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By Ian Welch, head of policy, ACCA

Last week's conference on audit policy organised by FEE, the European accounting federation, gave the profession the first chance to hear from EC Financial Services Commissioner Michel Barnier since his 'the status quo is not an option' speech in February.

Surely, we thought, things must have moved on in the intervening five months?

After all, since Barnier's tough talking in February, European parliamentarians have put forward a series of amendments which ACCA largely welcomes. The MEPs' legal affairs committee issued a report which included:

  • Calling for an extension of the scope of audit, namely to risk, which ACCA has argued for over the past three years.
  • Clear demarcation of audit and non-audit services provided to the same client rather than a ban on the latter.
  • Strengthening the role of the audit committee, which would be responsible for permitting the provision of those non-audit services, and have a crucial role to play in the tendering process
  • No compulsory rotation of external auditors

But observers last week could have been forgiven for thinking that none of this had happened. Barnier confirmed that the EC would be putting out legislation in November, despite rumours that it would be delayed. To remove any doubts, the Commissioner spelled it out: "you might think I'm being too severe – but as I said in February, the status quo is not an option".

Barnier said 'the key word for the profession is independence'. Shareholders and others have lost confidence in corporate reports because they doubt the independence of auditors. 'We see auditors who are too closely linked to clients.' So, contrary to the MEPs' report, the Commissioner went back to firm rotation and non-audit services.

On rotation of firms, he said there needed to be ‘a balance between too much, which would damage quality, and too little, which would harm independence'.

On non-audit services: 'too many are given to audit clients. They will often be higher fee than the audit.'

And then the big one: 'How can you be wholly independent? We have to limit or even prohibit non-audit services for audit clients'. The Commissioner went on to float the idea that 'strictly auditing firms' would open up the market to smaller competitors, though later backtracked on that option – viewed by ACCA as extremely damaging to the profession – in the Q&A session.

On competition or 'diversity' of firms, he insisted that he was 'not crusading against Big Four' although he added: 'we do not believe we should have only four.'

So what was an answer? Another standby from February: 'We are considering joint audits and regular tendering'. At the February event, joint audits clearly divided the delegates along national lines – the French profession was largely in favour while the other states saw them as costly and ineffective. Little had changed except, it seemed, a hardening of the EC's position. Stephen Haddrill, CEO of UK regulator the FRC, had earlier criticised joint audits as being 'an iconic issue within the EU – but not a good issue'. And a UK accounting academic questioned why such ideas from the past were being wheeled out again as an answer to the crisis now.

Nathalie de Basaldua, EC's head of audit unit, who after pointing to the House of Lords Economic Affairs Committee's criticisms of the UK audit profession, insisted that in France joint audits 'have been a way of showing that there are other important players in the market.' So it seems pretty clear that joint audits are still the way the EC is determined to go.

The most persuasive argument was put forward by Wouter Bos, now KPMG partner but formerly Finance Minister of the Netherlands, who said the profession must not react defensively to proposed changes and hide behind standards but must engage with the wider debate and accept that its response to date had been inadequate. In the age of reduced deference to professions, there is no future in just dismissing criticisms as ill-informed, he argued. The audit role must evolve to meet public expectations and even if proposals ultimately come up which we disagree with, this may be the cost we have to bear as a way of rebuilding trust among wider society. In our recent paper 'Audit under fire: a review of the post financial crisis inquiries', we’ve also argued that constructive proposals for audit reform should be welcomed.

To end the day on a wider global perspective, James Doty, CEO of the US regulator, the PCAOB, went through the options laid out in its recent 'concept release'. One of the interesting possibilities floated in that paper is for an Auditors Discussion and Analysis (AD+A), a freeform report which gives the auditors the opportunity to go into greater detail on their findings, mirroring the Management Discussion and Analysis narrative report by the company. This is also one of the suggestions put forward by an ACCA-commissioned paper on extending audit reports, which will be out very soon.

A less welcome area of interest from PCAOB has been on mandatory rotation of firms, which Doty argued might be more effective than lead partner rotation within the same firm. The US audit debate has been slower to get going but PCAOB has been undertaking extensive outreach among investors and other stakeholders during 2011 and Doty is clearly determined to make his mark. ACCA has been active in that debate and will continue to keep you informed.


By Ian Welch, head of policy, ACCA

The long-awaited interim report from the Independent Commission on Banking, headed by Sir John Vickers, has been published today and already the UK blogosphere is alive with cries that the Commission has not gone far enough.

