The Public Sector Accounting Board is introducing new standards that will impact public sector financial reporting for years to come. The proposals are largely focused on creating greater transparency and understandability in order to increase accountability. How will the new rules impact the financial future of the public sector and institutions under financial pressure?
Umar Saeed, partner at Welch LLP, is an expert in public sector accounting standards, as well as international public sector accounting standards. Umar Saeed joins Sharon Bowes at NewsPoint360 to discuss these new standards in the video below.
Understandability: the concept that we should all be able to easily comprehend public sector financial information.
So, with broad strokes, what are these new standards and who is going to have to adhere to them?
[Umar]
This is a topic that doesn’t always get a lot of attention, but I think is very important and it’s in the public interest. I think, over the next several years, we’re going to see many major changes to public sector accounting. Simply put, these existing standards just don’t cut it.
The Public Sector Accounting Board (PSAB) has a plan in place. Some of these examples I’m going to talk about really speaks to the sophistication of the deals that the government is doing, and the increased risks that we’re taking on as a society. The move that the board is making is essentially going to fill in these gaps in our Public Sector Accounting Handbook, and make sure that there are proper standards in place so that governments are accountable for these risks and these liabilities.
I’ll speak to one complex financial instrument such as derivatives.
Governments borrow all across the world. They don’t borrow from people like you and me, they actually go to institutional investors. Those investors are sophisticated – they don’t necessarily want Canadian dollars, they might want foreign currencies; they don’t necessarily want fixed interest, they want variable interest. So as the government is aggregating these funds to run the operations at home, it’s taking on currency risks, it’s taking on interest rate risk, and it uses derivatives to mitigate those risks.
Currently, we don’t have a standard in place to establish the groundwork, the recording of derivative, and the risks associated.
Another topic, which I think post-pandemic will be quite relevant, is the subject of public-private partnerships. What do we do when we run up against the wall where we can’t just borrow and build something again? I’m not really here to say whether these deals are good or bad, but at this point, it is a way to alternatively finance something. You share the risks with the private sector, you share the rewards with the private sector, but you don’t have to upfront fund the entire infrastructure. So, with aging infrastructure, this is going to be a tool that governments will probably use.
Considering the vast Canadian landscape, British Columbia might do a deal similar to Ontario. However, everybody is sort of left to their own devices in terms of how they want to account for that deal, what they want to record on the books, what risks they want to disclose. That’s another standard that’s going to come into play, and really just establish a level of consistency across the board.
Finally, who is impacted? This is a very broad, sweeping impact. The Federal Government of Canada, the provinces and territories, indigenous governments, local governments, regional governments, and then even the broader public sector. This includes hospitals, school boards, universities, colleges, and museums. Thousands of entities will be impacted by these standards when they come into play.
So is this move aligned with the adaptation of the International Public Sector Accounting Standards? How does it better serve the public interest?
[Umar]
PSAB has made a recent decision to align itself with international standards to harmonize. This is in line with a lot of nations around the world – Australia, New Zealand, the UK, South Africa. There are a couple of reasons why this is in the public interest, but first, we will talk about why governments adopted PSAB standards in the first place.
I think we take for granted that PSAB has no legal authority over the governments – the governments voluntarily adopt and apply their standards. This goes back to a movement in the 80s and 90s, among many of the nations that I mentioned, where there was an effort to legitimize the books and records of the governments. It’s key that the government doesn’t set the standards themselves or is in a position to govern those standards, so an outside body is essentially the only way they can do it. That’s the role that PSAB plays. That’s why this movement to further harmonized standards across the globe is really just another step towards the government relinquishing their power and influence, telling us that these standards will be fairly set with due process, and the government is going to follow them in a transparent and accountable way.
With this backdrop in mind, there are some practical implications for what’s about to happen to the public sector in Canada. By moving internationally, we are looking at a bit of a regime shift.
Traditionally, Canadian standards have been rooted in historical cost, reliable figures, hard dollars, and focusing on the annual surplus and deficit, considering questions like “did we balance the budget?” “Okay, there’s a deficit, how do we get the path to balance?” This traditional approach, although quite similar to the private sector, has been recognized as fairly limited because we’re not looking at the balance sheet. This approach is focusing too much on the annual results. The balance sheet tells a different story: our liabilities are growing at an incredible rate.
Additionally, we’re not talking enough about the long-term risks of some of our actions. And again, that may not show up in this year’s annual surplus deficit. So this is an effort to get these broad themes, such as sustainability, into the realm of public sector accounting.
