THE GREY AREAS OF EUROPEAN ECONOMIC GOVERNANCE: FINANCIAL ACCOUNTING STANDARDS.
By Giancarlo Grignaschi Supervisor, Dr. J. M. van Cauter Second Reader, Prof. A. Verdun
Even before the outbreak of the 2008 crisis, European economic governance had already experienced moments of severe setback. Due to an increasing financialisation of European economies, financial accounting standards became an essential tool to ensure safe and sound financial transactions. In 2000, the European Commission decided to make the use of International Financial Reporting Standards (IFRSs) mandatory for all listed companies in the EU, and delegated the issuance of these standards to the International Accounting Standards Board (IASB), retaining only little monitoring power. Contrary to industrial standards, IFRSs are issued by a private standard-setting body, yet their application is mandatory within the EU. The thesis argues that this change in European economic governance signals a potential deepening of “democratic deficit” that has been poorly investigated. Accordingly, it will analyse the current European financial standard-setting, insofar as it is a field of European economic governance not traditionally connected to democratic deficit theory.
Introduction.
European economic integration is still an ongoing process, during which the EU already went through difficult moments, sometimes on the brink of disintegration. Indeed, while the last year has witnessed a positive break from the difficulties that Member states were facing beforehand (Verdun 2018), one of the ill-fated times was undoubtedly the 2008 financial crisis (European Commission 2018), whose fury also hit the real economy. Even before the outbreak of the crisis, European economic governance had already experienced moments of severe setback. The Stability and Growth Pact (SGP) – a major tool of coordination in the Economic and Monetary Union (EMU) – had been breached several times since its birth in 1997 (Heipertz and Verdun 2010). It underwent a reform in 2005, but the process did not reinforce it enough1. European economic governance,
1 Put simply, Member states’ banking supervision authorities for many years would apply their own rules, making it hard to keep the system united and protected against the 2010 euro crisis (European Central Bank 2018). In fact, the Single Supervisory Mechanism (SSM) has been devised for this very purpose: it is led by the European Central Bank (ECB) and coordinates the different national supervisors.
if not responsible for what happened, certainly was not prepared to win the battle against the economic crisis (Naert 2014).
In addition to the official, institutional understanding2, European economic governance is meant to safeguard the “four freedoms”, which are perhaps the very leitmotif that triggered European economic integration – or the EU substantive law (Barnard 2013). For goods, capital, labor (individuals) and services to move freely within a market composed of several countries, it is necessary above all that movements be not constrained by tariffs or non-tariff barriers (NTBs) – this is not an exclusive dynamic of the European market, since the same purpose has been pursued globally by the GATT/WTO over the last seven decades (Charnovitz 2005).
Nowadays such an integrated system encompasses areas that were not fully explored in the past. For instance, alongside the pivotal role of economic standards as means to eradicate NTBs (Schepel 2005; Delimatsis 2014), there is a peculiar category of standards dealing exclusively with financial and capital markets, whose aim is to ensure safe and sound financial transactions, namely financial accounting standards3. These tools were usually provided by member states, which often struggled to coordinate national regulations with each other and hindered transnational financial transactions. Yet the European Commission, in 2000, decided to harmonise the sector in the way described over the next sections, as a step towards a common capital market.
Research Question.
By and large, international standards are not much different from “technical regulations”. Both are rules for market-based activities, whose aim is to influence (or not to influence) private behaviour (Charnovitz 2005). However, technical regulations are issued by national governments and, therefore, are mandatory for all the agents in the market, whereas the application of international standards may be at best highly encouraged4. Nevertheless, the case of International Financial Reporting Standards (IFRSs) is indeed peculiar,
2 Frank Naert explains that the meaning of the expression “European economic governance” tends to be different depending on the source. Usually both the so-called “fiscal union” and “banking union” fall within the definition (Naert 2014). However, a fiscal union does not technically exist as of yet in the EU, and economic governance is institutionally defined as the system of rules and mechanisms that aims at achieving common economic targets through the coordination of economic policies among the member states (see http://www.europarl.europa.eu/factsheets/en/sheet/87/economic-governance).
3 Financial accounting standards are rules to guide harmonized accounting practices. Accounting is an essential activity to any business, however large or small. It is essential to provide relevant and reliable financial information relating to resources and necessary for companies’ decision-making. On the other hand, financial accounting and financial reporting provide performance information to users dealing with companies’ securities in financial markets (van Mourik and Walton 2014, 3-33).
4 A widely shared approach uses the distinction between de jure and de facto standards (Murphy 2015; Schepel 2005; Delimatsis 2017): the former is the type of standard that usually emerges as a “legal” requirement set forth by a sovereign country; the latter describes the situation in which a product (or a process) becomes a standard once it corners the market against another competitor (a product or a process) that could be a possible standard too – an example being the supremacy of Microsoft Windows over Macintosh.
since they are issued by a private standard-setting body (PSB), namely the IASB, yet their application is mandatory within the EU.
The fact that the EU delegated accounting standard-setting to an independent organisation upon which it does not exert any statutory control (Chiapello and Medjad 2009) arguably influenced two parallel events. First, IASB in a couple of years became the leading global PSB in the financial accounting sector (Zeff 2012)5, thus signalling an increased connection between European economic governance and the broader context of global economic governance6. Second, this change in European economic governance signals a potential deepening of the wound that both academia and the public call democratic deficit – provided of course that the EU actually suffers from such an issue and that financial accounting standards are considered part of the public debate.
