BUSINESS BLOG - Ian Welch

Crying wolf does not help regulation debate

So the Dodd-Frank Bill, dubbed the biggest overhaul of US financial regulation since the 1930s, has been signed into law. 

President Obama's political opponents are already warning that the vast 2,300 page bill will damage US competitiveness and lead to business uncertainty, given that it instructs government agencies to create hundreds of new rules and regulations and guidance notes.

It will only be possible to say whether such a huge regulatory and structural change is a success with the benefit of several years' hindsight, but there are parts that look good. The establishment of a regulator for consumer protection has to be a good thing, given the sub-prime mortgage disaster that sparked the financial crisis. While the principles of caveat emptor must always apply, groups of consumers who are new to financial products markets are entitled to expect a degree of official support.        

Similarly, the efforts to address one of the key aspects of the financial crisis - the 'too big to fail' banks - must be applauded. A re-introduction of Glass-Steagall was never going to be on the cards, given the strength of US banks lobbying, but procedures that will allow the safe dismantling and winding down of a huge bank in peril, without causing mayhem in the wider market as the fall of Lehmans did in 2008, must be a big step forward. The concept of moral hazard has to be maintained and this appears to achieve it.

Other measures such as driving more derivatives trades through public exchanges should increase transparency while the requirement for credit ratings agencies to establish internal mechanisms for determining their ratings, to use additional external sources of information and to disclose their methodologies, seems eminently sensible. The promised SEC probe into agencies which for years have suffered from an essential conflict of interest - ie rating the same institutions that pay them - will keep them on their toes.  

Of course, any huge regulatory shake-up - especially one that involves setting up new agencies and reshaping responsibilities of existing ones - suffers from the potential danger that teething bureaucratic problems will overshadow and mar what is trying to be achieved.   

It is interesting that some are comparing the current US regulatory overhaul with the Sarbanes-Oxley legislation of 2002. That Act, which followed the Enron scandal, was for years demonised by many in the West as the epitome of knee-jerk, excessive over-reaction, which cost business billions to no great purpose. Last month, it even had to survive a concerted legal effort to derail the Act by its opponents.

Yet it is now largely recognised that Sarbox, by requiring senior corporate officers to take personal responsibility for the accuracy of their firms' accounts, has led to increased accountability and transparency. And while it did not prevent the governance and ethical failures among financial institutions that was central to the financial crisis, how much worse might the situation have been without it? Sarbox, together with strict US Federal sentencing guidelines, has had an impact on executive behaviour.

A 2007 survey carried out for ACCA by CFO magazine found that among finance executives in Asia Pacific more than half found that Sarbox was useful to them in helping to establish financial disciplines, processes and internal controls. The fact that everything had to be documented and audited, far from being a burden, was seen as giving the businesses more confidence to focus on growth.

Might it be that opponents of regulatory change simply have to accept that a huge crisis will inevitably mean a major response? Certainly, bureaucratic overload must be contested - and Sarbox's requirements have probably had adverse effects on smaller-listed businesses. But crying wolf and exaggerating the threat to national competitiveness is not helpful.  

Ian Welch

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At last! New tax body is ACCA campaign success

Like London buses, you wait ages for a new Treasury body and then two come along at once.

The Office of Tax Simplification (OTS) was launched on 20 July by the new-ish UK government to a wide welcome. It joins the more-heralded, but already under-fire, Office for Budget Responsibility (OBR) which was established almost immediately by the coalition government in May.

ACCA can claim at least some credit for the OTS. For exactly 10 years, as the UK's tax system has become ever lengthier and more complex, we have been arguing the case for a tax policy committee of experts that would attempt to take the politics out of tax. We also argued that other countries, facing similar problems in the creation of tax policy, would benefit from such a set-up.

The basic thesis was that while government would set the overall economic framework of the tax environment, the tax committee would work on adjusting the tax system as appropriate, with a view to making the system more effective, simple and transparent over the medium and long term.

The point - as illustrated vividly by the previous government's endless tinkering with the tax system over the past 10 years - is that politicians find it irresistible to introduce tax breaks to 'reward' certain classes of taxpayers while cracking down on supposedly less-deserving groups.