It is true that many would have liked a break-up of the big banks and a formal split of the retail and investment arms. In our 2009 report 'the Future of Financial regulation', ACCA sympathised with the thoughts behind a return to the Glass-Steagall era. While the proponents of universal banks tended to focus on the fact that the original law was introduced in the era of the Great Depression in 1932, it should be remembered that it was as recently as 1999 that the Clinton administration repealed the law. And it can certainly be argued that looser banking regulation since then contributed hugely to the crisis. Mervyn King, Governor of the Bank of England, has repeatedly said that there is no obvious reason why the complications inevitably involved in splitting investment and retail banking should not be overcome.

But one of the problems is that while back in 2009, it seemed that the G20 countries were coming together to co-ordinate financial regulation, two years later things have retreated to a national outlook.

Or, it could be argued, to 'normal'.

While ACCA believes that effective supervision should always be carried out at a national level – one of the principles we set out in the paper was that the regulator should always be closer to the regulated, so that both sides fully understand and appreciate the objectives of the exercise – we hoped that international agreement over best practice and shared fundamental principles would continue.

In reality, this has not happened. The UK is the only leading economy with a 'bank tax' and no other country is actively considering splitting the banks in two. So it is perhaps understandable that the Vickers Commission, even had it been so inclined, has backed away from recommending such a step.

But the proposal it has put forward, to 'ring-fence' the retail from investment arms, and for it to be run under a separate subsidiary, seems a sensible compromise. Capital requirements for the banks will be higher than that proposed under the Basel III Framework – 10% compared to 7% – which no doubt the banks will protest at. And while it is true that the more capital banks are required to hold is capital not available for lending to businesses (the dichotomy at the heart of the government approach to the banking issue) nonetheless this does not seem unreasonable.

It is good to see that competition has been put at the heart of Vickers' thinking. For while the Commission has inevitably concentrated on the high street end, with Lloyds Banking Group faced with selling hundreds of branches, the fact is that competition or the lack of it, was instrumental in creating the financial crisis.

The existence of 'too big to fail' monoliths is anathema to competition and hence to effective regulation. Higher capital requirements and 'living wills' are sensible measures but they also echo the sound of stable doors being locked long after the horses have fled. There is no easy answer to how to deal with the SIFIs (Systemically Important Financial Institutions) but the emphasis on competition and on restoring consumer confidence – consumer deposits and payment systems will be protected via the ring-fenced operations even if the wider system fails – is good.

The five months until the full report will no doubt see vigorous lobbying by the banks against measures they do not like, and equally furious denunciations from some commentators that Vickers has pulled his punches. But in a difficult situation, the interim report seems to have steered a steady course.

Update: Liam Halligan’s piece in the Sunday Telegraph on why he thinks we need a complete separation between retail and investment banking is worth a read.

By Ian Welch, head of policy, ACCA

In last week's Budget the Government called upon the Office of Fair Trading to assess whether bank clauses in lending agreements unfairly restrict competition in the audit market. I wondered whether that might have stolen some of the thunder from the House of Lords Select Committee on Economic Affairs' inquiry into audit competition. From today's inquiry report I can safely say I was wrong.

The Lords Committee has called for a full-scale investigation into the audit market by the OFT (with a possible referral to the Competition Commission), on the basis that the highly complex issues raised go beyond the time and resources available to the Committee. Some of these issues include: lack of choice; higher fees caused by lack of competition; lower quality and the huge risks to the market if one of the Big Four was to fail.

ACCA agrees that greater competition would be a good thing - the Financial Reporting Committee bemoaned last year that previous measures to bridge the yawning gap between the Big Four and the rest had failed. An oligopoly is never a healthy situation, as we saw with 'too big to fail' banks. ACCA believe the Lords recommendation for the OFT to examine the issue of restrictive covenants and audit liability would be an excellent move – both these issues clearly act as a roadblock to competition. We strongly disagree with the view put forward by some of those participants referred to in the Lords report that potentially ruinous liability somehow 'keeps auditors on their toes' – the threat of reputational loss from poor performance is enough to do that. And with audit firms being named and shamed by FRC monitoring visits, this is a reality.

We do not agree that fees are too high – there is genuine competition between the top 4 firms. And the ‘living wills' concept being floated should help to address the 'Big Four becoming a Big Three' issue.

We are very pleased with the Lords’ endorsement of ACCA's long-standing call for the audit to be expanded in scope to provide broader, more up-to-date assurance on matters such as risk management, the business model, and the business review. We believe such reform would do much to reduce the ‘expectations gap’ and meet stakeholders’ needs. Even though most of the investors quoted in the report acknowledged the value and importance of audit in the economy – which we welcome – nonetheless expansion of scope, in conjunction with the necessary liability changes, would be a good thing.

But ACCA is worried at the Lords’ claim that audit quality has been reduced, partly as a result of the introduction of IFRS. ACCA does not believe the banking crisis was predominantly caused by accounting issues and we are not convinced that IFRS provides less scope for auditors to exercise prudent judgement, as is alleged.