I believe that these facts and developments are intimately intertwined in that both international and European standards entail an unavoidable friction between national law (expression of democracy) and global economic interests (which IASB represents). Also, this tension reflects a meaningful trend within Law: “soft law”7 is nowadays filling many juridical lacunae of traditional “hard law” (Delimatsis 2017). Moreover, the majority of standards are created within technical committees in which technological knowledge replaced the need for consensus, ensuring a matter-of-fact leadership8 – and contributing even more to the erosion of representation.
These considerations have serious implications, of such a concreteness that it would be unwise to overlook them.9 Accordingly, the aim of this study is to analyse the current European accounting standard-setting, insofar as it is a field of European economic governance not traditionally connected to scholarship on democracy and democratic deficit. In particular, I would like to spell out the reasons why European financial accounting standardisation, and the role of the IASB, deserves to be studied within that theory and what are its potential concerns in relation with democratic deficit.
In doing so, I first provide a necessary contextualisation from a political and legal perspective, in order to portray (at least the essential characters of) the global arena in which international and European standards play their game. I then examine the issue of “democratic deficit” as it is defined by the academic debate, with a special view to European integration theory. Finally, I cast light on standardisation and employ mainly
5 To be clear, US domestic listed companies are not permitted to apply IFRS standards, whereas they have to rely on the US GAAP, which makes FASB and SEC major competitors in the global accounting sector.
6 According to Posner (2010), accounting standard-setting was dominated throughout the ‘90s by the US and its General Accepted Accounting Principles (GAAPs), while the 2000s opened up with the new leadership of the IASB. That proves why accounting standardisation is connected with changes in global order.
7 By “soft Law”, I refer to the concept developed by Weil (1983) and then refined by Abbott and Snidal (2000), among others. They use it to identify a set of deviations of what is called, by contrast, “hard Law”. These deviations are in terms of obligation, precision and delegation. Soft Law is a residual category difficult to define, representing obligations that seem formally legal but lack the usual binding character (Guzman and Meyer 2010). At any rate, understanding the growing relevance of soft Law is a necessary step to frame international and European standardisation properly, insofar as standards are, above all, rules without a binding character in their own right.
8 According to D’Aspremont (2008), this represents as a sub-process of the transition from a positivist legal universe to the “softness of Law”.
9 I believe it is worth quoting Chiapello and Medjad (2009, 451): “a complete privatisation of standard-setting is not unknown in other areas, but unlike in accounting, it typically happens in connection with the production of non-mandatory standards. In fact, no comparable abandonment of sovereignty has taken place in any other area of European hard law.”
Political Science criteria and categories to gauge the degree of accountability in European standard-setting. The methodology chosen for this paper is textual analysis. The collection of data entailed the examination of written documents, mainly primary and secondary literature in the form of journal articles and books, as well as official websites and other types of online data sources. The coding and analysis phases employ concepts and categories derived mainly from political science, while a part of the research also borrows from scholarship in the discipline of economics and finance.
The EU and the global order.
As a matter of fact, today’s global order is different than the one that shaped the world from the nineteenth century onwards (Slaughter 1997). The conventional account points to a pivotal change occurred somewhere in the seventeenth century when a new form of government emerged – a turning point that signalled the advent of the modern state, otherwise called the nation-state, whose structure has influenced the development of the contemporary world order. Alternative accounts, however, provide a more complex picture that contests the straightforward connection between the Peace of Westphalia and the birth of the nation-state. In fact, the fundamental shift from feudal heteronomy to modern sovereignty – through the emergence of principles of exclusive territoriality, non-intervention and legal equality – would not be simply provided by the Westphalian treaties, but rather resulted from other variables.10
What I am interested in, however, is how contemporary global order has been shaped by further impacting changes occurred in the last decades. As a matter of fact, the post-World War II era was characterized by the emergence of international organisations that acquired considerable power and, according to some scholars, triggered a constitutional shift in the international order (Wiener, Lang Jr., Tully, Poiares Maduro and Kumm 2012).
In order to test that claim, Kreuder-Sonnen and Zangl produced a useful taxonomy of global orders, which revolves around the shape that horizontal and vertical relationships between legal and political power have taken throughout history (2014)11. This scheme allows them to obtain a useful scale to measure how authority (and power relations) can be structured within international organisations. They identify a five-level model that entails the following categories: democratic, partially democratic, hybrid, partially autocratic, autocratic.
10 Here the literature is vast, being difficult to mention those texts that focus precisely on the Westphalian myth. However, in order to have a comprehensive idea of the critique to the traditional account, see Agnew (1994), Osiander (2001), Anghie (2004), Hobson and Sharman (2005) Branch (2011), Buzan and Lawson (2012). In order to have also an economic perspective on the issue, see Teschke (2002), Anievas and Nisancioglu (2013).
11 The authors argue that authority relations are usually structured in vertical and horizontal axes. They can entail relations of equality between the members of a system or a hierarchical/vertical structure. By crossing these dimensions with each other, one can obtain the variants that characterise the Westphalian and the post-Westphalian orders and observes the distribution between legal and political powers (Kreuder-Sonnen and Zangl 2014).
The more autocratic the exercise of authority is, the more decisions are taken arbitrarily (Kreuder-Sonnnen and Zangl 2014) 12.
This model proves to be particularly interesting for our purposes in that it has been applied to the EU too. The authors present an insightful thesis: the purpose of creating a common single market unavoidably entailed the delegation of considerable authority to supranational institutions, such as the Commission, the European Central Bank (ECB), the European Court of Justice (ECJ), which are not democratically elected13. They conclude by saying that EU represents the highest constitutionalist attempt which, nonetheless, left a considerable space to autocratic decision-making – that is the essence of an authoritarian rule. And this combination of constitutionalism and authoritarianism is seen as typical post-Westphalian legal order (Kreuder-Sonnnen and Zangl 2014).