But such an approach does not lead to coherent tax policy-making. We argued that if the government would set the public policy objectives in terms of public finances and fiscal targets that tax measures were designed to achieve, then the committee could get on with finding the best way of achieving these.  

For many years we were told that this was politically naïve and that no politicians would give up power in this respect. But the OTS will come close, in having a group of experts reviewing the colossal 11,000 pages of UK tax law and suggest ways of cutting out the endless thickets of reliefs, allowances and exemptions. Serious simplification can only be a good thing, not least for small businesses, who are least able to cope with the ever-expanding tax law jungle.

Of course the success or otherwise of the initiative depends on the government taking the committee's proposals seriously and acting on them. It also requires the Treasury not to insist on having 'representatives' on the group who can steer the ship in an 'acceptable' way. Such fears of government interference have already seriously undermined the much-trumpeted OBR, which was supposed to be an independent economic forecaster incapable of being influenced by 10 Downing Street, but which has been caught up in the hurly-burly of party politics. 

Some argue that budget forecasting is an integral part of the Treasury's responsibility and the government has no right shifting this role on to another organisation. While this is a reasonable argument, the recent history of government economic forecasting is one of over-optimistic growth figures and tax receipt forecasts, which suggests another system is worth a try.

Of course, it is still early days for the OBR and we must hope it finds its feet and establishes its credibility. Likewise the OTS, because the effective management of the taxation system is a crucial factor in helping to encourage long-term stability and competitiveness in the economy.

Tax simplification will be no mean feat. It will take a valiant and determined group of people to tackle issues such as capital gains tax taper relief, inheritance tax in relation to trusts, national insurance and income tax benefit rules, VAT partial exemption... the list is endless.

We wish the group luck and offer it our support wherever possible. Other countries will be looking on with interest to see how the OTS and OBR perform.

Ian Welch

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Regulatory musical chairs won't stop excessive dancing

The new UK chancellor has announced a radical shake-up of the City's system of regulation. A system which, not entirely co-incidentally, was set up to great fanfare by the former prime minister in 1997. 

The 'tripartite' system, where regulatory responsibility was shared between the Bank of England, Treasury and the newly-created Financial Services Authority (FSA), was, along with the establishment of the independent Monetary Policy Committee, Gordon Brown's big initiative in his first days as new chancellor. And for the next 10 years many commentators thought it was his best.

1997-2007 was, of course, what Bank governor Mervyn King termed the NICE (non-inflationary consistent expansion) decade - one of benign economic growth. As we now know, in fact an unsustainable debt bubble was building up along with huge economic imbalances, and the US sub-prime mortgage disaster proved the spark to bring the years of plenty to a juddering halt. The regulatory system in the UK, along with many other countries, proved not to be fit for purpose when put to the real test.     

But does this mean that the scrapping of the FSA and its incorporation into the Bank, as part of a myriad of new Bank agencies, is the right approach? There seems a whiff of fighting the last war here and it must be hoped that the system is not being put through a new period of vast organisational upheaval by the new government in order to make a political point.

True, the FSA was unquestionably asleep at the wheel going into the crisis. But the Bank, under King, was responsible for keeping interest rates excessively low - the main domestic cause of the debt bubble. Has it proved worthy of the new regulatory powers that are now being invested in it?

The FSA has certainly upped its game considerably in the past two years and is now a very pro-active supervisor. It should be noted that the biggest cheer given by the City audience for the chancellor's speech was the news that Hector Sants, the FSA chief executive, was going to remain as a powerful figure in the new set-up. This may at least prevent the worst of the inevitable uncertainty that now sets in over the next two years until the new structure is fully operational in 2012. Although the fact that he was, reportedly, only persuaded to stay on in the last few days does little to ease any anxieties. 

And uncertainty there still will be. Any large structural change runs the risk of turf wars breaking out and staff becoming distracted. With the financial system and wider economy barely out of intensive care, this seems a strange time to be looking inwards again, not outwards. The eurozone crisis could break out at any moment and engulf the UK.

In its 2009 paper The Future of Financial Regulation, ACCA argued that there was no one regulatory model that was demonstrably superior, which is why any talk of a global super-regulator must remain only talk. There is, of course, a reasonable argument that the central bank is best placed to monitor systemic risk. But we are where we are - and that is 2010 and not 1997 before the FSA existed.

