow easily at relatively logical interest rates and the euro faces problems, then it must be understood that the problem is not only economic but also political. Therefore, if the European leaders realize the problem and take brave decisions, the current financial recession is the best opportunity for the EU to develop and be able to support the generous social model. On the basis of studies by experts in his Department Mr. Olli Rehn, Commissioner for monetary and economic matters, stated that if restructuring does not take place, the EU will be destined to remain stagnant with an annual growth rate of 1.5% and unemployment rate around 7 - 8% even after the end of the economic recession. Some EU countries, led by France, argue that the chaos which has spread from Greece to Western Europe indicates that the Eurozone needs more government intervention so that Europe will have more political and less technocratic management. These countries also wish to set up a “European Economic Governance” of the member countries of the Eurozone. On the contrary, Germany, being afraid of such experience, does not trust the politicians in regards to monetary policy. Therefore Germany asks for strict regulations which will not allow to member countries to increase their public expenditure irresponsibly. The European leaders now exert efforts to reduce expenditure but the taking of measures to face structural problems is also needed. According to economic analysts Eurozone today has two options: Either to disintegrate or to pursue a greater fiscal integration. If the first option is considered inconceivable, then it must concentrate on the second that is the greater fiscal integration. At a recent meeting of the ministers of finance, it was decided to promote the improvement of the coordination of the national budgets and the more strict supervision of the countries with high fiscal deficits and public debts. Many economists consider this decision as the first step for the setting up of a fiscal governance. In the meantime, after months of negotiations between the representatives of the Ministers of Finance of the EU, and of the Euro - parliamentarians agreement has been reached for the introduction of legislation which will regulate the system of supervision of banks, insurance companies and securities markets. It is envisaged to set up a European Council for the avoidance of systemic dangers which will generally warn for the financial system and three European supervision authorities for the banking, insurance and the securities markets. However the day - to - day supervision of the companies will remain with national Supervisory Authorities, although the reform package also aims to increase coordination between national regulatory bodies in an effort to ensure they follow the same rules. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ MARCH 2010 Taxation Cyprus displays the highest reliance on indirect taxes in the EU - results of the edition “Taxation trends in the European Union” INTRODUCTION The edition “Taxation trends in the European Union” with the results from the years 2000 to 2008 of tax revenue for the 27 Member States (EU-27) was issued in June 2010 by the European Commission. The edition is the result of cooperation between two By Therapon Mafkas Directorates-General of the Director in Baker Tilly Klitou European Commission: the Member of the VAT Directorate-General for Committee of the ICPAC Taxation and Customs Union (DG TAXUD) and Eurostat, the Statistical Office of the European Communities. The publication provides a breakdown of taxes according to different classifications by type of taxes (direct taxes, indirect taxes, social contributions) by level of government, and by economic function (consumption, labour, capital). SOME COMMENTS FOR THE MAIN RESULTS OF THE REPORT In the report the breakdown of tax revenue data computed in percentage of GDP provides indicators of the tax burden and of the structure of taxation in the different Member States, as well as developments over time. As the interpretation of the tax-to-GDP ratio as an indicator of the tax burden requires additional information, cyclically adjusted tax revenues are provided, an economic classification of taxes has been developed and implicit tax rates have been computed for the different economic functions. Implicit tax rates measure the effective average tax burden on different types of economic income or activities. The European Union is, taken as a whole, a high tax area. In 2008, the overall tax ratio, (that is the sum of taxes and social security contributions in the 27 Member States (EU- ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 27) amounted to 39.3% in the GDP-weighted average. It must be noted that the overall tax ratio in EU-27 is more than 1/3 above the levels recorded in the United States and Japan. The effects of the global economic and financial crisis have hit the EU with increasing force from the second half of 2008, which is the last year for which the European Commission possess tax revenues data with the high level of disaggregation needed for the purposes of the report. This means that the data used by the European Commission refer only to the beginning of the recession, and not to its entire development. Developments in 2008 were also marked by the circumstance that many countries still recorded satisfactory growth in the first six months of 2008, so that the year as a whole is made up of two rather uneven halves. The report takes stock of the wide range of tax policy measures enacted by EU governments in response to the crisis, up to spring 2010. THE RESULTS FOR CYPRUS For Cyprus the tax-to-GDP ratio has increased substantially since 2000 (about 9 percentage points) albeit starting from a very low level. The increase was steady but most notable in 2007, when the pick-up amounted to almost five percent of GDP. Although tax revenues were falling in 2008, they were still benefiting from favourable economic conditions; hence they were higher than cyclically adjusted revenues. Compared to 2000, revenue went up in all major tax categories, but the increase was strongest in indirect taxes - in particular in VAT - which doubled and was still increasing in 2008. Cyprus displays the highest reliance on indirect taxes in the EU-27. It derives 47.4% of tax revenues from indirect taxes, -nine percentage points above EU-27 average- (EU27 average 37.6%) of which VAT accounts for more than half. This is due to the high share of consumption in the economy, as VAT rates used by Cyprus are among the lowest in the EU. Also, the imposition of VAT on the sales of new buildings as from 1st May 2004 has increased significantly the revenues from VAT. 69 Taxation For Cyprus the share of taxes on capital in GDP (12.2%) is the second highest in the EU, almost twice the EU-27 average. This is due to both the capital income taxation of corporations, which includes the Defence Contributions, and the capital income taxation of households, which is three times higher than the EU-27 average. The main reason of the high taxes on capital is likely to be the construction boom of the last years. Since 2000, the implicit tax rate on capital increased by 12.7 %, reaching 36.4% in 2008 - about 10 percentage points above EU-25 and euro area average. In 2008 the decrease of the implicit tax rate was driven by the drop in the implicit tax rate of capital and business income of households and selfemployed. THE REACTION OF TAX AUTHORITIES TO THE GLOBAL ECONOMIC AND FINANCIAL CRISIS The revenue data covered in the “Taxation trends in the European Union” report cover the years up to 2008, before the global economic and financial crisis spread to Europe. From the second half of 2008 onwards, however, governments have introduced a wide array of measures to support the economy or to consolidate public finances. Although the majority of the measures adopted has had an estimated budgetary impact of well below a half point of GDP, the overall impact of the adjustment had been quite high several measures, typically those involving adjustments in the tax rate, amount to nearly one percent point of GDP or, in a few cases, even more. Reforms of the VAT, the personal income tax or the reforms of social security, as well as some excise rate increases, have often involved large amounts. The headline impact of a reform on the budget balance cannot, however, be taken as a measure of its importance; the microeconomic impact of a targeted measure on a specific sector can be quite high even in the absence of a large budgetary effect, as the impact in not spread over a large population. In other words, one should not confuse the budgetary implication of a measure with its economic impact CORPORATE INCOME TAX RATE Several countries chose to cut the corporate income tax rate, even though during a deep recession, this will not give an immediate benefit for the many loss-making companies. This choice seems therefore primarily linked with the wish to give a political signal on the long-term attractiveness of the country to investors. There was also considerable activity on the corporate income tax base and on special tax regimes; many Member States attempted to support business investment through measures such as more generous depreciation allowances or investment tax credits; in a few cases, the cuts were targeted towards small and medium entities (SME’s). Several Member States have 70 opted for granting these incentives for a limited period of time only, in order to give an immediate boost to capital spending. PERSONAL INCOME TAX RATE As for the personal income tax rate, one of the most common types of measure was the direct support of household spending power by reductions in the personal income tax rate. This happened more often through increases in allowances than cuts in rates, mainly because an increase in allowances, having a proportionally higher impact on lower-income households, is expected to more directly boost private consumptions. In few cases personal income taxes were increased, but this was typically to higher incomes. Some countries suffering from particularly pronounced drops in GDP decided to defer previously decided personal income taxes rate cuts. SOCIAL SECURITY CONTRIBUTIONS Surprisingly, although governments were striving to maintain or increase the employability of workers, the report records relatively few measures in the field of social security contributions, and many of them involve hikes. The net effect of this on the cost of labour is, however, unclear as several countries have raised basic allowances or taken other measures reducing the tax burden on the low paid. At least in some cases, the apparent inaction has been linked to the desire to postpone any tightening of provisions made necessary by the deteriorating labour market situation. VAT In the case of VAT, the situation is not clear-cut as there has been a predominance of rate increases but also a high number of measures narrowing the base. Base narrowing was in many cases linked to equity considerations, as more countries reduced the tax burden on food or necessities. Generally, however, the measures increasing the standard VAT rates have had a much larger (positive) budgetary impact than the base narrowing measures. Overall, therefore, given also the widespread increases in excise duties, one of the effects of the crisis on tax systems seems likely to be a reinforcement of the trend of the last few years towards higher, consumption rates. THE REACTION OF THE CYPRUS GOVERNMENT TO THE ECONOMIC AND FINANCIAL CRISIS In Cyprus in order to combat the global economic crisis and in order to improve the competitive situation of the Cypriot tourism sector, the government reduced temporarily VAT for the tourism sector, in particular hotel accommodation and restaurant services by three ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Taxation percentage points. Airport landing fees levied on airline companies were decreased and overnight stay fees levied by local authorities were cancelled. supply of pharmaceuticals and most foodstuffs or whether to impose VAT on the supply of these products as from 1st January 2011. The government reduced the corporate tax rate for semigovernmental organizations from 25% to 10% bringing it in line with the corporate tax rate applied to nongovernmental corporations. THE IMPORTANCE OF INDIRECT TAXES Furthermore, in April 2009 social security contributions were increased by 0.5% for both employers as well as employees. In October 2009, the parliament passed amendments to the Income Tax Law and Special Contribution for Defence Law providing new advantages for Collective Investment Schemes, in an effort to attract re-domiciliation of funds from other territories to Cyprus. In the 2010 budget the government announced measures to improve the fiscal situation, among which the combat against the tax evasion. VAT collection periods for the largest firms were reduced from three months to one (_200 Mio in cash terms in 2010). Having in mind the results for Cyprus, it can be concluded that the government is heavily rely on indirect taxes rather than on direct taxes. Reviewing the system of taxes all over the world it can be seen that VAT and Goods and Services Taxes (GST) are very important for many countries and the shift from direct taxation to indirect taxation is a fact in many other counties, not only for Cyprus. In the European Union that the VAT system is wellestablished the effort to harmonize and simplify the system between Member States is continuous. The amendment in the EU VAT Directive as from 1st January 2010 on the cross border supply of services was one of the major steps of the Commission’s strategy to modernize and simplify the VAT system in the European Union. In other countries that the VAT and GST systems have recently introduced the opportunities for fraud, non-compliance or avoidance have reduced significantly, due to fact that the systems are taking into consideration other already established systems of VAT like the European one. Additionally in July 2010, the Cypriot parliament rejected a proposal of the government for the increase of corporate tax rate from 10% to 11% for 2 years and for the immovable property tax to be charged on property values reflecting 2010 prices instead of 1980 values. The government had banked on the taxes to help lower a projected 7.0 % deficit of 2010 to 3.0% by the end of 2012. The increase of the corporate tax rate by 1% would have affect local firms and hundreds of international companies which take advantage of Cyprus’ low tax status. Multinational and other companies all over the world are taking advantage of the low tax regime and have relocated in Cyprus because of the stability of the tax regime. In its regular assessment of the Cypriot economy, the International Monetary Fund (IMF) comment that a tax rise would send out a message of uncertainty and suggested that the government should focus on public sector wages and employment for reducing the deficit to the limit of 3% under EU rules. The Organization for Economic Co-Operation and Development (OECD) in a publication issued with subject international guidelines on VAT/GST, recognized that the spread of VAT and GST across the globe have been the most important development in taxation over the last halfcentury. On the same publication, OECD recognized that as VAT is spreading across the world and due to the fact that international trade in goods and services are expanding rapidly as part of globalization developments, spurred on by deregulation, privatization, and the communications technology revolution, the potential for double taxation or non-taxation has increased substantially. The role of OECD for international cooperation is vital and this publication with subject international VAT/GST guidelines was issued by OECD in an effort to avoid the possibility for double taxation or nontaxation of goods and services. The press release of the 2842nd Council meeting of the European Union held in Brussels on 20th December 2007 announced that the Council adopted a Directive renewing temporary derogations that allow Cyprus to apply a zero VAT rate to the supply of pharmaceuticals and most foodstuffs. The renewal was given for a period until 31 December 2010. This mean that the government would have to make a decision whether to ask for a further extension on the derogation to apply zero VAT rate to the Based on the results of the report is widely accepted that Cyprus displays the higher reliance on indirect taxes within the European Union. This should force both the government and the professionals to question whether the tax system of VAT and customs and excise is sufficient. The sufficiency of the VAT and customs and excise system should be reviewed both in terms of fairness to the business and households and from the perspective that government is benefit at the maximum. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 CONCLUSION 73 Business promotion skills The 8 biggest mistakes in promoting your audit firm ....and how to avoid them! By Demetris Stylianides, DipLC, CTM, CL, FAIA, FCCA, CPA, Certified Trainer of NLP ARE YOU ANY GOOD IN PROMOTING YOUR BUSINESS? BIG MISTAKE NO 1: FAILING TO “QUOTE” WHEN SAYING SOMETHING GOOD ABOUT YOURSELF The information in this article is probably far more interesting than what you’re expecting. This article teaches you, business promotion skills that you can immediately implement in every aspect of your communications. Where would you want to use this? Anywhere that you want to say something good about your company to sound impressive, good things about your services, testimonials from your happy customers, etc. Suppose that I am a very hardworking accountant and I deliver accounting work complete within 7 days from the day I receive the transaction vouchers from clients. If I am in a conversation with you and I want you to know that fact, I could simply state “You know, I deliver accounting work within one week from the day I receive your transaction vouchers!” But is that believable? A statement like that doesn’t sound like it really carries a lot of credibility, does it? As auditors we know that third party evidence is better than internally generated evidence! “Many of my clients tell me they are happy about the fact I deliver accounting work complete within a week of receiving their transaction vouchers!” Suddenly, the sentence is a lot more believable. Instead of me saying that, clients are saying it. This is automatically more believable. The content of this article follows the core structure of a two day workshop to be held in December 2010 which covers 12 CPD units for professional accountants. I will only summarize the workshop’s content as it is impossible to fit the enormous amount of information in a small article. WARNING: As professional accountants, we all have an understanding and acceptance of the Ethical Rules of Professional Conduct regarding Advertising and BIG MISTAKE NO 2- USING THE”BUT” WORD Did you know the word, “BUT” can actually be a dangerous word? If you use it during your communication, you’re probably weakening your ability to persuade others about what you want to promote. First, let’s look at what happens when other people use “BUT” as they are talking to you. Suppose I tell you: “I agree with you, but your fee is too high.” I used the word “BUT” in the sentence, and what happened to the meaning? When I said, “I agree with you, but...” what was I really saying? Think about it. What I am really saying is, “I don’t agree with you!” Promoting our businesses. The following guidelines are to be used with caution and always within the letter of the relevant ethical guideline. 74 A very easy way to eliminate “BUT”, is to replace it with the word, “AND”. Consider these sentences. Before intervention: “I agree with you, but I still think that I am right.” After intervention: “I agree with you, and I still think I am right”. Can you hear the difference? So replace “BUT” with “AND” in all the sentences in which you want to be persuasive. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Business promotion skills To get their highest values start by asking the question: “What’s important to you about a good accounting service?” The question here is: ‘What’s important to your about _______” and then fill in the name of your service. Once you ask the question, listen very carefully for their answer. Whatever answer you get, make a note of it. Next, you repeat back to them their own answer, explaining how your service satisfies that particular value. BIG MISTAKE NO 5 - USING THE WORD “TRY” IN YOUR CONVERSATION BIG MISTAKE NO 3 - NOT USING YOUR RAPPORT-BUILDING SKILLS Have you ever met somebody to discover that your business relationships just seemed to “click?” For some reason, you seemed a lot alike. You shared similar opinions and values. And you “fell into rapport” with them quickly. What makes that happen? And why can’t we make it happen all the time? To create this chemistry with other people, all we need to do is look, think and act like them! And to do this, we’re going to mimic two things: the way they act and the way they talk. We are going to start by positioning our body in the general way the other person positions theirs. If they fold their arms during conversation, you fold yours. If they gesture with their hands when they speak, you gesture with yours when you speak. Okay, this may sound strange, but believe me, once you do this, you’ll find it feels perfectly natural! And, more importantly, it will cause you and your prospect to fall right into rapport! When you use the word “TRY,” you presuppose failure, and your listener assumes failure also. When other people tell you they are going to “TRY” to do something for you, you will, from now on, automatically know that they don’t intend to actually succeed at doing it. Suppose someone is saying: “I will try to have that report done by Monday” What he really means is: “I will begin the report and I will fail to get it done by Monday.” Do you see how this works? When people use “TRY,” they are actually assuming the failure of the whatever they are talking about. To eliminate this, when you ask questions to other people, To make your rapport even deeper, you can also pace their voice patterns by altering your speaking speed, your volume, tempo and pitch. In other words, if the other person starts talking very quietly, you should talk quietly, too. If they slow down, you should slow down. If they get loud, you get loud right with them and you’ll experience a remarkable deepening of your rapport with the other person. BIG MISTAKE NO 4 - FAILING TO ELICIT THEIR VALUES REGARDING YOUR SERVICE The mistake people make is spilling out their long list of “what they have to offer” before finding out what’s important to the listener. Instead, doesn’t it make sense to find out what’s important to them about your service first? In other words, what if you could immediately discover the “hot button” of your prospect before you start describing your service? ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 never ask if they will “TRY” to do something for you. Instead, ask if they will! BIG MISTAKE NO 6- SAYING BAD THINGS ABOUT THE COMPETITION Here’s a major mistake that almost everyone makes at one time or another. The sad part is that few people realize the 75 Business promotion skills damage they do when they say bad things about their competition. What you say about your competitors says more things about yourself than about your competition. To avoid this mistake speak with respect and understanding about your competition. You’ll gain credibility for doing so. BIG MISTAKE NO 7- USING THE WORD “IF” The word, “IF” can be deadly! Why is “IF” deadly? Suppose that I am an accountant talking with a possible client and I tell him “Mr Jones, if you agree on our firm becoming your auditors for the next year then you will be very happy about our service and about the advice you will receive from our company.” This statement may sound familiar to you and you may even use it often. What’s wrong with this statement is the use of the word “if” which presupposes that the person we are talking to is not yet convinced about joining our clientele. Instead, you could replace “IF” with the word “WHEN” which now presupposes that the person will joint our clientele sooner or later and it’s just a matter of time! Hear how the same statement sounds now: “Mr Jones, when you agree on our firm becoming your auditors for the next year then you will be very happy about our service and about the advice you will receive from our company.” BIG MISTAKE NO 8- DISAGREEING WITH THEIR OBJECTIONS When people offer an objection to your product, service or idea, the biggest mistake you can make is to start arguing with them about it. We can disarm their objection by first being able to agree with them, then we’re going to handle their objection. The way of turning around any objection someone may have about your service is by appealing to their higher values in order to find agreement. This is called “reframing”. For the sake of contrast, listen to what happens when you argue with the objector: Customer: “Your fee is too high.” You: “No it isn’t. It’s low compared to the local market rates.” Customer: “Wrong! I know of three other firms with lower prices...” At this point, you’re in trouble. You’ve: ñ Fell completely out of rapport with the customer ñ Made them angry ñ Ruined your credibility ñ Probably lost the customer. 76 Now, we’re going to start by agreeing with the customer. We’re going to actually repeat their words back to them and then search for “higher ground” on which we can really agree. Let’s use the same example: Customer “Your fee is too high.” You: “Our fee is too high. And every time I say that, I think, ‘Compared to what?’ Because I know that no one else in this town offers our level of service at this fee, even though some small sized firms certainly offer lower prices.” Isn’t this smoother? At this point, you can then move forward with your conversation. The skills taught to you here, come from Neuro-Linguistic Programming (NLP) and are absolutely at the cutting edge of marketing technology today. Use them always in a “win-win” environment. As with any skill you’d like to perfect, time and practice are the key ingredients. Go over this article a few times. Read it. Practice it. Make it part of who you are. I guarantee that for every minute you spend reading and practicing this material your professional career will be enhanced many times the effort you’ve put into learning this. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Financial Instrument Reporting What investment professionals say about financial instrument reporting In June 2010 PricewaterhouseCoopers published the results of a survey on what investment professionals say about financial instrument reporting. This article presents a summary of this publication. ñ Respondents that favour the mixed measurement model think the information better reflects an entity’s underlying business and economic reasons for holding an instrument. They also stress the importance of keeping net income free from fair value movements in instruments that are held for long-term cash flow rather than for short-term trading gains. ñ Fair value information for financial instruments is The survey process was structured to obtain investor and analyst responses across By George Kazamias Partner geographic regions, key Assurance Services industries (e.g. banking, PricewaterhouseCoopers insurance, generalists), analyst specialisms (e.g. equity analysts and credit analysts), and by nature of organization (e.g. buy side, sell side and credit rating agency). In total, 62 individuals were interviewed. The interviews were conducted in the first quarter of 2010 and were intended to engage participants in meaningful conversations that focused on learning how they used financial statement information and what changes they would make to improve that information. The goal was not to establish definitive conclusions or positions on financial instrument accounting but to capture and present views held by a variety of investment professionals. A number of opinions from survey respondents on all sides of the debate were heard, but the following consistent trends in survey responses were noted: ñ A majority of respondents favour a mixed measurement model, with fair value reporting for shorter lived instruments and amortised cost reporting for longer lived instruments (particularly bank loans and deposits) when the company intends to hold those instruments for their contractual cash flows. This view is held consistently across all the geographies and industry sectors included in the survey sample. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 considered relevant and valuable by most respondents but is not necessarily the key consideration in their analysis of an entity. It is used in a variety of ways by respondents, but usually as they form their views on an entity’s liquidity or capital adequacy or in an enterprise value calculation. It is seldom used as an indicator of future cash flow generation. ñ Respondents voice a consistent desire for improved disclosure of fair value information. Specific improvements cited include detailed but not excessive information about portfolio composition and risk factors, valuation methods and assumptions, and sensitivity analyses for movements in key assumptions. ñ There is widespread support for an impairment model based on expected losses, as opposed to one based on incurred losses. This preference is accompanied by a desire to define how an expected loss model would be applied. Respondents voice concern that if loosely defined, an expected loss model could lead to excessively subjective reserving in order to facilitate earnings management. Which factors should determine how financial instruments should be reported? Respondents across all geographic regions and industry sectors consistently express a preference for both the entity’s business model (72%) and instrument 79 Financial Instrument Reporting characteristics (68%) to be the primary consideration when determining balance sheet classification and measurement of an instrument. This approach is consistent with the IASB’s model. Many of the investment professionals that were interviewed appear to disagree with the financial instrument measurement and presentation model proposed by the FASB under which financial instruments would be reported on the balance sheet at fair value, regardless of the business model for an instrument or an instrument’s characteristics. Respondents that favour the mixed measurement model think the information better reflects an entity’s underlying business and economic reasons for holding an instrument. They also stress the importance of keeping net income free from fair value movements in instruments that are held for long-term cash flow rather than for short-term trading gains. How important is it that the information be reported at fair value or amortised cost? Across all regions and industry sectors, the sample of the survey indicates that both fair value and amortised cost information provides important and useful information for most types of financial instruments. Based on the interview results, however, fair value is thought to be much more important than amortised cost for shorter term instruments _ or those likely to be sold or settled soon, including loans held for sale, trading instruments, and derivative assets and liabilities. Consistent with that view is the desire to see fair value measurement on the balance sheet and changes in value reported in net income for those instruments. By contrast, for instruments of a longer term nature (loans held for the long term, deposits, an entity’s own debt), respondents favour amortised cost for the balance sheet and the income statement, with fair value information provided in the footnotes. Respondents say that a mixed measurement model of reporting based on a company’s business model results in a balance sheet and income statement that best reflects the underlying economics and performance of a company. Fair value information for longer lived instruments is also considered to be important by respondents. However, they believe disclosure is the most appropriate way for it to be reported for these types of instruments. What approach should be used to recognise a credit impairment? Asset impairment is central to the financial instrument ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 discussion. A large majority of respondents are dissatisfied with the current incurred loss model and would prefer a credit loss model based on expected losses. Survey participants overwhelmingly believe that the incurred loss model delays loss recognition until well after a loss could be reasonably estimated. Most believe that an impairment model based on expected credit losses provides a more practical, realistic and timely recognition of credit risk and loss. But many of those same supporters of an expected loss approach caution that clear definitions and methods need to be developed and consistently applied. They express concern that if left unconstrained, some applications of expected loan loss reserving could become too subjective. Taken to its extreme, some fear that these potentially subjective estimates could result in excess provisioning in good years, leading to earnings management. Once an impairment charge has been recorded, if the impairment ‘reverses’ or ceases to exist, should any impairment charges be allowed to be reversed and reported? Under US GAAP, most impairment charges create a new cost basis and cannot be reversed regardless of improvements in market conditions. Under IFRS, impairments related to debt instruments can be reversed but those related to equities cannot. Respondents are nearly unanimous in their view that impairment reversals should be allowed when conditions warrant. Most believe that the reversal should be reported in the same manner in which the original charge was taken. 81 Improvement in Data Reporting XBRL explained: A crash course NEW STANDARDS FOR FASTER, BETTER DATA REPORTING AND EXCHANGE eXtensible Business Reporting Language, or XBRL, is revolutionizing the business world in much the same way barcodes revolutionized merchandising. Like the barcode, XBRL is a system for coding and decoding By Yiannis Leonidou information. However, XBRL Deloitte goes further than the barcode: XBRL represents a huge leap forward in how complex business information and financial data is electronically transferred and reported around the world. WHAT YOU AND YOUR COMPUTER CAN DO WITH XBRL XBRL lets you to sit at your computer and gather information electronically from the office next door or the other side of the world. You can quickly collect data to create reports, complete regulatory filings, or use in any other way. To begin, your computer must have XBRL-enabled software and the documents you access must be XBRLcoded, or “tagged,” so they are readable by a computer. A tag is a string of computer code that represents one concept such as “product revenues” or “total revenues.” Data types are tagged identically — all company names have the same tag, all net assets have another tag, and so forth. A collection of tags is called a taxonomy. A tag is like a word within a dictionary, while a taxonomy is like the language used to write the dictionary. Just as there are many languages and dialects, many taxonomies exist. Core taxonomies are developed for different reporting purposes. Different core taxonomies can exist for IFRS, U.S.GAAP, and banks regulatory reporting. New tags may be added to a core taxonomy to create a taxonomy extension to accommodate reporting requirements of local jurisdictions, industries, companies, or other XBRL users. A taxonomy extension is to a taxonomy as a dialect is to a spoken language. HOW XBRL WORKS 1. Taxonomy tags are added to information in a document to create an instance document. Because XBRL enables your computer to access documents directly, you don’t rekey the information and there’s less chance of human error. It’s fast and efficient. 