This unconventional IR account does not represent a definitive statement about how the EU actually is. Indeed, it needs to be compared with and supplemented by different interpretations presented within the field of European integration theory; interpretations that will be discussed in the following sections. Nonetheless, this brief account constitutes an interesting point of departure14, as the scope this paper is to investigate how legal and political power is “checked and balanced” in a specific field of European economic governance.
The concept of democracy and its shape in the EU.
The concept of democracy has been the subject of intense scholarly debate. While it is beyond the scope of this research to fully capture its essence, the following will nonetheless help us understand its contemporary development.
According to Wendy Brown (Cheah and Guerlac 2009), the concept has been puzzling since its very birth. She explains that untangling its meaning, however difficult this may be, nonetheless is particularly important today, especially when dealing with the EU. In fact, a common way to measure the level of democracy is to check sovereignty15: since the beginning of European integration, transfers of sovereignty from the member states to the EU have been an essential condition for the system to work.
When dealing with the EU, it is first necessary to acknowledge that European integration theory is a heterogenous academic discipline. Indeed, Wiener, Börzel and Risse use the expression “mosaic of European integration” (2018) in order to shed light on how different theoretical approaches interplay with each other. In
12 Contrary to the interpretation pointing to a constitutional shift in the global order, Kreuder-Sonnen and Zangl (2014) argue that the rise of international organisations has to be interpreted rather as an authoritarian shift.
13 In fact, the only institution elected by universal suffrage is the Parliament (since 1979).
14 Moreover, the first three major theories about European integration – Federalism, Neofunctionalism and Liberal Intergovernmentalism – built upon IR to a considerable extent. This is an additional reason for contextualising our analysis in relations to the broader evolution of global order.
15 According to Derrida, sovereignty is essential to democracy if only because it is functional to freedom and self-determination (Cheah and Guerlac 2009, 115).
particular, European integration theories can be divided along three stages that roughly correspond to ensuing phases of integration: explanatory, analytical and constructive (Wiener et al. 2018, 7).16
The case I have selected is first and foremost representative of a broad dynamic informing the way in which more and more sectors are regulated nowadays: the specific case is not about financial accounting standardisation per se, nor about an overall assessment of European democracy, but rather about accounting standards within the EU. Nonetheless it fosters a broader reflection on what perils may jeopardise the effectiveness of (democratic) European economic governance. Several theoretical approaches may be employed to this examination, but I will not explore all of them because of the limited space available for delving into the topic. However, it is my concern to mention those categories which I will ground my analysis on.
First, Governance Approaches help us to catch “the nature of the beast” (Wiener et al. 2018, 11), namely what kind of polity the EU is. In fact, Governance approaches are right in considering the EU as a peculiar entity resulting from the interaction of different actors (a multilevel governance17), both nation-states and non-state actors, whereby governance means the very combination of heterogenous types of governing – not only states have the steering power traditionally associated with government (Weiner and Diez 2009, 92). Above all, however, Governance approaches have coined the concept of “Open Method of Coordination” (OMC), which involves economic actors in designing and implementing policies (Wiener et al. 2018, 95), being an archetype of cooperation between the public and the private to achieve public goals.
Partially linked to the point on multilevel governance (MLG) is that scholarship which focusses on the distribution of power within the EU. Particularly relevant here is that the EU constitutes an MLG setting: not only there are member states and European Institutions (the Council, the Commission, the Parliament and the Court of Justice), but also several independent authorities both at the national and the supranational level (Brandsma 2013). Of course, not all the units of the system have the same competencies, which requires a reflection on what exactly is the relationship between them. Principal-agent theory serves this very purpose.
The principal-agent theoretical framework has been often employed in relation to European integration18 for it poses the following crucial question: “what if the agent behaves differently from the principal’s command?” (Wiener and Diez 2009, 132). This perspective is particularly pertinent to my paper, as I will show, since the IASB may be considered the agent appointed to the issuing of accounting standards. European integration theory suggests to lock the agency into a detailed agreement that provides for instructions and sanctions, yet the degree of autonomy varies considerably within the EU system (Wiener and Diez 2009, 132).
16 The first stage encompasses all those theoretical approaches that explain why European integration took place and how its outcomes can be spelled out. The “analytical” phase, instead, focusses on the type of polity the EU represents and seeks to describe its political and regulatory processes. Finally, the last stage aims at contextualising European integration within the broader socio-politico-economic reality and tries to identify its ultimate goals. To be clear, there is a considerable degree of overlap between the three stages and it is outside the reach of this paper. Nonetheless, the next sections will show how different theoretical approaches to European integration can be combined to achieve a comprehensive understanding.
17 This model is conventionally employed to describe the European setting, yet it is helpful to understand the implementation of European directives at the national level (Wiener and Diez 2009, 96).
Furthermore, the principal-agent framework has left room for discussions about comitology, the EU’s favoured decision-making procedure.19 Its specific function is to support the European Commission (and other institutions) on several matters for the preparation of norms, standards and other activities. According to Brandsma (2013), the most meaningful consequence of giving comitology a pivotal role is an imbalance between legislative and executive power: legislative procedures have a limited reach, since they would just outline the normative framework of the regulated issues, while it is the Commission to flesh out these acts by implementing executive measures that are practically elaborated by technical committees.