King told the audience that his main role in enforcing financial stability will be to 'turn down the music when the dancing gets a little too wild'. This is a fairly obvious reference to the notorious remark by Chuck Prince, CEO of Citigroup, who said of the investment bank's aggressive leveraged lending policies in July 2007 that 'as long as the music is playing, you've got to get up and dance. We're still dancing'.

The chances are that in the next two years, no one will be dancing too wildly, although with big bonuses still being paid, the banks do not show too many signs of contrition. But if they do, will the new regime be any better placed to stop them? And more worryingly, what will happen if there is a new crisis before it is fully operational?

Let's hope it's not a case of 'there may be trouble ahead… let's face the music and dance'.

Ian Welch

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Collapse of bank tax shows limits to global agreement

The collapse of much-vaunted plans for a global bank tax at the G20 finance ministers' meeting in South Korea last weekend has interesting ramifications for both tax policy and the extent of international regulation generally.

In the end, the 'anti's', led by Canada, Australia and China, scuppered any chance of a deal. These countries did not have to bail out their banks during the financial crisis and so, not surprisingly, were less than enthusiastic about having to burden their financial institutions just to show solidarity with those countries where supervision of banks failed. And even France and Germany, loud proponents of such a move, may have had doubts about the domestic effects of doing so.

It is possible that pressure will build up again ahead of the Toronto summit at the end of the June, and, being good hosts, Canada may wish to facilitate agreement on principles of such a tax for those that want it - which the UK and US seem determined to follow. But, clearly, the lack of global agreement means the effect on banks will be diluted.     

Would such a tax have made sense? The proposed levy on the industry into a resolution fund to provide for an orderly winding down of failed firms has its attractions and it is hard to see how this introduces moral hazard as some have argued. But the general tax on profits and size - which will go into government coffers as a way of 'making banks pay their share for the bail outs' - is more dubious.

Windfall taxes hardly ever work and even if individual countries make them stick, customers will end up paying for it on one way or another. Good tax policy requires clear objectives - a mishmash of trying to raise revenue, punish banks and change behaviour simultaneously is not promising.

It is to be hoped that more efficient regulatory supervision and capital requirements under Basel III will be more effective in reining in banks' excesses than hurried taxation. The authorities would do better digging out the IMF paper last year (Debt Bias and Other Distortions: Crisis-related Issues in Tax Policy, IMF staff paper, June 2009) which pointed out that debt was treated more favourably than equity for tax purposes, which seems counterproductive in the present era.  

More generally, does the breakdown of the tax plans mean that the G20 highpoint of global co-operation in the financial crisis has been reached and we are back to every country for themselves? Hopefully not, as global agreement on best practice can be key to good international regulation. But countries will not be prepared to countenance top-down 'one-size fits all' policies that damage their own interests to benefit others.

In last year's paper The Future of Financial Regulation, ACCA argued precisely this point. Regulation must ultimately be implemented nationally, so country buy-in is essential. 

Ian Welch,
ACCA head of policy

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Audit reports - the ultimate answer?

As fans of the late Douglas Adams' Hitchhiker's Guide to the Galaxy will know, the Ultimate Answer to the Great Question of Life, the Universe and Everything is 42. 

Similarly, readers of financial statements will know that the auditor's opinion on whether a company's accounts represent a true and fair view is usually 'yes'. In both scenarios, the reader could be forgiven for wanting to know slightly more of the reasoning behind the conclusion.    

The Hitchhiker analogy was mentioned at one of ACCA's recent UK audit roundtable discussions, which form part of a global series of such high-level discussions. Another participant there referred to the audit 'blackbox', the key to the information that explains the final verdict.    

Both participants were making a similar point that it can be frustrating being presented with a bald conclusion when one knows a lot of detailed work and thinking has gone into that statement. One of the points made in ACCA's recent policy paper on the future of audit is that the profession needs to think a lot harder about promoting the value of audit.

This might be an example where reticence needs to be shed. Is there no way that more of the auditors' input, the sort of material that might be given to audit committees, or included in the letter to management, can be visible to other stakeholders? Investment groups said they thought the audit process too opaque and would value getting more than just a binary pass or fail. Given that shareholders are paying for the audit, what sort of issues should they be made aware of? Greater communication and disclosure in the audit process has come up as a major theme in the roundtables.