There a different kinds of sustainability. Financial sustainability addresses the government’s growing debt, and looks at the balance sheet and what level of debt it can sustain; Social sustainability addresses entitlement payments, universal basic income, the effects of politics on our balance sheet; Environmental sustainability which addresses the increasing flooding events, wildfires in the West Coast, freezing rain events.
So when we look at our assets and our public infrastructure, they’re becoming impaired. How do we recognize that on the balance sheet? For very big, pervasive climate change events, a lot of these risks fall through the cracks – private sector policies won’t cover it, so who’s left to foot the bill?
I think we have to recognize some of these environmental costs are actually going to end up being an obligation for the government, again, impacting that balance sheet.
I don’t think we will stop talking about the surplus and deficit altogether, but I think the aim is to start talking about other really relevant things at this day and age and make sure that’s part of the policy conversation as well.
Right now Laurentian University in Sudbury is making headlines after seeking creditor protection due to unprecedented financial challenges. That’s not something that you hear in the news every day. Is this a classic example of why these new standards are needed? If implemented, could this have been prevented?
[Umar]
I think primarily, this is an issue about governance. I’m not personally convinced that new standards could have prevented this – PSAB standards in this particular area, are fairly robust. But the accounting is sort of co-mingled with governance, and I want to speak to that a little bit.
This is a classic example of how accounting motivates, or sometimes demotivates, the proper governance from happening. And really, if we look at the Ontario setting, universities are not controlled or deemed to be controlled by the government. Therefore, they’re not consolidated, they’re off book. Their debt and deficits, are not really the government’s financial reporting responsibility, and vice-versa. Since some of our universities are older than the institution of the government in Ontario, this has been the case for a long time. Universities aren’t necessarily interested in being controlled by the government. The universities like their perceived independence, and they want to be able to openly critique the policy of the governments. But also, the government is not interested, in having an active role in governing the university sector. As such, both parties have sort of been hands off, and it’s worked well.
But consider this: in British Columbia, all the universities are controlled by the British Columbia government. They are reported for by the government, and there is accountability in place for matters such as this not to happen. That being said, it’s not to say that this couldn’t happen in British Columbia, it’s that we wouldn’t be sitting around in a room trying to figure out who to point the finger at. The British Columbia government essentially owns that responsibility and that relationship, whereas in Ontario, we’re looking at the board and the government, and everybody’s struggling trying to figure out what went wrong.
I think that’s a key distinction. I don’t want to imply that there’s been any accounting tricks in this situation – I think the government and the Auditor General are satisfied that the universities are not controlled and that there’s an independence there. But I think what the implications of that is it means that the government can step in. If the government doesn’t have desire for this control, we have no practical tools to step in, to right the ship before it goes wrong, to perhaps stop a project from going ahead, etc. It’s essentially up to the existing governance structure.
Even outside of the university context, this is a classic issue. It’s always politically convenient for the government to have a crown corporation be at arm’s length, but the ministers are removed from it. And they want that autonomy. It’s actually more efficient. I don’t want to waste the burden of government to oversee every little thing you’re doing. 95% of the time, it works out fine. The problem is in the minority of times where it won’t work out. This happens with poor governance, with fraud, with mismanagement. The government’s hands are tied, but they’ve actually tied their own hands because they wanted this distance in the relationship. And I think that’s really the underlying problem we have to address.
So, in a situation like this, what’s the likely outcome? The Minister of Colleges and Universities Ross Romano has said Laurentian students remain the government’s priority. So what’s the likelihood of a bailout? Is there a possibility of a loan with reduction in annual grants over the next several years, or is the taxpayer ultimately going to be on the hook? What’s the most likely scenario in your eyes?
[Umar]
I think the form of it is up for debate, but there will definitely be a bailout. I mean, this is a public university, there needs to be an injection of liquidity. We’re talking about years of research at stake. Teachers, students, so many stakeholders are going to be affected. But more importantly, I think we need to recognize that essentially the public sector debt, and this includes Laurentian University, is implicitly backstopped by the more senior levels of government.
