The adoption of international financial reporting standards (IFRS) carries key risks for the credit ratings of Australian firms, according to a leading ratings agency.

Standard & Poor’s (S&P) said last month that while experience from Europe suggested there would be limited ratings actions stemming from IFRS adoption, there were a number of risks to ratings through transition.

The largest risk to credit quality, according to S&P, is a change in management behaviour. The fear is that if management makes decisions based on the portrayal of financial health through accounts, rather than economic reality, the company’s cash flow may be subject to greater risk and volatility. In the areas of interest rate risk, commodity risk and currency risk, this issue will be particularly acute.

Additionally, there are fears of behavioural changes from key counterparties due to IFRS transition.

“New insights may become apparent to shareholders, bondholders, regulators and other stakeholders, causing them to change their view of a company or how that company may compare with its peers,” S&P credit analysts wrote. “In this way, a change under IFRS could morph into a change in sentiment or behaviour, either positive or negative, toward a company.”

Problems regarding communication with the capital markets are also likely.

“There is likely to be greater volatility reported in the profit and loss statement under IFRS because of the application of fair value to some balance sheet items,” S&P said. “Investors and other stakeholders are likely to look to management for reassurance that such results are only a function of the accounting methodology, not actual greater volatility of profitability.”

Managing market reaction to changes in reported accounts would be key to ensuring a trouble-free IFRS transition, S&P said.

However, it may not be easy, according to a recent KPMG survey.

Companies must prepare financial reports to comply with IFRS commencing on or after 1 January, but KPMG’s study found that two-thirds of capital markets analysts will mark down a company’s shares if they do not understand why the company’s results look different.

None of the analysts surveyed said they felt very confident about their ability to distinguish between changes in a company’s reported results due to changes in underlying business performance and those that relate to IFRS adoption, according to Geoff Wilson, national managing partner at KPMG’s audit and risk advisory practice.

Moreover, two-thirds of the surveyed analysts said they believe it was the responsibility of the companies they track to educate the market on IFRS in Australia.

“Yet most have so far received little or no information about IFRS matters from those companies,” said Andrea Walters, KPMG’s IFRS leader.

“To help analysts and the market better understand and appreciate the move to IFRS, companies really need to put a high priority on market communications.”

But the responsibility to manage market communications in this area lies with boards of directors, as does managing the transition to IFRS.

The move to IFRS – a bone of contention for many corporates here – will be a drawn out process, while financial disclosure is also an issue, according to Fitch Ratings. Enhanced disclosure through IFRS and local initiatives has the potential to change disclosures and this could reveal aspects of transactions that were not properly disclosed in the past, and could uncover previously unidentified risks.

Moreover, derivatives – dubbed financial weapons of mass destruction by legendary US investor Warren Buffett – are also an area of concern, with the potential for incomplete and inconsistent disclosure.