What has been encouraging is that banks and credit ratings agencies at the UK events have clearly valued the audit and, indeed, rely heavily on it, in their lending and ratings decisions. Let that point be made clear - in an era where everyone is worried about lack of bank lending, SMEs that are audited will be able to access finance easier than those that are not.

This is a point that policymakers around the world need to bear in mind the next time they come to consider increasing audit thresholds. But the liability issue simply has to be resolved - it is clear that this is seen as having a deadening effect on auditors' ability and willingness to innovate.  

Timeliness has also come up. It is clear that audit reports are typically coming out much sooner after the year-end than used to be the case, but there is still the issue of how audit can match the requirement in other areas - such as management accounts - to report using up to date information.

Will the profession have to ultimately grapple with verifying monthly accounts filed by companies on the internet? There is clear demand for forward-looking information in the audit report rather than a restriction to giving a view on historic figures.

These are just some of the issues that have come out from the audit events held so far. We have further events soon in Brussels and Poland. I am encouraged by the range of suggestions to enhance the role of audit that have come from the roundtables and ACCA will collate these at the end of the current series.

We may not come up with the Ultimate Answer but I'm confident we will have some good recommendations to give to governments and regulators.   

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Sovereign debt - Greece is the word

For the last two years the global financial crisis has centred on banking and corporate debt. But the current financial crisis in Greece is the most dramatic example yet of sovereign debt.

Could it be the forerunner of wider problems? Already Portugal, Italy, Ireland and Spain (which, when added to Greece, have spawned a particularly unfortunate moniker) face serious economic problems while European and other financial markets are beginning to slide as fear grows of further contagion. The UK's huge debt will now encourage further unwelcome attention from currency speculators.

There are so many aspects to the crisis it is hard to know where to start, but as good a place as any is Greece's entry into the Eurozone back in 2002. Goldman Sachs is now under investigation from the US central bank for its role in using derivatives and complex currency swaps, which allowed the Greek government to cut its national debt sufficiently to meet the criteria for entry.

There was dark murmuring in certain quarters, both at the time and since, that hard questions were quietly shelved by Brussels for the greater good of securing Greek entry. Which makes it somewhat ironic that Eurostat, the Commission's statistics agency, is now pressuring Athens for information about the Goldman swaps - some would argue that such querying of the finances has come about eight years too late.    

ACCA does not get involved in the political arguments surrounding the euro or EU, although it should be pointed out that a survey of our members in Central and Eastern Europe in 2007 revealed very strong support for their countries being in the EU. But we do believe that the current Greek situation shows all too clearly the need for governments to take serious action to reduce debts.

Of course there are arguments raging as to when and how quickly they should do this, given the dangers of slipping back into recession. But the countries that have over-borrowed are now facing the price of having their credit ratings downgraded, which will mean it becomes even harder and more costly to raise finance. Greece is already seeing a sell-off of its sovereign bonds. Business needs certainty and financial volatility prevents this.

Cutting public spending at a time of high and rising unemployment is never easy. We hope and trust the Greek government's austerity measures will not add to social unrest. But Latvia has quietly done a good job in cutting its debts after the decade-long economic boom came to an end in 2007. And it should be noted that it has achieved this without resorting to devaluation, which at least gives an alternative perspective to the obvious charge that Greece's problems have been caused the euro's one-size-fits-all currency and interest rate.

In an inter-connected global economy there are no hiding places in the long run for economies that lose control of debts. The slower growth rates of the PIIGS economies and the UK are testament to this.

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Can audit help stop corruption? Kiev debates...

In a country where corruption is a widely acknowledged problem, it is encouraging to report huge interest in the Ukraine for an ACCA event on the future of audit last week.

Plunging temperatures of -15°C in Kiev did not stop an enthusiastic gathering of media and ACCA members, all keen to hear first hand from senior Big Four audit partners, regulators, government and the auditors chamber, talking with admirable frankness about the role played by audit in the financial crisis and what could be done to improve things for the future.     