What I find interesting is everybody charged with governance in the Laurentian University ecosystem really did operate as if somebody is going to swoop in at some point and solve whatever problem we have. You have the governing board that essentially, in retrospect, green lighted a lot of questionable business plans. You have years of deficits that are being approved, you have the auditor really making no mention of any sort of growing concern issues or cash flow issues. You have the governing board overlooked. You have research funds that were repurposed for paying the bills. And again, that just really shows that they never really were concerned about external obligations. They just assumed that, at some point or another, the money will flow through. Consider even the banks. From the bank’s perspective they continued to lend to Laurentian University, seeing the ongoing deficit, seeing the cash flow issues. And so we have to ask ourselves, why are all these rational actors in the university sector so willing to take on financial risks on themselves or on behalf of the university? It’s really because there is this implicit promise, not a legal guarantee, which public sector debt or bonds are going to be backstopped in one way, shape or form by a more senior level of government.
So whether it’s Laurentian University borrowing from the banks, or a small municipality issuing a bond, or it’s Ontario itself, which runs the largest debt program for any sub-national organization, the investors in that debt think of Canada as a unified institutional framework. If anybody became distressed and had problems paying the next interest payment, or the next monthly payment, somebody’s going to swoop in from somewhere, and there will be a transfer payment, or a loan, or something. That is effective for us because it allows us lots of credit at a very cheap cost.
Now, what if we were to let Laurentian fail? What if the government said “we’re hands off”? I think what we would immediately realize is that the banks and all these lenders would increase the risk profile of public sector debt. It’s not that you can just put a box around Laurentian and say this is a one off, because there’s an implicit assumption that we are going to backstop these sorts of debts and promises. So I think that’s really an important thing to know about public sector debt.
The second part to your question: what is the likely structure of a bailout? I think the suggestion you made is reasonable. It makes sense that you would provide the loan, it gives Laurentian University some liquidity, which is what it needs right now. It also holds them accountable, in the sense that there’s a reduction of grants, and as we move forward it’s time to right the ship – let’s get this house in order.
But in order to do that, there’s some fundamental questions underlying all the governance stuff. Are the revenues post-COVID going to be there to sustain its existing operations? Does it need to scale back its operations? Maybe it’s just overextended, and it needs a small sustainable footprint?
To me, the interesting question is what role does the government play in establishing that vision? Are they still going to be hands off and sort of say “you come up with a plan and we’re going to give you the funding?” Or is the time to just recognize, maybe we need to step in? Maybe we do need to enhance our legislative powers and be more involved and craft a plan together that’s in the public interest. So I think that’s really more fundamental for the government to figure this out.
Well, what can governments do to assess and manage these risks? You suggested earlier that the new accounting rules introduced by the Public Sector Accounting board will go so far. Will they go far enough?
[Umar]
Yes, I’ve mentioned a couple of standards. I think the broader takeaway is that this is really a regime shift. And there’s going to be increased focus on public sector balance sheets and the risks associated with.
Laurentian University is a good example of why we need a new approach. Governments are effectively becoming insurance companies. In addition to backstopping all this debt, which I think we sort of know the governments are backstopping our standard of living through social benefits. As I mentioned before, these CPP, EI, OAS, this year was CERB – another aspect that I guess we didn’t know until the pandemic was the government effectively backstops business losses during a pandemic. I don’t think anybody had any idea that they would do that, but that’s effectively what happened because private policies didn’t cover business interruption related to pandemics.
Finally, climate change. We touched on that earlier as well. Where the private sector is not willing to cover the costs of these pervasive tail risk events, the public sector has to recognize they’re the ones going to be footing the bill. So this approach is kind of a risk based approach, and really recognizing these risks is key. All these seemingly distant risks ultimately convert into hard dollars that we have to cut the check and deal with the issue. That’s what it feels like we’re doing right now, we’re just cutting a check, after check, after check, because we really didn’t do the scenario analysis and the risk analysis that we should have done a long time ago. I think that’s what the approach is going to bring to the table. So moving to that approach, my hope is we start to identify these risks, and we start to quantify the magnitude of what they could potentially be. That is what the account’s role is going to be, then it’s up to the policymakers to figure out what’s the right policy to address this issue in the long run.
When I speak to the insurance issue, we need a shared risk model with private insurers to talk about these tail risk events. These big events are just going to knock us off our feet because otherwise we’re just constantly trying to catch up to the things happening in the real world.
From my experience, accounting does change behavior. I think, a few years ago in the public sector, we had adopted environmental remediation obligations. We recorded millions of dollars of books across the nation. What it shed light on was we’re so quick to invite people to dig mines, to dig oil wells, to create jobs. And yet, when the companies disappear, and they’ve taken the profits and the mines are dry, we’re left with the remediation obligation. So we need to think a little bit more holistically about our policies. That standard should shed light where we need financial assurances from these companies in advance. There is a long-term cost to those jobs and that economic stimulus.