As already mentioned, the theoretical framework described in this section is to pave the way for the discussion to come, which requires first of all the introduction of the concept of democratic deficit.
Where is the “democratic deficit”?
The necessity of asking “where is the democratic deficit?” arises essentially from the fact that its presence is observable only after a proper examination of other issues deeply intertwined with it. To begin with, questions of responsiveness and responsibility, as well as accountability and legitimacy, are unavoidable for anyone who aims at grasping a comprehensive picture of the actual status of democracy in the EU.
“Responsiveness” is considered a fundamental character for a political party (applicable to the state as a whole), since it coincides with the capacity to respond to society’s short-term needs, while “responsibility” entails implications at both the national and the international level, implying consideration of a national long-term needs and compliance with international commitments (Bardi, Bartolini and Trechsel 2014). Political Science has explored extensively the tension between these two requirements20, yet I am only interested in recent developments, since a balance between the two roles became more difficult in the last decade of European integration: in a highly integrated international arena, the tension between responsiveness and responsibility increases, putting European member states before the hard choice of what interests deserve urgent protection (Bardi et al. 2014). European integration implies a high degree of responsibility, which often prompts member states to pursue non-democratically determined targets.
Such a dynamic would probably be harmless, or at least less harmful, if those who are supposed to be the ultimate beneficiaries of public policies had the chance to hold policy-makers accountable. Indeed, accountability is a foundational mechanism of democracy, but it should be understood here in the peculiar shape it takes within the European MLG. A solid definition considers accountability as the way in which an organisation (and its workers) manage the expectations formed within and outside itself (Romzek and Dubnick 1987), while an alternative approach preferers to understand it as a composite of two associated mechanisms, namely popular control and checks and balances (Brandsma 2013, 45-47). At any rate, in a multilevel governance such as the European Union, accountability is not an easy target to achieve.
19 The system of comitology is far more active if compared to Council’s and Parliament’s normative activity (Brandsma 2013, 2).
Responsibility and accountability lead us to the question of legitimacy. Indeed, Bellamy and Weale make an interesting point about the natural connections between the quantity and quality of the commitments the EU requires, on the one hand, and the necessity of a type of normative and political legitimacy to secure them, on the other (2015). In essence, the authors analyse how relations between member states are shaped within EMU and realise that such an intergovernmental setting require states to be “simultaneously21 […] responsible and
accountable to their domestic citizens” (Bellamy and Weale 2015, 259). Such relations of responsibility and accountability are possible only when states take credible commitments, which in turn depend on domestic legitimacy.
Put bluntly, if a state has to commit not to breach the limits put by the SGP in relation to budget deficit22 – which means that is has to decrease its spending thus affecting citizens’ wealth – that state needs to be credible to its population. That can be defined otherwise as being politically legitimate. This means that domestic legitimacy will in turn underpin the structure created by virtue of international commitment.
We will see later what the last point means in relation with European standardisation. The next section will finally seek to conceptualise “democratic deficit”.
The standard version of “democratic deficit”.
It is important to mention that a clear understanding of how democracy ideally should look like has not yet been achieved, neither in relation to the EU nor with the nation-state. In addition, although scholars have discussed about the issue of democracy in the EU (especially since the ‘80s), there is not a proper definition of “democratic deficit” (Stavridis and Verdun 2001). Stavridis and Verdun (2001) argue that there are three reasons that harden any attempt to clear-cut conceptualisation: first, the EU is not an international organisation nor a federal state; secondly, it is not yet clear what kind of democratic form of governance should be applied to the EU; thirdly, democracy itself is a recent form of governance, therefore it is still subject to adjustments (as I mentioned earlier).
Considering these difficulties, Follesdal and Hix (2006) sought to conflate the high number of definitions given by intellectuals, scholars and commentators in order to offer their standard version of democratic deficit. Their refined version of Weiler’s analysis23 proves to be a useful handbook on how to identify democratic
21 Italics in the original.
22 “Budget deficit” occurs when expenses exceed revenues. The SGP provides that national deficit cannot be over 3% of the Gross Domestic Product (GDP).
23 To be clear, this operation was previously attempted by Weiler, who has to be credited for recognizing the mutual-reinforcing nature of the three major approaches to European integration, namely the international, the supranational and the infranational (Weiler et al. 1995). According to Weiler, the history of European Union witnessed complex events, it must be understood by using all the mentioned approaches in order to capture every single shade – hence, the trichotomy internationalism/supranationalism/infranationalism is essential to draw a complete picture of the European governance (Weiler et al. 1995). The categorisation adopted by Weiler et al. (1995) is, however, a simplification that does not really correspond to the division between different approaches adopted by European integration theory. In fact, beyond the supranational approach (represented by Weiler himself), the other theories would have different names, respectively Liberal Intergovernmentalism and a peculiar Governance approach called “regulatory state” (see Wiener and Diez 2009).
deficit within the EU. The first important evidence for its occurrence is the increase of executive power without parliamentary control. Indeed, this trend constitutes a difference between member states and European institutions, in that member states usually provide the power to a parliament to hire and fire a national cabinet, while European executives are generally outside the reach of this parliamentary control (Follesdal and Hix 2006).
A second point, related to the first, concerns the weakness of the European Parliament. In spite of the many reforms that aimed at strengthening it, the Parliament still suffers from competition with the Council, especially in the field of legislation. Although a great deal of European legislation emerges out of the “ordinary” procedure, in which the Parliament plays a central role, many legislative acts are adopted still through either “consent” or “consultation” procedures, in which the Council is in a superiority position (Follesdal and Hix 2006).