It is important to note that the specific IFRS weakness identified by the Lords – around expected rather than incurred loan losses – is already being remedied in the revised IFRS9. The recommendation that UK GAAP should be continued ignores the fact that the key accounting standards in UK GAAP – on financial instruments – are virtually identical to existing IFRS. The IFRS regime includes an overriding requirement that the financial statements should present fairly the position and performance of a company, and we feel the Lords have over-emphasised the differences between UK GAAP and IFRS in this respect.

And we are even more anxious at the message that the inquiry will send to other countries, especially the US as it gears up to make its decision in the next few months over whether to join 126 other countries in adopting IFRS. Of course the standards have to be good enough – and the committee report has quoted many eminent participants in the inquiry process who have disagreed with the Lords’ assertions on IFRS. But any shortcomings of the accounts and audits of banks should not be either a reason to deny global standards to other companies or a justification of continuing to impose on other UK businesses the extra costs of maintaining both systems.

There are other issues with which we disagree. On the thorny topic of non-audit services – always a favourite with politicians both in the UK and in Brussels - while we accept there is a strong case for auditors to be excluded from internal audit work, we do not feel that tax advisory work should be included in any ban, and certainly not for smaller entities. Most companies will feel aggrieved at the prospect of having to take on another firm of advisors to do tax work, something that seems costly and unnecessary.

And on smaller audits, the report almost ritually calls for a reduction in the audit requirement for smaller companies in order to ‘lower regulatory costs’. The Department of Business, Innovation, and Skills (BIS) has also recently suggested this, but both the Lords and BIS have failed to recognise that there would be a downside to removing external checks on small companies’ finances. Audit must not be so lazily confused with red tape.

On the brighter side, the Lords have rightly rejected the idea of compulsory rotation and joint audits, both of which have been floated by the European Commission but which ACCA believes would actually do little to increase audit market competition. Proposals for risk committees in banks and more regular dialogue between bank auditors and regulators should also be supported.

So, in all, a mixed bag. The issue of going concern and how the auditors applied that on bank audits will probably generate headlines but we should let the FRC continue its review into revised guidance in this area. The OFT certainly have a role to play in examining aspects of the audit market – notably restrictive covenants and liability – but on other issues mentioned by the Lords it might do best to dampen down expectations of huge changes which the committee report will inevitably have raised.

By Ian Welch, head of policy, ACCA

If anyone was wondering where more than 500 senior figures of the profession had disappeared to on 9 and 10 February, I can reveal they were all in Brussels. A two-day conference on financial reporting and auditing would not normally have got such a huge response but this was no ordinary event.

This was the event arranged by the European Commission last October when it unveiled its landmark Green Paper on the future of audit, post-financial crisis. Last week the Commission issued a summary of the 700 responses it had received, and on the second day of the conference, EC Financial Services Commissioner Michel Barnier gave the assembled auditors, business leaders and regulators the first indication of his thinking. It proved to be far from everyone's cup of tea.   

Barnier, hot-footing it across town, where he had just told another high-powered audience that he was keeping up the pressure on bank bonuses, got straight to it: 'The status quo is not an option' for auditors, he declared. There would be proposals for legislation by November, and his five areas of concern were:  

  • Enhancing independence
  • Clarifying the role of audit
  • Market structure
  • SMEs
  • International convergence

While stressing that nothing had been decided and that all the responses were being considered, it soon became clear that three issues – all concerned with independence – were at the forefront of probable action. Firstly the provision of non-audit services by auditors to clients. Secondly, mandatory audit rotation and thirdly, joint audits.

Barnier said that he had been looking on the websites of the big firms. Nothing sinister in that, you might think. But the firms' promotion of non-audit services and positioning themselves as internal business advisers clearly concerned him: 'we cannot just assume audit independence – how can you be sure the audit will not be watered-down?'

To be fair, Barnier's reaction is typical of many politicians – witness the UK Treasury Select Committee in 2009 and the Commons report on Northern Rock both of which seized on the issue of non-audit services even though it had little to do with the problems being addressed.

ACCA's view is that there is no evidence that non-audit services affect the audit adversely – on the contrary, there is a considerable body of business opinion that prefers the knowledge of the company built up by the auditor not to be dissipated by the recruitment of a different firm to do the tax work, for instance (see a previous blog of mine).

But it has always been a difficult case to make to a sceptical audience – and the financial crisis has stripped away any inclination the EC had to give auditors the benefit of the doubt. Sometimes realpolitik is too strong and it may be that the profession has to give ground on this issue; but the outcome must not be the nuclear option of 'audit-only' firms, which would lead only to a serious tailing-off of talent coming into the profession. That simply has to be avoided.   