The event represented the third in a global series (following Poland and Singapore last autumn) hosted by ACCA as part of our 'audit and society' activities. The audience heard KPMG partner Gerry Parfitt concede that the profession had been partly to blame for the crisis of the past two years by not doing enough to ensure transparency and beat corruption.

Vladimir Vakht, managing partner of Deloitte, believed that the profession would be a crucial part of the recovery but openly accepted that downward pressure on audit fees made it very difficult to invest as much in employees and procedures as the firms would like to. These are serious issues which the profession must address.  

It was positive to hear Volodymyr Bogatyr, deputy minister of justice, confirm that the government was committed to bringing in IFRS as a matter of urgency, which can only be a positive development for the country's future. Monitoring and implementation of laws in accordance with EU requirements can only help too.

Angela Prigozhina of the World Bank also stressed the importance of auditors and regulators working closely together to stamp out unprofessional and non-ethical behaviour, which was good to hear. It was also heartening to read later in the FT of a business school in Ukraine that is now teaching ethical business courses.
 
Other speakers were more criticial of the audit profession, including Viktor Suslov, a senior financial services markets regulator, who asserted that auditors could tailor their reports depending on who paid them. Some long-standing critics of the profession in the UK would no doubt be cheering that suggestion on. Such plain speaking made this observer's eyebrows shoot skywards on several occasions. The value of ACCA's decision to hold such events in various markets and learn from different perspectives was immediately clear.

It is only by facing up to such straight talking head-on that the profession can begin to win back the confidence of many players in the world economy given the scale of the financial crisis.

ACCA firmly believes audit has a key role to play in re-establishing business confidence, not only in Ukraine but globally. High-level events such as this will place ACCA at the centre of the ongoing debate, and will fulfil our aim of gathering intelligence from different markets that will in turn inform our thinking and policy-making. We have a paper out shortly which will set out our views. Stay tuned.

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Will future tax policy signal end for the nation state?

Tax debate has been strangely quiet over the past two years as the world has gone into financial freefall. But two major new surveys by PwC and KPMG show that the future of tax policy will be a key issue for governments and corporates as we enter a new decade.

PwC's Paying Taxes study carried out with the World Bank, examines the ease of paying taxes in 183 countries from the standpoint of the same case study company. It ranks its comparative findings in three data groups - the total tax rate paid, the time needed to comply and the number of tax payments. And very interesting the findings are.

A total of 45 countries (but few of the leading economies) introduced tax reforms to help businesses in 2009 - some cutting corporate or labour tax rates and others making it easier to file tax returns and pay taxes. Noticeably, the cuts in labour tax were concentrated in Central and Eastern Europe, already the epicentre of flat-tax regimes in recent years. Have they not been radical enough?

The study found that corporate taxes comprised just 38% of total tax paid - worth bearing in mind next time you hear politicians going on about having reduced the corporate tax rate as if it were all that mattered. And the development of electronic filing in many economies in recent years has had a real impact - companies in countries still lacking e-filing for all their main taxes such as Cyprus, Slovakia, Poland and Romania had to endure the largest number of different tax payments.

A company in unashamedly high-tax Sweden, on the other hand, could pay all its main taxes (corporate, income, labour, VAT and property) in a single online payment. So much easier, though whether it makes up for the high rate depends on your politics.

The KPMG Corporate and Indirect Tax rates survey revealed that the long-term reduction in corporate rates by countries competing for inwards investment - an annual finding over recent years - juddered to a halt in 2009 as governments sought to balance their books. In Europe for example, the rates remained unmoved for the first time since 1996 and in Latin America since 2004. Yet indirect tax rate in both regions edged upwards.    

KPMG points out that over 150 countries now have indirect taxes and the range of services covered is increasing all the time. Asia-Pacific rates are expected to increase while Europe's may soon hit 20%. Given that indirect taxes hit goods and services that are relatively immobile, is this the future of tax policy for governments that will trumpet a renewed cut in corporate rates while quietly increasing VAT? A broadening of the tax bases in most economies seems inevitable.

The study poses one last question - are we seeing a debate beginning on worldwide rather than territorial taxation? It could be seen as the logical extension of revenue authorities working much more closely together in recent years on issues like transfer pricing as they try to combat global tax avoidance. KPMG says that 'if that occurs, the financial crisis will truly have triggered a revolution in the way companies are taxed'.