The third element signalling a democratic deficit within the EU refers to the European elections, since “neither national elections nor European Parliament elections are really ‘European’ election” (Follesdal and Hix 2006, 535). The two authors argue that the elections become a battlefield for national parties and that, independently of the outcome, national representatives at the European level cannot decide the agenda as the member of the Council do so (Follesdal and Hix 2006). Furthermore, democratic deficit is also observable in the distance between European citizens and the possibility of an electoral control over European institutions, which is something not yet achieved (Follesdal and Hix 2006).
Finally, as a likely result of the above-mentioned elements, European policies will not likely be supported by a majority of citizens, since governments usually carry on at the European level what they are not able to achieve at the national level because of several constraints, such as parliamentary control. Furthermore, alongside executives’ power, the European decision-making is considerably influenced by private interests, which seldom coincide with those of the domestic population (Follesdal and Hix 2006)24.
With these elements in place, the following sections will outline essential characteristics and developments of standardisation, focussing particularly on European standardisation and financial accounting standards. Afterwards, I will draw logical conclusions from the application of the theoretical framework presented so far.
The basics of standardisation.
I have mentioned that European and international standards entail a serious tension between national laws and economic interests, the main purpose of standardisation being to harmonize the different legislations which may have an impact on international trade. Indeed, industrial standardisation has played a pivotal role for the
24 The most robust critique to the original “standard version” of democratic deficit came from Majone and Moravscik. These two scholars took different posture from each other yet converge in that there is not such a “democratic deficit” issue in the European Union, as scaremongers warn. Whereas Majone (1998) argues that technocrats (in the form of independent regulatory agencies) eventually safeguard people’s interest more than the majoritarian European Parliament, Moravscik (2002) holds that the EU does not suffer from a democratic deficit because its intergovernmental setting secures indirect democratic control and citizens preferences are met as a matter of fact.
development of the world economy (Murphy 2015) and nowadays is an important form of regulation, in almost all aspects of modern life (Brunsson, Rasche and Seidl 2012). 25
The World Trade Organisation (WTO) was born with the very aim of coordinating trade policies among nations in order to achieve the targets listed in the GATT preamble, such as a high standard of living, growth and full employment (Lowenfeld 2008, 30-32). Parallel to the birth of the WTO, two important agreements relating international standards were signed, namely the Technical Barriers to Trade Agreement (TBT) and the Sanitary and Phytosanitary Agreement (SPS), in order to provide the first legal framework for the regulation of the subject – notably defining what an “international standard” is, as well as the process for its creation.
The rules embedded in this legal framework have been considerably inspiring to European standardisation, which actually aligned a large part of its discipline with the principles enunciated over the decades by the WTO and the International Organisation for Standardisation (ISO).26 In short, European standard-setting as a legal framework has borrowed much from the system WTO had already implemented. However, WTO itself (and its treaties on standardisation) has cooperated with ISO to a considerable extent and integrated its regulations with the rules adopted by the latter.
European standardisation.
Standards are also an essential element for the European Single Market, since they allow harmonisation of national legislations through the overcoming of possible obstacles to trade within the European Union (Schepel 2005, 39). In the years preceding the Treaty of Maastricht, many scholars advocated the need for a more rapid economic integration and already proposed harmonisation to solve the crucial issue of technical barriers to trade (Pelkmans 1987).
In the ‘60s, a huge plan for the elimination of tariffs and quotas was accomplished. Motivated by this success, the European leaders decided to fight also against the technical barriers to trade that were caused by technological advancements and need for protection of public national interests – the project was incorporated into the Single European Act. Voting on the legislative package necessary to implement this liberalisation of the market was fairly difficult, in consideration of the unanimity principle and the length of the package. For this very reason the Commission decided to reduce the burden by delegating many decisions on details and practical aspects to existing standardisation bodies (Usherwood and Pinder 2013, IV), as well as by directly inspiring to the principles enunciated by the WTO. Eventually the Single Market programme turned out to be an outstanding success.
25 As Lundqvist acutely notices (2014) standardisation is becoming more and more relevant in the recent years and that is not because of someone’s decision to do so, but rather because of a series of factors, among which the markets and globalisation are relevant ones.
26 To be fair, both European and American standardisations are influenced by the legal framework devised by the WTO. In particular, six principle inspire the matter: transparency, openness, impartiality and consensus, effectiveness and relevance, coherence, development dimension (Lundqvist 2014).
Looking at the path of European standardisation one can see that it went through different stages. First, the phenomenon is something that began later than national standardisation, which continued being managed independently by the member states up until the 1980s. Therefore, as soon as the intention of harmonising the field was formalised, European standardisation could borrow considerably from the member states’ fully-fledged experience (Schepel 2005, 101-144). A second phase involved the development of the main European Standard-Setting Organisations (ESOs27), which initially operated outside the limits of a normative framework. In fact, especially the CEN28 – since its transformation into a private non-profit association in 1975 – managed to increase its production of standards and paved the way for a more incisive role that acquired formal status in 1985, when the so-called “New Approach” was released (Lundqvist 2014, 120-127)29.
By and large the New Approach strengthened both the ESOs (CEN, CENELEC, ETSI) and the National Standard-Setting Bodies (NSBs) (Lundqvist 2014, 122-123). As Harm Schepel argues (2005, 107-111), an intriguing consequence of Europeanisation of standard-setting, has been the tightening of the relationships between member states and their NSBs, which resulted in the increasing power of CEN. This outcome has been automatically produced by the necessity for stakeholders to participate in standardisation, which was eventually possible only through NSBs. However, the need for a highly technical expertise brought NSBs to be privatised or at least endowed with considerable autonomy from the state.