Mandatory audit rotation also seems likely to be brought in. Once again, it is hard to justify to critics how a firm can be auditor to a company for 30 years without becoming part of one speaker called the 'organagram' of the company. Speakers including FRC chief executive Stephen Haddrill who followed Barnier, made the case eloquently that this could be overkill and rather than increasing competition and independence would simply add costs and lead to one Big Four firm replacing another. But again, the odds must now be on this happening.   

Finally, having repeated his view that Big Four dominance posed a systemic risk ('prevention is better than cure') and that the EC had to find ways to increase competition, the Commissioner turned to joint audits.

This was an area where national differences were stark. Barnier's compatriots at Mazars and the French regulator praised the use of two firms as being a success in France – 'two pairs of eyes are better than one" – but UK and German speakers condemned them as costly and ineffective. But given the lack of any other effective ideas to help the second-tier firms challenge the Big Four, joint audits must also be a good bet for action.

Turning to accounting standards, Barnier warned the US that the EU's patience would run out on convergence if they did not act reasonably soon. Luckily Arthur Lindo, the US Federal Reserve's chief accountant had already responded to this blogger's question in the Q&A session, to say that he was confident the US would accept IFRS 'quite soon'.

It is just as well that peace seems likely on the convergence front, because there will be more than enough lobbying and politicking going on in Europe on audit over the next few months on this evidence. The European Parliament will have its say in May which should give more clues as to the likely outcome. But it is clear that Barnier has already decided on the essential direction of travel. And the profession is going to have to give ground on some areas it would rather not.

By Ian Welch, head of policy, ACCA

Over the past year, ACCA has held a series of 10 high-level roundtables on the future of audit in various markets around the world. While the individual country reports on the events in UK, Poland, Singapore, Ukraine, Brussels, Zambia, and Malaysia have been available on our Accountancy Futures microsite, it was important to bring them together, consolidate and summarise the main findings. This we have now done with our new report Reshaping the Audit for the New Global Economy.

The events, in which investors, corporates, banks, regulators, auditors and other stakeholders were brought together to give their views, took place in a year in which the role of audit has come under increasing regulatory scrutiny. In the UK and Brussels in particular, there are a series of regulatory inquiries into the role of the auditors in the financial crisis, which could have a major bearing on the profession in 2011 and beyond.

We will be speaking to policymakers about our findings and hope that they will be taken on board before any far-reaching legislative proposals are put forward. For our events found that market participants still valued the audit as a source of confidence in public statements. The frustration was not, on the whole, focused on a handful of bank audits during the crisis but that mainstream audit can do more to meet stakeholder needs.         

The roundtables concluded that auditors should report not just on historic financial statements but on risk, governance, the business model and other forward-looking information. Investors wanted 'red flags' to be raised when problems loomed; for more timely reporting, leading ultimately to real-time reporting, or as close as is possible; and most of all, for greater communication of the extensive work that goes into an audit to be made available outside the hallowed confines of the boardroom.

In the UK, one delegate wondered why the grilling that her business endured as part of the audit process was not known about by their stakeholders. Surely lenders and would-be investors would take great comfort from the robustness of the approach? And in Malaysia, one investor complained that extensive effort resulted only in a two-page binary audit report saying little of interest.

'Boiler-plate reporting, standardised, is not sufficient. We want more from you,'
she exclaimed. Given that the work is going on, and investors are paying for it, this does not seem unreasonable and ways must be found for increased communication to take place.   

But one issue hung like a deadweight across all the events – audit liability. Delegates accepted that it would be very hard to make significant progress in developing the audit to better meet stakeholder needs, and for audit firms to be more innovative in their approach and to take on wider responsibilities if these meant huge potential increases in liability. If audit scope is to broaden in the way that our events suggest, then this problem simply has to be solved. ACCA will be looking at this issue in detail and suggesting some possible solutions. 

An interesting feature of holding events in different markets is that while the general conclusions hold true for all, there are particular issues of local importance. In Ukraine and Singapore, there was concern that fee levels were not sufficient and that talented people would be lost to the profession. In Poland, the issue of audit committees was of major concern, which necessitated a second event in Warsaw dedicated to this topic. In Zambia, there was concern over audit independence and the issue of non-audit fees. In Cardiff, delegates felt there was no longer sufficient dialogue between auditors and regulators – this was seen as a particular problem for public sector bodies that rely heavily on expert audit reports when dealing with taxpayers' money.

It is important for the profession in each country to address local concerns where it can, but also that the global profession steps up to the plate and takes on board the need for audit to evolve. Audit is valued by business – but much more could be done and it would be better coming from within, than change being forced on the profession in the form of heavy-handed regulation, which is an increasing possibility given the number of current official inquiries into audit.