2. Using the same taxonomy, your computer reads the instance document and identifies information associated with the tags. HOW INFORMATION MOVES FROM A DOCUMENT INTO YOUR REPORT: TAGS, TAXONOMIES, AND INSTANCE DOCUMENTS 3. Your software extracts and integrates the information into your new document. It’s easy to understand how XBRL works, but first you need to know some basics. THE INSTANCE DOCUMENT An XBRL-tagged document is called an instance 82 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Improvement in Data Reporting document. It is a computer-readable version of a statement, business report, or other document, and contains both tags and information. An instance document looks like one long page of computer code. However, if you look closely, you can identify XBRL tags and the numbers and information the tags surround. Although you can read an instance document, software tools are more effective than humans at creating and reading instance documents. Example: See a portion of an instance document below that reflects annual sales for a Company and Subsidiaries. The instance document includes the facts and figures that appear in the original statement, plus the XBRL tags that allow your computer to read those facts and figures. A WORD ABOUT RENDERING How are XBRL instance documents turned into humanreadable form? Rendering focuses on content and structure of displayed data: that numbers and information appear in proper sequence, order, or group, and that data can be interpreted clearly and reassembled as originally intended. By combining the rendering with presentational features such as font, colors, graphics or pagination, you can develop business reports or other “fancier” documents using data from XBRL instance documents. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 An XBRL International, Inc. working group is now developing rendering standards. The group is tasked with delivering a standard that defines an end-user representation of XBRL instance content that is repeatable, accurate, consistent, and understandable by human readers. THE XBRL PROCESS: FIND A DOCUMENT, READ IT, PULL CONTENT, RENDER IT Now that you know the terminology, the process will seem easy. You locate one or more instance documents, your computer reads the tags, and your office tool pulls the information you want into a spreadsheet or other format. The content is also rendered to be certain it is accurately portrayed. Numbers and data can be pulled from many documents in different locations and reassembled into your own document. Your computer also can read the same documents again and again to extract different information for different purposes. SAMPLE FINANCIAL STATEMENT AND HOW XBRL HELPS YOU INTEGRATE INFORMATION XBRL is used with many types of business information and reports. The example below illustrates how you might create an XBRL-generated financial statement using the following steps: 85 Improvement in Data Reporting 1. Add tags from an agreed-upon XBRL taxonomy to numbers or other information in a financial statement to create an instance document. In this example, the tags identify products, services, and total revenues. 2. Using the same XBRL taxonomy, your computer reads the instance document and identifies the numbers associated with tags for products, services and total revenues. 3. Your software extracts the numbers and integrates the information into your new financial statement, possibly using information from other sources as well. 86 THE BENEFITS OF XBRL, HOW XBRL HELPS YOU WORK MORE EFFICIENTLY The global use of XBRL can allow financial professionals to access documents and transfer or report information electronically. XBRL’s many advantages include: ñ Greater accuracy: XBRL makes the analysis and exchange of corporate financial information more reliable because your computer application accesses data directly. No data is rekeyed, so the possibility of human error is reduced. ñ Better data management: The XBRL framework gives you the power to systematically manage and check ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Improvement in Data Reporting data. Information can be monitored in real time, enhancing validation. ñ Timesaving: You can sit at your desk and collect information inhouse or from the other side of the world. In the past, this may have taken hours, days, or even months. You can increase productivity and file regulatory reports more easily. ñ Reusing data: XBRL-tagged reports allow organizations to share and reuse data in business reports more easily, both internally and with other organizations. Applications can take advantage of the self-describing nature of XBRL tags to process information automatically for further reporting and analysis. ñ Easier document reading: XBRL taxonomies can enable your computer to read any document. If you speak only Chinese or French, you can collect and reassemble data from documents written in Finnish or Welsh if they are XBRL-tagged. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 CONCLUSION This article provided an overview of the XBRL and how it can used to improve efficiency. A more detail analysis of the functionality of the XBRL with more detailed examples could be a good topic for discussion in a future article. This publication contains general information only and is not intended to be comprehensive nor to provide specific accounting, business, financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Before making any decision or taking any action that may affect you or your business, you should consult a qualified professional advisor. Whilst every effort has been made to ensure the accuracy of the information contained in this publication, this cannot be guaranteed, and the author of this article will not have any liability to any person. 87 Accounting for Insurance Contracts IASB proposes to fundamentally change accounting for insurance contracts The IASB has issued an exposure draft (ED) of a comprehensive standard that will fundamentally change the accounting by insurers and other entities that issue contracts with insurance risk. The proposals are the output of the IASB and FASB’s joint efforts to develop a By Anna G Loizou single converged insurance Director Assurance Financial Services standard. The FASB plans to issue a discussion paper that PricewaterhouseCoopers will incorporate the IASB’s proposals. The proposed standard would replace IFRS 4, which currently permits a variety of practices in accounting for insurance contracts. SCOPE OF THE PROPOSALS The proposed standard would apply to all entities that issue contracts that contain insurance risk. The ED retains the IFRS 4 definition of an insurance contract as “a contract under which one party accepts significant insurance risk from another party by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder”. This broad definition could result in contracts issued by non-insurers being subject to the standard, such as certain financial guarantee contracts and loans with waivers upon death of the borrower. However, unlike IFRS 4, fixed-fee service contracts where the level of service depends on an uncertain future event (such as maintenance contracts where specified equipment is repaired after a malfunction) will not be within the scope of the proposed standard. The standard does not address the accounting by policyholders (other than reinsurance) entering into insurance contracts. MEASUREMENT MODEL The proposals require all insurance contracts to use a 88 current measurement model of the present value of expected cash flows to fulfil the obligation, where estimates are re-measured at each reporting period. Except for certain short duration contracts, this measurement model is based on the building blocks of discounted probability-weighted cash flows, a risk adjustment and a residual margin to eliminate any initial profit. The cash flows are explicit, unbiased, probabilityweighted cash flows that the insurer expects to incur in fulfilling the contract, including expected premiums, policyholder benefits, expenses and participating dividends. Unlike the previous discussion paper proposal, the cash flows are measured from the issuer’s perspective (rather than a market participant) although any market variables must be consistent with observable market prices. Acquisition costs that are incremental to a contract (such as commissions) will be included in these net cash flows rather than deferred as an explicit asset, but all other acquisition costs will be expensed when incurred. The estimated cash flows are discounted at risk free interest rates adjusted for differences between the liquidity characteristic of the insurance contracts and the corresponding risk-free instruments. The discount rates will not be based on the assets backing the insurance contracts, unless those asset returns affect cash flows to the policyholders. The measurement model includes an explicit risk adjustment for the effects of uncertainty about the timing and amount of future cash flows. This adjustment is the maximum amount the issuer would pay to be relieved of the risk that the ultimate cash flows exceed those expected. The inclusion of an explicit risk adjustment has been one of the most controversial issues in the boards’ discussions. The ED limits the permitted techniques to calculate this adjustment. The residual margin eliminates any initial gain on the contract. It is not subsequently re-measured but is released in a systematic way over the coverage period. Any initial ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Accounting for Insurance Contracts loss on a contract is recognised immediately in profit or loss. WHO WILL BE AFFECTED AND HOW? As a result of the debates around the risk adjustment, the ED outlines an alternative measurement model favoured by the FASB that also eliminates any initial profit but has a single composite margin, rather than recognising an explicit risk adjustment and a residual margin. The proposals will affect all entities that issue contracts that meet the definition of insurance contracts, including financial guarantee contracts. The proposals are likely to result in increased volatility in the income statement and significant changes in the presentation of the income statement. The proposals will create additional demands on data and modelling systems. The proposals require that short-duration contracts of approximately 12 months or less that do not contain any embedded derivatives or options are initially measured as premiums less any incremental acquisition costs. This preclaim liability is reduced in a systematic way over the coverage period, with any claims that occur being measured using the building-block approach described above. Given the profound impact of the proposed changes, all entities that issue contracts that meet the definition of insurance contracts should begin to assess the implications of the new model on their existing contracts and current business practices. Comments are expected on the ED by 30 November 2010 and a final standard is currently expected in mid-2011. At each balance sheet date, the discounted estimated future cash flows and risk adjustment are updated based on current estimates. Any changes (both positive and negative) in either financial variables (such as the discount rate) or other estimates (such as expenses, claims experience, lapses and the risk adjustment) are recognised immediately in profit or loss. INCOME STATEMENT PRESENTATION The income statement will be driven by the measurement model. Issuers will not recognise premiums as revenue (except where the short-duration simplified approach is used) but will separately show an underwriting margin (comprising changes in the risk adjustment and residual margin) and changes in estimates and experience variances. Supplemental disclosures would provide premium and claim information. TRANSITION ARRANGEMENTS The ED includes transition provisions that require insurance contracts in force at the transition date to be measured at the present value of the expected cash flows and risk adjustment as described above without any residual margin. Any deferred acquisition costs will need to be written off. The only profit that will be recognised in future profit or loss for contracts in existence at transition will come from the release of the risk margin, experience variances and any subsequent changes in estimates. This will be a significant change for most life insurers. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 91 Mergers & Acquisitions Perspectives on mergers & acquisitions in the banking sector By Savvas Pentaris Senior Manager Ernst & Young Financial Services Under normal economic conditions, the time looks right to at least consider mergers and acquisitions in the global banking sector. After all, many important financial metrics are slowly improving. In a normal recovery period, banks would now put capital to work, hunting for strategic acquisitions, particularly among the firms that did not fare so well during the downturn. But this recovery is turning out to be far from normal, especially for the global banking industry. Key performance indicators such as capital_adequacy ratios, revenues and profits are improving at some banks, which could put them in a position to target acquisitions. But for many institutions, any potential deal_making on a large scale will remain on hold until the global banking community can begin to comprehend the paradigm shifts in rules and regulations. of voluntary and required divestment of assets and business lines throughout the world. ñ In Asia, many observers predict that the region’s largest banks, many of which were not nearly as damaged by the financial crisis as their Western counterparts, will embark on aggressive expansion plans. For example, in March, China’s ICBC, the world’s largest bank by market value, targeted ACL Bank of Thailand in a deal reportedly valued at USD $545 million. ñ All of Japan’s major banks are reportedly interested in boosting their international presence. In 2010, Mitsubishi UFJ’s Union Bank acquired two troubled banks from the US Federal Deposit Insurance Corporation (FDIC). ñ Elsewhere in Asia, Malaysia’s sixth_largest lender, Hong Leong Bank, targeted the country’s seventh largest lender, EON Capital, in a USD $1.46 billion transaction. Hong Leong Bank executives made it clear that the stricter capital and liquidity requirements they expect as a result of the financial crisis prompted them to expand the breadth and depth of their organization. ñ The financial crisis created a buying opportunity for In the US, the Dodd_Frank Wall Street Reform and Consumer Protection Act, passed last July, is introducing many changes to the world’s largest financial services market. Bankers are also waiting the full set of Basel III capital standards, while managing requirements for new “living wills,” or banks’ self_directed plans for their own liquidation. These changes and others are expected to restrict merger and acquisition activity among banks for the remainder of 2010. JPMorgan Chase, which is paying US$1.7 billion for the Asian and European commodities trading operations run by a joint venture between Royal Bank of Scotland and Sempra Energy. ñ In a move characteristic of the small, strategic deals being done today, Citigroup increased its stake in the company that controls Chile’s second_largest bank, Banco de Chile for nearly US$520 million. ñ In Europe, the first quarter of 2010 saw the lowest level ñ Banks that were shaken by the financial crisis - such as of overall M&A activity in 12 years. Spanish bank Santander is one institution, however, that represents a prime example of a firm making opportunistic deals. Santander recently acquired more than 300 branches of Royal Bank of Scotland and NatWest in England, Scotland and Wales for approximately USD $2.6 billion. Santander had previously acquired faltering UK lenders Alliance & Leicester and Bradford & Bingley. Citigroup, Royal Bank of Scotland, Lloyds, ING, etc. have been narrowing their focus through a combination ñ An area that bears watching in Europe is the private A BRIEF LOOK AT RECENT DEALS However, deals are happening around the world on a limited basis. The transactions that have been in the news in recent months are indicative of the forces that are driving M&A around the globe. 92 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Mergers & Acquisitions banking sector. Last year, Deutsche Bank became the biggest wealth manager in Europe when it acquired Sal Oppenheim for m1 billion. Also in 2009, Julius Baer bought ING’s Swiss private banking assets for CHF 520 million. ñ In the US, smaller commercial banks have moved strategically to acquire the assets of struggling and failed institutions. More than 100 US banks have failed already in 2010, pushing them into the arms of the US FDIC. In many cases, competitors have been able to acquire strong deposit franchises at deep discounts through the FDIC liquidation process. ñ Additional transactions have occurred in the UK. For example, in 2009, Barclays, which weathered the financial crisis relatively well, acquired the banking business of Standard Life to expand its UK savings and mortgage portfolio. business mix, company structure and operating model banks should consider the following issues when considering their strategic M&A targets: ñ With increased scrutiny around capital and liquidity levels, banks will have to very carefully assess their capital requirements and needs before considering any acquisition activity. ñ Boards and shareholders may need more convincing than ever that the intended deployment of capital fits with the strategic direction of the acquiring company, and is not simply an opportunistic play. ñ Acquiring banks needs to examine all the risks and potential pitfalls - including worst_case_scenario models - posed by a deal, including existing relationships with counterparties. Acquirers should pay special attention to any possible reputational risks. ñ The volatile banking market in the UK has also created opportunities for new ventures. Start_up banks such as Metro Bank, the first new bank to open on Britain’s high streets in more than 100 years, and Virgin Money are aggressively pursuing market share among consumers and small_ and mid_size businesses. POINTS FOR CONSIDERATION In the aftermath of the financial crisis, many stakeholders have criticised large banks, once assumed to be “too big to fail,” simply for their size and scope. Major global banks may face statutory restrictions or come under increasing pressure to restrain growth through acquisitions. If and when the M&A market heats up, will private equity (PE) firms step in to take advantage of buying opportunities? Complicating matters further for large banks, they are also waiting for more clarity on issues such as Basel III. Even with these question marks lingering over their heads, smart banks with adequate capital cushions are already planning for a return to M&A activity. Because when they are ready to move, they may well find the acquisition process more complex than ever. The financial crisis has prompted many bankers to question their approaches to such strategic imperatives as asset_liability matches, asset valuation and counterparty relationships. All these issues must be taken into account by any bank targeting an acquisition in this new landscape. Both internal and external stakeholders, including boards, shareholders, lawmakers and supervisors, will be monitoring any proposed deals warily. While specific actions will vary by institution - based on ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 ñ Banks should be prepared to scrutinize all assets and liabilities, both on and off the balance sheet. ñ Banks must be ready to pore over their book of loans one by one. ñ Acquirers need to weigh all potential deals in light of not only forthcoming changes in the global regulatory structure, but also modifications in tax regimes in many countries. Supervisors are looking to reduce or eliminate opportunities for “regulatory arbitrage” by global banks. ñ Acquirers should pay special attention to the integration of systems and cultures. Technology investments at a target company may have been neglected to preserve capital during challenging times. In addition, employee morale may have been affected by the downturn and this may have negative effects on compensation and the size of the workforce. FINAL THOUGHTS Despite the number of hurdles, it is clear that near_term growth opportunities exist for those firms that fared relatively well during the economic downturn. Many observers of the banking industry argue that the future will see the strong get stronger. But that may be a cynical point of view. Instead, the smart will become smarter, finding strategic targets that fit well with their business strategy. Note: This article was written in August 2010 and refers to the market conditions and events up to that date. 93 Standard of living On LIFO and Opera One of the fundamental REPUBLIC OF CYPRUS measures for the standard of By Marina Theodotou* living in a country, based on Cost of Living 48 well known indices such as Leisure & Culture 65 the Economist Standard of Economy 58 Living Environment 62 Index, Mercer’s Quality of Life Index etc, Freedom apart from the basics of Health 85 levels of per capita income, Infrastructure 36 access Risk & Safety 100 to healthcare, 100 education, peace and safety Climate 76 among others, the existence, Final Score 68 accessibility, breadth and depth of culture is also included. In Cyprus we enjoy multifaceted, multicultural events all According to the Happy Planet Index (HPI) (www.happyplanet.org) which measures Life expectancy, Life Satisfaction, the Ecological Footprint and the Happy Life Index itself, in 2009, Cyprus ranked 62 out of 143 countries, nested below Kyrgyzstan and above Guyana. The county at the top of the list is Costa Rica. The Happy Planet Index for Cyprus is 46.2. The Economist Intelligence Unit (EIU) devised an ingenious model for measuring and comparing the quality of life in different countries. Its worldwide quality-of-life index looked at the factors that people say in lifesatisfaction surveys affect their sense of wellbeing: money matters, of course, but so do a number of other things, year long: theater, classical music concerts, gallery openings, museums, sculptural exhibits, photography, mixed media, contemporary dance, even opera. Or do we enjoy these events? Having attended opera in at least three countries in Europe and the United States, Cyprus, is the only country where Opera and accounting share one strong and fundamental metric: LIFO. Last in, First Out. While LIFO works in accounting, it does not work in cultural events: Every individual attending an event is essentially opting to dedicate a couple of hours to elevate his or her spirit, to reach katharsis, a notion coined by ancient Greeks, to allow themselves to be transported to including, health, freedom, employment, and family and another world, to suspend thoughts of the mundane, community life (www.economist.com). In 2005, Cyprus everyday problems and challenges in the office, at school ranked 23 out of 184 countries. at home and let themselves reconnect with their senses. In 2010, International Living in its Quality of Life Index From a purely economics point of view, the ticket holder is (/www.internationalliving.com) Cyprus scored at total of entering into a two hour contract agreement designated by 68, with a rank 65 in Leisure and Culture. Not a very high the ticket, whereby he or she agrees to silently attend and score. The highest score in this category is 94 enjoyed by event, while the performers are upholding their end of the Sweden. Of course Cyprus ranks high in several other key agreement, which is to perform, or provide a good, a categories, but here, we will focus on leisure and culture service in which they are the trained expert specialists in, and mostly, culture. for example an opera performance, or a classical concert. 