A new stage of European standardisation began in 2012, when the Council and the Parliament adopted Regulation 1025/2012 to reorganise the subject. The same year, the ECJ decided a case which considerably changed the framework regulating relationships between national and European standardisation, namely the fra.bo case (European Court of Justice 2012).
Indeed, a kingpin of the system has always been article 34 TFEU (former article 28 TCE), whose provision prohibits measures that have an effect equivalent to quantitative restrictions to trade. This norm, along with articles 28 and 30 TFEU that prohibit charges having an effect equivalent to that of custom duties, constitutes the “free movement of good”. Both the norms apply exclusively to states. Conversely, in fra.bo, for the first time the ECJ applies article 34 to a private NSB.
27 The major ESOs are the European Committee for Standardisation (CEN), the European Committee for Electrotechnical Standardisation (CENELEC) and the European Telecommunications Standards Institute (ETSI).
28 The European association for standardization (CEN) was born in the ‘60s in Paris but soon moved to Belgium where it got the status of a private association. It is composed of technical committees, the national standard bodies (NSBs) of the members plus the 4 EFTA countries. The latter, alongside the EU Commission, have the status of counsellors, therefore can even participate at the committees’ meetings (Schepel 2005).
29 The “New Approach to harmonisation and standardisation” was not the first measure towards the achievement of a free movement of goods – the first of the “four freedoms” – but rather a further effort required to accomplish supplementary objectives related to the elimination of custom duties and quantitative restrictions between member states (European Parliament 2017). It was suggested in 1985 by a Council resolution that delivered guidelines for the development of a harmonised standardisation and legislation at the EU level.
Financial accounting standards.
As regards the specific case of accounting standardisation, the first point to make refers to the linkage between standards and global finance. As a matter of fact, the financial sector is bigger than the real economy (trade in goods and services); notably it registered an astonishing expansion from the 1980s onward. Indeed, financial markets grew considerably both in absolute and in relative terms (Thomson and Dutta 2016).30 The decision of the EU to harmonise the sector in order to achieve an efficient comparability between financial statements of different European companies therefore was not surprising (Chiapello and Medjad 2009). Financial accounting standards, as mentioned before, are functional in providing performance information to users dealing with companies’ securities in financial markets (van Mourik and Walton 2014), which are essential for maintaining safe financial transactions. However, their impact has to be measured also beyond the narrow financial sector, since its activities affect many more subjects, such as “employees, shareholders, lenders and a number of public actors” (Chiapello and Medjad 2009, 449).31
To be clear, financial accounting standardisation went through two distinct phases, one before and the other after the 2008 crisis. Today the main player in the system is the International Accounting Standards Board (IASB), which was born out of a renewal of the old IASC32. The latter was founded in 1973 on initiative of Lord Benson, who led an accounting company currently part of the well-known PwC, together with eminent leaders of accounting bodies from around the world (Zeff 2012). The intention was to promote a world-wide harmonisation of accounting standards that could follow a different model from the then-leading German one, namely the Anglo-Saxon approach to financial accounting (Zeff 2012).
Since its foundation and reorganisation, the IASC grew considerably, nonetheless its composition did not change much, entailing always a large representation of the accounting and auditing sector. However, more jurisdictions joined the enterprise and the small working groups started meeting regularly. Moreover, many NSBs decided to participate in the project and brought their own view. Some of them preferred to maintain the national accounting practices, therefore the first series of standards were planned for a voluntary application only. What matters here however, is that both the European Commission and the Financial Accounting Standards Board (FASB) initially did not pay much attention to the IASC – at least until the late 1980s.33
At the end of the ‘90s, innovations in the financial markets increasingly challenged the model applied by European countries, whose accounting systems were strictly connected to taxation purposes (as the
30 In 1973, e.g., the ratio of the value of foreign exchange transactions to global trade was 2:1, in 2004 this ratio reached 90:1 (Thomson and Dutta 2016).
31 To give an idea about the concrete consequences of accounting standardisation, it will suffice to consider that they determine, for instance, whether an economic activity is considered as profit or as loss (Chiapello and Medjad 2009). 32 In its decision to impose the adoption of IASC standards from 2005 onwards, the Commission formulated the intention of the IASC to go through a reformation the would make IAS the highest quality accounting standards.
33 The International Organisation of Securities Commissions (IOSCO), a confederation of securities markets regulators, offered IASB an attractive opportunity in 1987: if IASB improved its standards, IOSCO would endorse them for use in the securities markets. Although this was a hard task for the then-part-time staff of the Board, the IASB efforts in fulfilling IOSCO’s demand drew the attention of the U.S. Securities and Exchange Commission (SEC). As a result, SEC, IOSCO and FASB decided to send an observer delegation to the IASC and prompted many other jurisdictions to do the same (Zeff 2012).
abovementioned German model). From 1987 to 2000, a high number of European multinational corporations decided to abandon their national GAAPs (General Accepted Accounting Principles) to embrace the standards issued by IASC (so-called IASs). Above all, it was the European Commission’s decision to make IAS standards mandatory for all European listed companies that bestowed a central role upon the IASC, which had to undergo a reform to become a high-quality standard-setter once and for all (Zeff 2012).