More than that surely? Wouldn't it effectively signal the beginning of the end of the nation state? In ACCA's tax principles paper issued last year, we support the principle of 'nations being free to determine their tax affairs within the context of a global competitive environment'. Let us not lose that. But it seems clear that, just as co-operation between states over financial regulation will increase, so the notion of a tax equivalent will be one of the key policy debates in the next decade.

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Financial regulation - is it heading in the right direction?

ACCA has just published a follow-up report to its well-received June policy paper, The Future of Financial Regulation, which enjoyed major profile around the world.

The sequel paper reviews the extensive regulatory developments that have taken place, principally in the UK, US and Europe, since June and assesses current proposals against the principles set out by ACCA in the original paper. These principles include the purpose and structure of regulation; competition; standards of conduct and competence; governance, accountability and incentives; risk management and capital funding.  

So what is our conclusion? It is still too early to give a definitive view as the proposals are still being consulted on at national and global level and the debate will go on way into 2010. But some of the key points made by ACCA have been followed, notably on the welcome maintenance of national supervision as the bedrock of regulation.

Speculation earlier this year of the introduction of some sort of 'super-regulator' has remained, mercifully, just that. The 'connect' between regulator and regulated must be maintained, which is why we also have some concerns about the proposed pan-EU regulatory architecture - co-ordination and best practice sharing is good, but remoteness is not.

Other concerns include a lack of action on the so-called 'too big to fail' institutions - a systemic risk surcharge is good, but why shy away from considering more seriously a Glass-Steagall type division of investment and retail banking activities? Ethics too, one of our key principles, has seen little activity.  

I will come back to this subject soon, but I must say how delighted I was to learn last week from Dr Nataliya Vovchuk, ACCA's head of Ukraine, the Baltics and Caucasus states, of the extremely positive response she has received when presenting the June paper to regulators, governments and top business people at a series of high-level events throughout her vast region, which stretches from north Europe to deep into Asia.

ACCA's belief in national regulation and a focus on effectiveness rather than a sterile 'light-touch or heavy?' debate has been strongly welcomed by those audiences.

It is tremendously encouraging to see ACCA's Thought Leadership being debated where it matters.

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SMEs are key to global recovery - let's help them

SMEs are, by their nature, resilient creatures. A major global survey commissioned by ACCA, and published today, shows just how important that tenacity has been over the past two years – and continues to be – as their ability to access finance has been squeezed.

ACCA, in conjunction with two other international accountancy bodies, CPA Australia and CGA-Canada, commissioned the respected Economist Intelligence Unit (EIU) to carry out a global report on the issues faced by SMEs. The three bodies then worked together to produce policy recommendations based on the EIU's findings.

The EIU study reveals a picture of SMEs battening down the hatches. Banks have not passed on interest rate cuts and executives at SMEs expect lack of funding to be the main constraining factor on their businesses over the next two years. Many are, to preserve cash, postponing investment and focusing on cost reduction.

This lack of investment, which includes staff recruitment, means it will be difficult for them to capitalise on the increase in demand, when it comes. Most of them predict slow improvement in economic conditions in 2010, with a return to some sort of normality in financing by 2011.

But it is also clear that there is a sizeable rump of SMEs facing particular difficulties. 26% said their debt had increased over the past three years and a similar number had refinanced in 2006, just before the slump. These businesses face a tricky time refinancing again in the near future. And 29% are not sure when, if ever, they will be able to access finance in pre-slump levels. So what are their business models looking like now?  

It is clear that governments, banks and small business advisers – notably accountants – must all act to help the SME sector through these tough times. Governments can help by putting SMEs to the top of their agenda and produce suitable fiscal incentives, proportionate regulation, and action to boost asset and equity finance – including business angel investment – to provide alternative sources of finance. Banks need to empower their staff to handle SMEs better – and accountants can mediate and, where necessary, advise of other options.

This is the first recession that a new generation of entrepreneurs have faced – and it is a bad one. Yet the resilience of the sector shines through, in all markets of the world. More than half of the SMEs surveyed still expected revenue growth over the next two years. Governments should remember – the SME sector will drive the recovery. Just give it a chance to do so.  

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