94 ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Standard of living The opportunity cost for each ticket holder is increasing at an increasing rate the last few years given the various cultural event options available across the island on a given evening. In any transaction, the one who pays usually retains a bit more the power in the buy-sell equation: the payer has the power in their pocket to select a product or service over another. In the performing arts hall, the ticket holder still has the power, but in Cyprus he squanders it carelessly to such a high degree that he or she actually has a negative effect to other ticket holders and squanders their right too. How? By applying LIFO! Last in, First Out. Cypriots arrive late at a performance and leave early. Why? This costs them more and actually subtracts from the value that others sitting next to them are trying to gain as they, too, entered into individual contract agreements with the The Economist Intelligence Unit (EIU) devised an ingenious model for measuring and comparing the quality of life in different countries. Its worldwide quality-of-life index looked at the factors that people say in life-satisfaction surveys affect their sense of wellbeing: money matters, of course, but so do a number of other things, including, health, freedom, employment, and family and community life (www.economist.com). In 2005, Cyprus ranked 23 out of 184 countries. performer and are trying to reap the maximum benefit from. they paid for to get when they purchased that performance Those that arrive late, make you get up from your seat to let them pass, take the call on their cell phone during the performance, talk incessantly to their friend or spouse sitting next to them, completely ignoring the fact that they subtract not only from their benefit, but also from that of the people sitting around them. Equally detrimental is the ticket. So, while LIFO may be good for accounting, it’s not good for culture. In a country that prides itself in excellent professional services including accounting and auditing, maybe it will be easier to explain and assist in this paradigm and cultural shift: need to leave early and beat traffic. No LIFO when we are in the Opera, for the maximum Appreciating the performers by clapping is again another benefit and value for ourselves and others. way for the ticket holder to exercise the final moments of their power in the agreement: More clapping may bring a Hopefully we can influence a rise in the International several minutes more of a performance, a bonus so to Living Quality of Life score in 2011 and beyond before speak. Just as in the restaurant we leave a tip, at the Cyprus assumes the Presidency of the EU in 2012! performance hall we clap. The better the performance, the * Marina Theodotou is an Economist (BA Honors, MA), longer and louder the clapping. Those that get up to leave Six Sigma Black Belt and IEMA Certified Climate while others are trying to clap, appreciate and hopefully Change Leader. She is the founder of Curveball Ltd, a get a bonus for their end of the agreement, are robbing both strategic consultancy services provider focusing on themselves and the surrounding audience members. social entrepreneurship. Previous roles include Unless there is an emergency, getting up to leave before the Director of Business Development and Operations at performance ends is plainly ridiculous. The perceived the Cyprus Investment Promotion Agency, Country delays caused by the imaginary traffic those in haste are Director of the Financial Services Volunteer Corps trying to avoid, are laughable given the size of the various Amman, Jordan and Vice President in Strategic cities, the population density and the distances compared Benchmarking/Quality & Productivity at Bank of to other comparable capitals in the vicinity and the EU. America. They are losing a significant part of the benefit for which www.curveballlimited.com 96 For more information visit ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Standard for insurance contracts Fundamental changes in accounting for insurance contracts IASB issues Exposure Draft on Insurance Contracts Developing a comprehensive standard to address the accounting for insurance contracts has been a long running project of the International Accounting Standards Board (IASB or the Board). The Board completed Phase I of the project with the issue By Liza Patsalidou of IFRS 4 in March 2004. FCCA, ACA Even though IFRS 4 Financial Controller addressed some urgent General Insurance of Cyprus Ltd issues in insurance accounting, it was intended to be only a temporary solution; it therefore allowed insurers to continue with a wide variety of existing accounting practices, with emphasis on disclosure requirements. Following a rigorous and comprehensive due process, Phase II of the insurance contracts project is finally approaching its completion with the issue of the relevant Exposure Draft (ED) on 30 July 2010. The development of a Phase II standard has been highly controversial, as it proposes to fundamentally change the current practices followed in accounting for insurance contracts. The IASB, with the release of this ED which, if adopted, will replace IFRS 4, proposes a comprehensive standard that addresses all aspects of insurance accounting, including recognition, measurement, presentation and disclosure. SCOPE AND DEFINITION The proposed standard would apply to all entities that issue ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 contracts containing insurance risk and reinsurance contracts held. The ED retains the definition of an insurance contract included in IFRS 4 and similarly it does not address the accounting by policyholders. RECOGNITION An insurance contract is recognised at the earlier of when the insurer is bound by the terms of the contract and when the insurer is first exposed to risk under the contract. The above means that insurers can be exposed to risk prior to the start of the coverage period. This could happen when the insurer can no longer withdraw from its obligation to provide insurance coverage for insured events and has no longer the right to reassess the risk and set a price fully reflecting that risk (i.e. re-underwrite). MEASUREMENT Except for certain short-duration contracts, the proposed measurement model uses building blocks to measure an insurance liability, as follows: The cash flows are explicit, unbiased, probabilityweighted estimates of the incremental future cash outflows less future cash inflows that are expected to arise as the insurer fulfils the contract; they include expected premiums, policyholder benefits and claims, expenses and participating dividends. Acquisition costs that are incremental to a contract would be included in the net contract cash flows rather than being deferred as an explicit asset. These are defined as the costs of selling, underwriting and initiating an insurance contract that would not have been incurred if the insurer had not issued that particular contract, but no other direct and indirect costs. All other (non-incremental) acquisition 99 Standard for insurance contracts costs would be expensed as incurred. The estimated cash flows would be discounted using a risk free discount rate adjusted for the illiquidity of the contractual cash flows. The discount rate should be based on the characteristics of the insurance liabilities and not of the assets backing the liabilities, unless the amount, timing or uncertainty of the cash flows depends on the performance of specific assets (e.g. participating contracts). The expected value is estimated by considering and weighting a range of scenarios reflecting all possible outcomes. The cash flows from each outcome are discounted and weighted by the relevant probability factor in order to determine the expected present value. There is not currently a widely accepted technique for determining illiquidity premiums. Insurers should be in a position to determine when it is appropriate to adjust for illiquidity; for example some contracts are deemed to be liquid due to policyholder surrender options and others such as annuities where the cash flows are predetermined and inflexible are deemed to be illiquid. The measurement model includes an explicit risk 100 adjustment to account for the uncertainty in the timing and amount of future cash flows. The risk adjustment represents the maximum amount the insurer would rationally be willing to pay to be relieved of the risk that the ultimate fulfilment cash flows exceed those expected. The ED limits the number of permissible techniques for determining this margin to three: confidence level, conditional tail expectation and cost of capital; it also provides some guidance on how to apply these techniques. The ED does not permit profits at inception. The residual margin releases the profit over the life of the contract and is calibrated so that no profit is recognised on inception. Any initial loss is recognised in profit or loss immediately. The estimated future cash flows and risk adjustment are updated at each reporting date based on current estimates, with changes going through profit or loss. The residual margin is not adjusted when there are changes in estimates; therefore the amount initially recognised is unwound but not re-measured. The building block approach would generate information about the changes in the insurance liability and its performance during the period as follows: ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Standard for insurance contracts SHORT-DURATION INSURANCE CONTRACTS The ED proposes a modified simplified version of the building block approach for most short-duration insurance contracts. This shortcut approach applies to insurance contracts with a coverage period of approximately one year or less that do not contain embedded options or other derivatives. For these contracts, the pre-claims liability is measured as the premium received at initial recognition plus the expected present value of future premiums less the incremental acquisition costs. This liability is subsequently released through profit or loss over the coverage period in a systematic way that reflects the exposure from providing insurance coverage (usually based on the passage of time). However, insurers are required at initial recognition and subsequently to assess whether contracts measured under the simplified approach are onerous. A contract would be onerous if the present value of fulfilment cash flows relating to future insured claims exceeds the carrying amount of the pre-claims liability. In such a case, an additional liability and a corresponding expense are recognised for the difference. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Therefore, even though the simplified model appears to relieve insurers from the burden of the building block approach, the above onerous test still implies the calculation of the present value of fulfilment cash flows to determine whether the contract is onerous. The post-claims liability for short duration contracts will be measured at the present value of the fulfilment cash flows using the building block model, as described above for all other insurance contracts. REINSURANCE The overall approach is the same as described for insurance contracts, i.e. building block approach. Also the cedant should treat ceding commissions it receives as a reduction of the premium ceded to reinsurer. PRESENTATION The presentation model is driven by the measurement model and represents a fundamental change from the way insurers present their results today. The main provisions of the proposed standard are as follows: 101 Standard for insurance contracts STATEMENT OF FINANCIAL POSITION ñ Reinsurance assets are not offset against insurance contract liabilities ñ Underwriting margin: disaggregated either in the income statement or in the notes into premium revenue determined as the release of the pre-claims obligation, claims incurred, expenses incurred and amortisation of incremental acquisition costs. ñ Unit-linked assets and liabilities are presented as separate line items and not commingled with the insurer’s other assets and other insurance contract liabilities. STATEMENT OF COMPREHENSIVE INCOME The model proposed by the ED focuses on margins and other key performance information. As a minimum the following items should be presented: ñ Underwriting margin: disaggregated either in the income statement or in the notes into changes in the risk adjustment and the release of the residual margin. ñ Gains and losses at initial recognition. ñ Changes in additional liabilities for onerous contracts. DISCLOSURES The ED generally builds on the current disclosure requirements of IFRS 4, which have been amended to also require disclosures driven by the new measurement model. TRANSITION At the beginning of the earliest period presented, insurers should, with a corresponding adjustment to retained earnings: ñ Measure each portfolio of insurance contracts at the present value of the fulfilment cash flows, ñ Non-incremental acquisition costs. ñ Derecognise any existing balances of deferred ñ Experience adjustments and changes in estimates: disaggregated either in the income statement or in the notes into differences between actual cash flows and previous estimates, changes in future cash flow estimates and discount rates and impairment losses on reinsurance assets. ñ Interest on insurance liabilities. The above implies that the statement of comprehensive income will no longer present: ñ Premiums; which instead are treated as deposit receipts. ñ Claims and expenses included in the measurement of the insurance contract; which instead are treated as repayments of deposits. Where the short-duration contract approach is used, the presentation is similar to the current practices followed. Insurers should present: ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 acquisition costs, and ñ Derecognise any intangible assets arising from insurance contracts assumed in previously recognised business combinations. INTERACTION WITH IFRS 9 The IASB is considering aligning the effective dates of the insurance contracts standard with IFRS 9 Financial Instruments, so that earlier adoption of IFRS 9 causes no accounting mismatch. The proposals in the ED allow the re-designation of assets to fair value through profit or loss upon adoption of the IFRS on insurance contracts to avoid any accounting mismatch. NEXT STEPS The deadline for comments is 30 November 2010. The ED does not propose an effective date for the new standard which is expected to be issued in mid 2011. 103 The International and Cyprus Economy Economic Bulletin THE BANK OF CYPRUS GROUP ECONOMIC RESEARCH DIVISION PUBLICATION INTERNATIONAL ECONOMY According to the recent World Economic Outlook Update (July 2010) released by the International Monetary Fund (IMF), the world economy expanded at an annualized rate of over 5% during the first quarter of 2010, mostly due to robust growth in Asia. More broadly, encouraging signs were observed in private demand, while consumer confidence continued to improve and employment growth resumed in advanced economies. For the whole of 2010 the IMF projects that the world economy is to grow by 4,6% and for 2011 by 4,3%. These projections have been based on the modest, but steady, recovery in most advanced economies, and strong growth in many emerging and developing economies. Despite the relatively positive projections for the course of the international economy (which in fact have been slightly revised upwards relative to the April 2010 World Economic Outlook), the IMF points out that downside risks have risen sharply amid renewed financial turbulence. More specifically, investor confidence received another blow as fiscal sustainability issues in advanced economies came to the fore within the year, especially for Greece but also for other fiscally vulnerable euro area economies. In this context, the IMF emphasizes the need for policy efforts in andvanced economies to focus on credible fiscal consolidation, notably measures that will enhance medium-run growth prospects. Fiscal actions should be complemented by financial sector reform and structural reforms to enhance growth and competitiveness. According to IMF projections, economic growth in the United States of America for 2010 is to reach 3,3% and for 2011, 2,9%. The Euroarea is to also resume positive growth, but at a significantly slower pace, with growth at 1% for 2010 and 1,3% for 2011. At the same time the Chinese and Indian economies continue to exhibit impressive economic growth rates at (2010: 10,5%, 2011: 9,6%) for the former and (2010: 9,4%, 2011: 8,4%) for the latter. CYPRUS ECONOMY GDP growth for the Cyprus economy in 2009 is estimated at -1,7%. The Cyprus economy recorded a negative economic performance for the first time after 30 successive years of growth. Economic contraction in 2009 was the result of the negative performance of the two main economic sectors, namely the Construction sector and the 104 Tourist sector. At the same time, other sectors such as the Manufacturing sector, the Wholesale and Retail Trade sectors and the Transport and Communications sector also contracted in 2009. For the first quarter of 2010 the economy contracted by -1,6% compared to the corresponding quarter of 2009. The slowdown in the eocnomy’s retreat, is mainly attributed to the positive performance which the Financial intermediation sector continues to exhibit, as well as to the improved performance exhibited by the rest of the sectors of the economy and particularly the Tourist sector, the Wholesale and Retail Trade sectors and the Manufacturing sector. The Harmonized Index of Consumer Prices for the period January - June 2010 exhibited an increase by 2,3% compared to the corresponding six-month period of 2009. For the period January - June 2010 the Consumer Price Index also exhibited an increase by 2,3% compared to the corresponding period of 2009. During 2009, unemployment rose to 5,3% of the total labour force, compared to 3,7% for the whole of 2008. The total number of unemployed persons at the end of June 2010 was at 22.460 persons. Following seasonal adjustments the number of unemployed persons in June 2010 rose by 1,7% compared to the previous month. Compared to June 2009, the number of unemployed persons increased by 5.720 or 34,2%, an increase which is attributed mainly to the Construction sector, the Public administration sector, the Trade sector, the Hotels and Restaurants sector, the Manufacturing sector, the Education sector, the Real Estate, Renting and Business Activities sectors, as well as to persons entering the labour force for the first time. Cyprus’ fiscal balance turned by the end of 2009 into a deficit of 6,4% of GDP, compared to a surplus of +0,9% of GDP for 2008. For the six months from January - June 2010, the fiscal deficit was at -1,9% of GDP, compared to a deficit of -2,5% of GDP fir the first six months of 2009. For the first six months of 2010, public income rose by 6,6%, compared to a decrease of -7,6% over the corresponding 2009 period, a fact which is attributed to short-term, non-recurring factors. On the other hand, public expenditure has risen at a slower pace of 4,1% (somewhat lower than the budgeted 4,9% rise for 2010). Assuming that trends exhibited over the first six months of 2010 will be sustained, the fiscal balance for the whole of 2010 is projected to remain in deficit at -6,0% of GDP (it should be noted that the corresponding projection by the European Commission in a relevant report is at -7,1% of ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 The International and Cyprus Economy For 2010 a mere recovery of the Cyprus economy is projected with the growth rate estimated at +0,5%. This projection has been based on the sound foundations of the country’s banking system (no exposure to toxic assets), as well as on the resilience that the Cyprus economy has exhibited throughout the years during periods of economic downturns. GDP for the whole of 2010). The public debt was at 56,2% of GDP at the end of 2009, from 48,4% of GDP at the end of 2008. Based on the abovementioned fiscal balance, the public debt as a percentage of GDP is projected to rise further and reach 61,5% by the end of 2010. Despite the projected slightly positive growth rate of the Cypriot economy, year 2010 is expected to prove another difficult year for tourism and construction, the two sectors being the key drivers of Cypriot economic growth in recent years. More specifically, in the tourism sector, the crisis has exposed key weaknesses in the industry, with high prices and an overdependence on British arrivals being the main problems. In the construction industry, a great deal of uncertainty still prevails, even though observing a rebound in the medium term is possible. The prevailing uncertainty stems from the vulnerability of the global recovery at present, where projections point to an anemic growth in EU countries, while investor confidence is still fragile, especially following concerns over fiscal positions and competitiveness in Greece and other vulnerable euro area economies. All the above have cast a cloud over the global economy’s outlook. Over January - June 2010 tourist arrivals were at 877.958 compared to 883.002 over the corresponding six month period of 2009, marking a decrease of -0,6%. Over the same period, tourist proceeds are estimated at m578,3 million compared to m565,8 million over the corresponding 2009 period, marking an increase of 2,2%. It should also be noted that tourist expenditure per capita over the first six months of 2010 rose to m658,7 compared to m640,8 over the first six months of 2009, exhibiting a rise by 2,8%. OUTLOOK The Cyprus economy was clearly affected by the world economic crisis during 2009. However, due to its small size, Cyprus suffered milder consequences compared to most of the other member states of the European Union. Note: above commentary takes into consideration economic developments and data available up to 30 June 2010. MAIN ECONOMIC INDICATORS G.D.P. (real rate of growth - %) Unemployment (%) Inflation (Consumer Price Index - %) Harmonised Index of Consumer Prices - % Fiscal Balance (% of GDP) Public debt (% of GDP) Repo rate* (31 Dec.