The resulting IASB34 is the private organisation appointed to producing accounting standards that are then adopted and incorporated into EU law by the European Commission – these standards take the name of International Financial and Reporting Standards (IFRSs). Today the IFRS Foundation is composed of 22 “Trustees” who appoint the 14 IASB Board members (IFRS Foundation website). The Trustees are accountable only to themselves but should represent geographical diversity. However, they mostly come from Anglo-Saxon countries and are in large part appointed by the well-known “Big 4”, who fund a third of the IASB budget. While the members of the Board should respect geographical representation, their actual composition has been harshly criticised (Chiapello and Medjad 2009).
The IASB Board is fully sovereign, meaning that the Trustees cannot question its decisions. However, the Trustees appoint two other important bodies, namely the International Financial Reporting Interpretation Committee (IFRIC35) and the Standards Advisory Council (SAC). The former carries out a significant hermeneutical function, while the latter is a forum where individuals and organisations with an interest in financial accounting standards can discuss them and advise the Board36 (Chiapello and Medjad 2009).
For an accounting standard to be adopted and put into a regulation, it requires a preliminary control by the Commission. To be clear, the standard is first examined by a body called European Financial Reporting Advisory Group (EFRAG), which checks possible incongruencies with framework directives. A second check is then carried out by the Accounting Regulation Committee (ARC), which is composed of state representatives and gives a political approval to the operation. The Commission does not exert any statutory control over EFRAG and ARC37, but it has a genuine interest towards the approval of the standard. As a matter of fact, in case there is no green light, listed companies can freely report their transactions in any way they find convenient (Chiapello and Medjad 2009).
Finally, IASB standards become mandatory after their incorporation in a regulation adopted by the Commission, which is directly applicable in all member states38. They have no chance of modifying any element, since accounting standards must be applied pursuant to the terms provided by the regulation.
34 For a detailed account of the restructuring process see Zeff (2012).
35 The committee has recently changed its name into “IFRS Interpretations Committee”. Its specific role is to providing the Commission with details about the correct interpretation of already issued standards.
36 Looking at the composition of the Council (a new board has been appointed a few weeks ago), it is hard to consider the members as representatives of people’s interest. See https://www.ifrs.org/news-and-events/2018/11/ifrs-foundation-trustees-announce-appointments-to-the-ifrs-advisory-council-from-2019/).
37 EFRAG, in particular, is managed and financed by the private sector. Curiously, its structure is identical to that of IASB: there is a supervisory board that wields the same powers of the IASB Trustees, and there is a committee of technical experts that deals with the standardisation projects. Moreover, technical experts work pro bono, therefore it is not surprising that audit firms play a relevant role also in this context (Chiapello and Medjad 2009).
38 It is worth mentioning that harmonisation of European is usually achieved by the adoption of directives, which, in contrast to regulations, require to be translated into national law by member states’ parliaments.
However, the Commission has no real input either, for IASB standards can be only rejected or approved – not adjusted (Chiappelo and Medjad 2009).
Connecting the dots: democratic deficit in European accounting standardisation.
In light of what I have outlined above, several concerns may arise. A crucial one refers to the question as to why the European Commission delegated the entire task to a non-majoritarian organisation such as the IASB. Indeed, answering that question might even nip in the bud any possible doubt about whether it is really necessary to investigate the object of this paper. In other words, provided that there is no alternative to a certain choice, worrying about it is completely useless.
Although the original responsiveness-responsibility framework was applied to national government only, I am confident that applying it to the EU might help answer the question. Moreover, the debate over democratic deficit seems to be premised on an unbreakable equation between nation-state (member states) and supranational organization (the EU): the EU should function as the state does if it wanted to be democratic – the standard version of democratic deficit (by Follesdal and Hix) already made that clear. The similarity, therefore, allows me to conceive of the IASB appointment as a question of “responsibility”, in that a growing internal market requires the EU to keep pace with advancing financialisaton by ensuring safe and harmonised financial transactions through the implementation of proper accounting standards. And such a goal is allegedly achieved by the involvement of a neutral, independent organisation of experts.
That entails two broader concepts which the power of IASB traces back to, namely delegation and technocracy. The former is a practice more and more applied not only at the EU level, but also within the national setting. Although delegation may seem completely compatible with democratic government, the fact that the issue has been addressed by several theoretical approaches signals its being potentially perilous for democracy, particularly in the European MLG setting where an Open Method of Coordination welcomed many economic, private actors to policy-making.
A revised version of the first Neofunctionalism, by Leon Lindberg, already emphasised the desire of delegating that some states were feeling due to the decreasing necessity of independent foreign and domestic policy in the middle of the Europe-building process (Wiener et al. 2018, 45). Elsewhere in European integration theory the question of delegation was treated by Majone (1998; 2001), who considered two basic reasons for the practice typically falling within the principal-agent framework: first, a principal may delegate in order to diminish the transaction costs, since the agent is an expert supposed to wield the necessary know-how; second, a principal may delegate because he needs more credibility for its policy.
Notwithstanding the credibility of these arguments, they do not necessarily enlighten us about the concrete reasons why the Commission appointed the IASB. Chiapello and Medjad (2009), adopting a
historical-sociological approach39, argue that the EU decided to outsource accounting standardisation to the IASB because it intended to overcome the problem of lack of consent between member states40 - this was apparently the concrete logic of delegation chosen by the Commission. In other words, appointing a body with a private status was rather a necessity, yet the way the relationship between the IASB and the EU has been shaped was a choice (Chiapello and Medjad 2009). The real issue at hand is, in fact, what happens when the agent does not behave pursuant to the principal’s command (Wiener and Diez 2009, 132).41
Here the concrete problem is further constituted by the extension of the arena in which the IASB operates. Indeed, being a private organisation, IASB is not exclusively linked to EU’s interests. In other words, it is as much a subject to EU’s lobbying as it is to non-European countries’ pressure42. In addition, the EU is composed of many members, therefore it often suffers from the lack of a cohesive voice in the global arena, which decreases the chance of achieving important targets. In theory, EFRAG was created in order to cope with the issue of political control/influence over the IASB. In practice, however, it has not secured this task until its second reformation in 2014 (Maydstat 2017).
