Alliance Notes: Ian Ball on the Critical Role of Accrual Accounting to Sovereign Decision Making, Community Consent in Mining with Emily Greenspan

Monday, May 18, 2020

This Week at the Alliance

Announcements

The Alliance’s Extractive Industries Working Group is gathering feedback on the recently published report by the Transition Pathway Initiative (TPI) on the carbon intensity of the global diversified mining sector. See our writeup of TPI’s report in last week’s newsletter, and reach out to us if you would like to participate in an upcoming call on this subject.

Ian Ball on the Critical Role of Accrual Accounting to Sovereign Decision Making

Source: Professor Ian Ball.

On May 5, our last Debt and Fiscal Governance Working Group call turned its gaze to the southern hemisphere, whence Professor Ian Ball of the Victoria University Wellington School of Business and Government joined us to talk about New Zealand’s public financial management (PFM), which serves as the gold standard for government reporting and decision making. New Zealand’s transparent, accrual-based accounting system, of which Ian was an architect, is arguably a contributor to the country’s strong governance record in other areas—such as its coronavirus response, which has lately been credited as one of the most effective, with just 1,498 confirmed cases and 21 deaths to date. As advocates for fiscal transparency, it is important for us to understand how New Zealand is able to run such an effective government, and the value of strengthening public sector balance sheets in emerging markets.

The International Budget Partnership ranks New Zealand #1 in the world in budget transparency in its Open Budget Index (OBI), the latest survey of which was just released. New Zealand is also one of the few countries to have implemented a comprehensive accrual accounting system across the public sector based on the International Public Sector Accounting Standards (IPSAS). It uses this framework for both  reporting and decision making.

Decision making is the key point here. Under accrual accounting, policy decisions are based not only on how they will  affect cash on hand, but also on the full impact they will have on public net worth, a more comprehensive measure of the fiscal position and national well-being. This is because accrual reporting involves recording the economic substance of transactions as they occur, rather than when cash settlement occurs. This is a fundamental measure of  good decision making, as well as transparency and accountability. High quality information is at the heart of most PFM systems. “Accurate accounting,” according to the IMF Global Finance Statistics Manual, means more than cash and debt—it includes all revenues, expenses, assets and liabilities.

In November 2018, before the pandemic, the International Federation of Accountants (IFAC) and Chartered Institute of Public Finance and Accountancy (CIPFA) estimated that for 150 jurisdictions, 65% of countries have adopted or will adopt some form of accrual accounting by 2023, up from 25% in 2018. IFAC expects most of this progress to be in Africa, Asia, Latin America and the Caribbean. However in most cases—including the United States and much of Europe—even when accrual accounting has been adopted for reporting purposes, decisions are still made on a cash basis.

This method needs to evolve. Poor fiscal governance limits countries’ ability to rebound from a shock. As the world headed into the financial crisis in 2008, government balance sheets were already weak. After taking a hit in 2008-2009, they did not recover as well as they should have. This lingering damage will only compound the current  pandemic, which is likely to have an even more detrimental impact on government debt than the financial crisis. To withstand this stress, countries need to have the best possible tools to understand the complexity of their financial positions, as Ian argued persuasively in a recent article in the journal Public Finance Focus.

What can emerging markets learn from the New Zealand experience as they address their own set of Covid and economic risks? While the full consequences of the pandemic are as yet unclear, government balance sheets are sure to weaken significantly. According to Ian, the lessons from New Zealand are not so much about implementing a new accounting system (although this can help) as they are about new ways of approaching governance decisions. These ways need to include an assessment of the comprehensive impact of fiscal policy on a country's net worth.  A net-worth perspective can be a valuable guide for policy makers at a time when they will need every management tool at their disposal. Indeed, fiscal positions are too complex to be measured and managed with cash and debt numbers alone.

What can investors do to advance accrual-based reporting and decision making? Ian argues that international financial organizations, such as the IMF, and investors associated with the Alliance can urge governments to commit to make progress toward implementing full accrual accounting aligned with IPSAS. See Ian's presentation here. - Fergus McCormick and Andrew Howell

Mining Spotlight: Community Consent with Emily Greenspan

Source: Oxfam.

Last week, our  Extractive Industries Working Group welcomed guest speaker  Emily Greenspan of Oxfam to discuss community consent in mining—or, to use the proper lingo: the “Free, Prior and Informed Consent,” (FPIC) of communities to nearby mining operations.    

Emily has worked on community consent issues for 15 years and has authored multiple editions of Oxfam’s Community Consent Index, which ranks the performance of 38 multinational companies (including EM players Anglogold Ashanti and Vale) in this area. This work has taken her around the world, including deep into the Peruvian Amazon to inspect Frontera’s controversial Block 192, associated with dozens of spills and protests. On the call, Emily discussed the international frameworks that govern FPIC, the risks that multinationals run in  neglecting it and some examples of FPIC best practice for companies to achieve better outcomes. See her presentation here.

It’s not hard to find examples of conflicts that have arisen between extractive companies and local communities that have led to project delays. According to research by the Centre for Social Responsibility in Mining (CSRM), community antagonism can cost a company up to $20 million per week. Today, under the stress created by the global Covid pandemic, cohesive relations with communities are arguably more important than ever. 

In her presentation, Emily presented a range of projects in which a more thoughtful FPIC process could have led to a better outcome for extractives companies: El Escobal in Guatemala (Pan American), Xolobeni in South Africa (Mineral Commodities Ltd), La Colossa in Colombia (Anglogold Ashanti) and Block 192 in Peru (Frontera Energy). She also reviewed Oxfam’s research ranking diversified mining companies on their level of engagement with the community and implementation of FPIC best practices. 

Her top five recommendations for companies with respect to community engagement were as follows: 1) Engage in a public FPIC commitment, respecting the community’s decision to give or withhold consent; 2) Provide detailed, public implementation guidelines; 3) Conduct transparent monitoring and evaluation; 4) Make public gender commitments and undertake a gender impact assessment; and 5) Respect human rights and indigenous peoples’ policies. These are all points that investors can raise in discussions with companies. – Andrew Howell 

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