-%) Euro exchange Rates (annual average) m/US$ m/GBP£ 2006 2007 2008 2009 20101 4,1 4,5 2,5 2,2 -1,2 64,6 4,25 5,1 3,9 2,4 2,2 +3,4 58,3 4,00 3,6 3,7 4,7 4,4 +0,9 48,4 3,00 -1,7 5,3 0,3 0,2 -6,4 56,2 1,75 +0,5 6,5 3,0 2,7 -6,0 61,5 1,75** 1,2556 0,6817 1,3705 0,6843 1,4708 0,7963 1,3896 0,8865 n.a. n.a. * As of 1st September 2006, the main refinancing operations rate (repo) replaced the marginal lending facility rate (Lombard) for the purpose of pricing local currency bank loans. It is also noted that as of 1st January 2008, Cyprus joined the eurozone and therefore, interest rates shall be set by the European Central Bank. **ECB marginal lending facility n.a: not available Source of statistical data for Cyprus’ economy: Ministry of Finance, Central Bank of Cyprus & Statistical Service Group Economic Research Division Bank of Cyprus, 51 Stasinos Str., Ayia Paraskevi P.O. Box 21472, CY - 1599 Nicosia, tel. 22.12.23.00 Edited by Elena Triantafyllou The content of the current publication is solely for information purposes and in no way does it intend to influence or encourage specific actions. Furthermore, its contents are by no means binding for the Bank of Cyprus Group. 1 Projection ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 105 Financial Regulation Banks will keep lucrative business This summer - on July 21 U.S. President Barack Obama signed into law the highly anticipated U.S. financial regulatory reform bill. Proposed more than a year ago, on June 17, 2009, this financial bill was introduced - in Obama’s words - as a “sweeping overhaul of the United States By Dr Olga Kandinskaia financial regulatory system, Part-time Finance Lecturer, a transformation on a scale Cyprus International Institute not seen since the reforms of Management (CIIM) and that followed the Great Intercollege Larnaca Depression”. With such a challenging aim it was bound to cause heated discussions among law-makers. You could have bet that its way through the U.S. Congress wouldn’t be an easy one - and it wasn’t. The House of Representatives cleared the bill named as Wall Street Reform and Consumer Protection Act of 2009 - very quickly (only 9 days passed from its introduction to its approval by the House on December 11 last year). But the Senate, which introduced its own version of the bill called Restoring American Financial Stability Act of 2010, turned out to be more sensitive to the financial lobbying and the bill stayed in the upper house of the Congress for several months. It would have probably still been there if not for the decisive actions of President Obama. On April 22 he gathered some 700 top representatives of the financial and business circles in the Great Hall of Cooper Union, a historic place next to Wall Street where in 1860 Abraham Lincoln made a stirring appeal for saving the Union. Obama’s speech at Cooper Union was no less memorable. “I believe in the power of the free market,” said Obama. “But a free market was never meant to be a free license to take whatever you can get, however you can get it.” Giving a meaningful look to the audience President Obama continued: “I am here today because I want to urge you to join us, instead of fighting us in this effort.” President - with all the intensity and force he 106 could express - called on the audience to support the proposed financial reforms and to stop “the furious efforts of industry lobbyists to shape them to their special interests.” Mr Obama is truly a remarkable speaker, but - with billions of dollars at stake for the financial industry - President’s words alone wouldn’t have been enough to change the dead-end situation. However his speech came right after some shocking and unprecedented developments in the U.S. banking sector, which had drastically weakened the position of the financial lobby. A few days before the Obama’s speech - on April 16 - the biggest U.S. bank Goldman Sachs was charged with fraud by the U.S. Securities and Exchange Commission. The civil lawsuit, filed by SEC, was based on a deal made in 2007, in which Goldman Sachs failed to disclose to its investors a conflict of interest on mortgage investments it sold. The story that was uncovered looked really ugly for Goldman, which had already been under public criticism over its high compensation and its preferential treatment. It is worth to recall what the case was about. At its core was a synthetic collateralized debt obligation, or CDO, called “ABACUS 2007-AC1”. Stephen Gandel from TIME Magazine gave a great explanation of the whole deal. In his article “The case against Goldman Sachs” he wrote: “On the surface, these deals look complicated. They are. But the alleged fraud at the heart of the case against Goldman and its CDO dealings is one of the simplest and oldest forms of deception: lying. According to the SEC, Goldman told one group of investors they were buying a AAA-rated highyield investment put together by an independent firm called ACA Management. But the SEC says the person really picking the collateral was Paulson, an investor whose only interest was: Paulson. What Goldman allegedly sold, like any good snake-oil salesman, was a worthless, well-packaged fake.” We know by now that three months later this unprecedented lawsuit will be settled rather amicably: Goldman will pay a fine of $550 million, which is not bad ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 Financial Regulation at all for Goldman since it amounts to just one percent of the bank’s net revenues last year. However - back then in April - the situation looked a lot more threatening. Four days after the SEC’s lawsuit the Financial Services Authority (FSA) of the UK announced about the opening of an official investigation of its own into the activities of Goldman Sachs. The share price of Goldman plunged from $184.92 on April 14 to $145.20 on April 30 reflecting a highly damaging effect of bad publicity. More unprecedented events followed. On April 27 seven witnesses - two former employees and five current top managers of Goldman including its CEO Lloyd Blankfein - were called to testify in the Senate for the hearing “Wall Street and the Financial Crisis: The Role of Investment Banks”. Ten hours of intense interrogation - that’s how it looked when shown live on Bloomberg TV - during which the Senators asked a lot of angry questions and hardly received any meaningful answers. Some information that had been disclosed turned out to be so shockingly revealing that it spoke enough for itself. Like, for example, an e-mail sent to a friend by Fabrice Tourre, the Goldman executive who was directly responsible for the Abacus deal: “More and more leverage in the system.The whole building is about to collapse anytime now... Only potential survivor, the fabulous Fab... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!” The members of the Senate committee had every right to be outraged. The situation was growing rather tense: bankers started to feel that their position was losing strength, but they still kept to the principle “All or Nothing” - not willing to make any compromises. We are NOT letting go of even a fraction of our business - that was their position in those days. An excellent insight into that kind of mentality provided famous interviewer Charlie Rose who has a popular daily talk show on Bloomberg TV. Discussing on April 30 with Goldman CEO Lloyd Blankfein the possible consequences for him of the new financial regulation Charlie Rose asked: “In the worst case scenario - meaning you will lose the whole business of credit default swaps to what extent will it affect Goldman? How much will you lose?” And when Blankfein replied: “Around five percent” Charlie couldn’t help but saying: “Oh, just that...” - which provoked a highly agitated remark on Blankfein’s part ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010 showing that he is prepared to - so to speak - fight to the death. It won’t be difficult to understand why five percent means so much to Blankfein if we look at the scale of operations in the OTC market. Over-the-counter derivatives became the most controversial and difficult issue of the U.S. financial reform for a good reason: they represent a market of $615 trillion. This is the “notional outstanding amount”, or the official OTC market size for 2009 published by the Bank for International Settlements. To illustrate what this number means we’ll just mention this: it is 10 times more than the world GDP and 14 times more than the world stock market. What kind of financial instruments are we exactly talking about here? The bulk of it is made up of swap transactions of all kinds: interest rate swaps, credit default swaps, currency swaps, commodity swaps and equity swaps. In total, swaps take up almost 67 percent of the OTC derivatives market - which will be a whooping $412 trillion. Another 21 percent of the total - $129 trillion - represent other types of OTC derivatives: forward contracts and options. In fact, they are pretty similar to swaps, only slightly different, so for the purposes of the financial law all OTC derivatives are actually referred to as “swaps”. Remarkably 12 percent of the total appears in the BIS derivatives statistics as “unallocated”, which once again illustrates how deliberately complicated these instruments are - even for the specialists. OTC derivatives market is dominated by largest banks. It is one of their most lucrative businesses. U.S. commercial banks held derivatives with a notional value of $216.5 trillion in the first quarter of 2010, according to the Report on Bank Trading and Derivatives Activities issued by the Office of the Comptroller of the Currency. While there are currently 1,050 U.S. banks involved in derivatives activities, this business continues to be monopolized by a very small group of large financial institutions. Five leading banks - JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley - hold 97 percent of that total. The original proposal in the US financial reform bill (made by Senator Lincoln, an Arkansas Democrat who is chairman of the Senate Agriculture Committee) would have banned all swaps trading by commercial banks, but of course it never had a chance to pass. In fact, even President 107 Financial Regulation Obama in his initial speech - back in June 2009 - only mentioned the notorious credit default swaps, which he said “have threatened the entire financial system”. CDS have been blamed for playing a substantial role in triggering the credit crisis of September 2008. In March this year they were again at the centre of political discussions when during his official visit to the U.S. Greece’s Prime Minister George Papandreou demanded to forbid CDS trading on the grounds that the massive speculation in this market undermines the credit status of his country. Credit default swaps account for a “modest” 5 percent share of the OTC derivatives trading, but let’s not forget that behind this five percent stands a financial market of $32 trillion. So - now that the legislative discussions have come to their end and the historical financial regulatory reform bill has been signed by the U.S. President - what finally happened with the OTC derivatives business? What kind of a compromise has been reached between lawmakers and 108 bankers? How much of their lucrative derivative business will the banks have to give up? As it turns out, the banks will have to give up (i.e. put in an affiliate) all business related to: commodity derivatives (all except gold and silver), all equity swaps and certain credit default swaps (those which are based on non-investment grade entities). May sound like a lot at first glance, but in fact, the above mentioned instruments represent no more than three percent of the world OTC derivatives market. In other words, the banks will give up pretty much nothing. And which derivatives will the banks continue to be allowed to deal? According to the new law, the banks may retain: interest rate swaps, currency swaps, certain credit default swaps (those which are based on investment grade entities), gold and silver swaps, also instruments hedging for the banks’ own risk. In other words, as far as their derivatives business is concerned the banks will keep pretty much everything. ACCOUNTANCY CYPRUS ñ VOLUME 100 ñ SEPTEMBER 2010