By and large, the EFRAG remains a private association.43 Moreover, the structure did not change much since the last reorganisation: its members are mainly from private sector’s associations or, at best, from hybrid organisations that foster public-private cooperation. That would not be a problem should EFRAG represent weaker parties, since a balance between majoritarian and minoritarian interest, which is a key democratic feature, would be achieved. Above all, that would not be a problem provided that we have a clear understanding of technocracy and its relation with democracy.
The linkage between technocracy and democratic deficit is, however, not easy to frame. Arguably, the main issue here refers to the alleged function of financial accounting standards, namely improving financial reporting for the ultimate benefit of investors who chose European market as the destination of their activity. That purpose would require what Radaelli calls politics of expertise44, which usually benefits from a high degree of legitimacy (1999). More legitimacy is then provided by the ideological position that claims for a “government of science”, which supports an evidence-based policy-making as it is supposed to identify better solutions to the issues presented by society. Radaelli, however, rightly comments that any “government of
39 Their study does not properly fall within European integration theory, but proves to be extremely relevant for this paper’s topic, since it does not underestimate the impact of financial accounting standard on European democracy. 40 Until 2005, NSBs were left a considerable degree of autonomy that allow them to keep their traditional approach while cooperating with other member states and the markets. However, the EU soon decided to implement a legal framework to achieve harmonisation between the (too much) diverse jurisdictions.
41 To be clear, Majone suggests a different application of the principal-agent framework, since the conventional theory does not match those cases where the principal delegate all its powers to the agent (2001). That is exactly what happens with the IASB, whose agency has been freed from any constraint – except for the single case in which the Commission demanded the creation of a specific standard in order to save devastated European banks from failure (Bengtsson 2011; Zeff 2012). This is not to argue that IASB is absolutely independent from any type of external influence, from state actors to private ones, because it did suffer from pressure quite a few times in its history, as Camfferman and Zeff show (2018). The point here is rather about the specific relations between IASB and the Commission.
42 The IASB is very active, for instance, in Asia (Maystadt 2017). As Camfferman and Zeff showed (2018), the IASB had to accommodate several countries’ requests over its life.
43 As it is clearly stated in its website (see https://www.efrag.org/About/Facts).
44 “Politics of expertise” represents a contemporary evolution of the well-known technocracy, which he describes as “[…] a political regime rooted in the social and economic transformations typical of contemporary societies with a high level of economic development” (1999, 11).
science” will be but a “government of scientists”, since in reality there is no “reason” without humans (1999, 25-26). Humans will always be the biased means through which any polity is implemented, whereby a politics of expertise is not enough to prevent technocracy from turning into oligarchy.
Concluding remarks.
I started off this paper by arguing that the decision taken by the European Commission in 2000, through which the IASB has been appointed to issuing mandatory financial accounting standards, is potentially detrimental for the already criticised democratic nature of the EU. At the end of the examination, there are specific points that undoubtedly prove how European financial accounting standardisation presents serious concerns in relation to democratic deficit and confirms the necessity of further investigation. First, the legitimisation of the IASB and its current composition raise concerns about its capacity to achieve the claimed target. The only political control is exercised by a body, EFRAG, which is a private association. Moreover, in case the IASB fell short, there is no certainty about who would carry the burden of that negative result in terms of accountability. Finally, technocracy helps shed light on how policy-making and regulation are in those policy areas dominated by low “political salience” and high “uncertainty” (Radaelli 1999), such as financial accounting standards.45
Furthermore, I have only mentioned the rising of a highly controversial form of regulation without addressing it properly, namely soft Law. It has been acquiring more and more strength vis-à-vis “hard” Law and its legitimisation through EU’s endorsement (Newman and Bach 2014), as in the case of financial accounting standards becoming mandatory. This issue is intimately related to democratic deficit and international standards. Therefore, it should be studied not only by students of Law, but also by political scientists.
From a wide political (and philosophical) perspective, what has been described so far is but a clash of heterogenous forces that shape our reality, from politics, through law, to economics. As encompassing as the debate about the democratic deficit may be, it is perfectly caught by Wendy Brown when she says that the relation between democracy and sovereignty “[…] is a question posed by the evolution of the European Union, as post-national political forms intersect with transnational economic powers to foment anxiety about the means by which democracy can be secured and practiced” (Cheah and Guerlac 2009, 117).
If, as it seems, this clash is a matter of evolution, which involves the concept of democracy also outside the EU, we should aim to achieve consciousness about the changes occurring nowadays and their major impact. Indeed, European financial accounting standardisation is widening the gap between the ideal of democratic institutions we pursue and the structure of the system that European economic governance is currently
45 Radaelli clarifies that experts play a different political role when an issue, even belonging to an “uncertain” policy area (because such an issue is puzzling), became politicised (1999, 47).
implementing46. Accordingly, it appears to me that “democratic deficit” is a subject still open to research, especially in the light of the growing relevance of international standardisation as “soft law” that increasingly regulates matters with a tangible impact on daily life. Therefore, it would be prudent not to dismiss the topic in the next future.
46 Moreover, that is consistent to the autocratic character which, according to Kreuder-Sonnen and Zangl (2014), the EU features.
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