As of today, 144 jurisdictions have already fully adopted the International Financial Reporting Standards (IFRS). Adding the number of jurisdictions that have not adopted but have converged their national standards with IFRS, the International Accounting Standards Board (IASB), the accounting standard setting body of the IFRS Foundation, is the world’s standard-setter on financial reporting. Lately, the IFRS Foundation is, yet again, at the epicenter of many heated debates as regulators and corporations all around the world are on the verge of making an important decision on how to have a harmonized set of standards on sustainability reporting (aka non-financial reporting). However, there are many other organizations focusing on such matters. Whereas IFRS, up until recently, had not even attempted to regulate these issues. From a distance it may be puzzling to see the IFRS Foundation at the heart of it all.
There, my article ‘Global Adoption of IFRS As an Example of International Financial Law Making’, forthcoming in The George Washington International Law Review, may be illuminative. The Article explains why and how IFRS Foundation turned into a sought-after international organization when it comes to harmonization of financial reporting standards for corporations all around the word. The experience built while harmonizing financial reporting standards may, after all, be the prolific muscle non-financial reporting standard-setters did not or could not have so far.
Interestingly, IFRS Foundation is a private non-governmental organization registered in the United States as a Delaware corporation while the Foundation’s standard setting body, IASB, sits in London and is composed of experts on international financial reporting standards. Although this Board has no binding authority, jurisdictions from all around the world, one after the other, adopted these standards at the national level and thereby mandate that their listed companies report using IFRS. These standards are designed mainly for companies listed in one or multiple stock exchanges. Until the rise of IFRS, these companies were required to comply with different standards in each jurisdiction they were listed. Now, companies can use the same set of financial reports wherever they are listed. The near-universal adoption of IFRS is puzzling because neither the IASB nor the IFRS Foundation have any binding authority over states. States have no formal legal obligation to pay any attention to IFRS whatsoever. Moreover, as I had analyzed in another article, ‘The Political Economy of International Standard Setting in Financial Reporting: How the United States Led the Adoption of IFRS Across the World’, the United States remains the only developed country that has not adopted IFRS, yet US institutions played a central role in forming the IASB and encouraging IFRS adoption by other states.
As a set of standards developed by a private international body, the IFRS constitute what is known as ‘soft law’, indicating the nonexistence of formal legal obligations. However, a more nuanced analysis of the operation of soft law reveals that even non-binding rules set by a private international organization can ‘harden’ in three steps into widely accepted international laws. First, there is self-interest: when companies and markets see the benefits of such global standards, they voluntarily adopt and comply. Second, because such benefits can be realized when all market participants play within these rules, there is a market pressure. Finally, mandating the use of these standards at the national level is, in effect, ‘hardening’ soft law through domestic legislation. Applying these concepts, IFRS adoption levels the playing field, enables market participants to realize various benefits, and illustrates a case of hardening soft law. In this way, soft law can take on a life of its own, but IFRS as soft law do not arise spontaneously. The self-interested decisions of powerful actors play an important role in creating soft laws and promoting their adoption. Thus, the specific, path-dependent history of IFRS is also important to understand why states adopt these standards.
The world-wide adoption of IFRS is a profound example of international financial lawmaking. The initial step taken in my Article is acknowledging ‘adoption’ as the tool that brings legitimacy and power to a private international organization with a board of experts setting standards as soft law. Therefore, the first answer to the major question at hand is that nations ‘adopt’ IFRS as a newfound mechanism of international financial lawmaking. These standards as part of international financial regulations create the new global order. This new global order is well supported by powerful states and international organizations. The second step is looking at the underlying reasons behind countries’ decisions to adopt IFRS.
The impact of these standards on a particular country’s financial and legal systems depends on the reasons behind the country’s decision to adopt IFRS. While each country has taken a different path, we can distinguish three models of adoption: mandatory, voluntary, and compelled. First, in the case of the European Union (EU) Member States, adoption was mandatory. The international standards became binding for all Member States with a decision by the EU Parliament. Second, in the case of many developed and developing countries adoption, or conversion, was voluntary but probably essential to be and stay competitive in international capital markets and to attract foreign direct investment. Finally, the third group of countries that adopted IFRS did so under pressure from international institutions such as the World Bank and the International Monetary Fund (IMF), which conditioned credits or financial aid upon the adoption of IFRS.
Using the modes of adoption as means for distinction between countries that have adopted IFRS can tell us more about the enforcement and implementation of IFRS than the typical distinction between developed and developing countries. Future research on IFRS adoption, enforcement, and implementation considering these three distinctive modes of adoption would bring new insights on new-found or existing institutions as incentives vary according to the mode of adoption. Finally, for the states that believed adopting IFRS would eventually lead to economic development, the law and development literature have long argued that adopting even the best possible standards would not itself bring about development, because laws become ‘alive’ only when there are the institutions to enforce and incentives to implement those laws.
Zehra G Kavame Eroglu is the Director of the Master of Professional Accounting and Law & Lecturer of Corporate Law and Finance Law at Deakin Law School.