Public Interest Committee roundtable November 2018

Record of a Roundtable held at RSM, 25 Farringdon Street, London on 8th November 2018

Present:

  • James Barbour, Director, Policy Leadership, ICAS
  • Ray Davies, Group Finance Director, Lok'n Store Group plc
  • Teresa Graham, Salix Finance (Member of Kingman support team)
  • Jeremy Mooney, Director, Communications and Brand, ICAEW
  • Liz Murrall, Director of Stewardship & Reporting, The Investment Association
  • Nigel Sleigh-Johnson, Head of Financial Reporting, Audit and Assurance, ICAEW
  • Mike Suffield, Acting Executive Director Audit and Actuarial Regulation, FRC
  • Mathew Wright, Partner, Sayers Butterworth LLP
  • Jonathan Ericson, Head of Audit, RSM UK Audit LLP
  • Tom McMorrow, Chair of RSM UK Audit LLP's Public Interest Committee (PIC)
  • Roger Alexander, Independent Non-Executive (INE) and PIC member
  • Ian Byatt, INE, and PIC member

Background

The big issues in audit of FTSE350/ PIE sector of the UK economy are Regulation, Choice and Competition and the Specification of the Public Interest (ie the nature of the public, in addition to the traditional private, responsibility of auditors). The dynamic interconnections between these three issues were important and, unless incentives were well alighted could be counterproductive.

These issues were germane to three reviews, the Kingman review of the Financial Reporting Council (FRC), the Competition and Markets Authority (CMA) inquiry into Competition, and to Project Flora, in whatever form this took. These reviews provide a unique opportunity for greater clarity on audit policy in the FTSE350/PIE sector.  Whatever developed in this sector would inevitably have implications for audit in the mid-tier and SME sectors. To avoid creating further uncertainty these implications should be as clear as possible. 

Note: On 14th November, following the Roundtable, Rachel Reeves MP for Leeds West and chair of the Business, Energy and Industrial Strategy Parliamentary Committee announced that it would hold its own inquiry into audit and its place in trust in business.

Roundtable discussion

The following interrelated points were made in discussion:

  • The larger audited firms were largely international, operating in a global economy. Public policy and hence regulation must adequately respect international situations 
  • Public policy should be both objective and proportionate, not driven by uniformity or the power of isolated events. It should take full account of incentives, including those created by regulatory enforcement, such as the scale of fines and how they are levied.
  • Public policy on audit should be considered alongside compliance by Directors of their Section 172 duties to produce accounts that properly show the current position of the company, including the risks it faces, and management's degree of confidence in handling them. 
  • Judgement is crucial to auditing; accounting rules are not sufficient.  Proper scepticism is crucial to good judgment. Both involve consideration of the quality, relevance and accessibility, rather than the quantity, of information.
  • There is a perception that enforcement of Section 172 duties has taken second place, leading to unrealistic reliance on audit, especially where Directors and management fail to reveal what becomes critical information.
  • Regulation should be proportionate both to the type of firm to be audited, and to the scale of its impact on the economy.  Banks (and shadow banks) are a special category because of their effect on monetary conditions. Following the growth of the charity sector, it would be worth considering the public significance of large and visible charities.
  • The days when 'an audit is an audit' are over. The scope and purpose of an audit should be carefully specified at the outset, taking full account of possible risks and uncertainties.
  • The proposal for auditors to be able to alert the regulator, in confidence, of issues that concern them when audit committees and management decline to listen, merits further examination, while remembering the requirements of  shareholders, the duty of company Directors to make market announcements, and generally to the treatment of market sensitive information.
  • Any easing of audit requirements or enforcement must not, lead to deterioration of audit quality, to the detriment of the effective operation of the capital markets.
  • Annual Reports of companies have become too long and, in some cases, subject to obfuscation. Having more data does not necessarily yield more practical information. Financial information, which is audited, should be distinguished from other management information, such as environmental and workforce information, which is not. The latter should be in a separate report. Public pressure for more information must be carefully justified and put in a practical context.
  • Financial reports and announcements, including prelims, should be better related to the needs of users, including shareholders, customers and workers. Currently many are too closely geared to the interests of management. More should be said about risks and who is likely to bear them.
  • The significance of elements of financial information needs further debate. Cash flow is crucial to any business, especially those in difficult circumstances. It is often more important than sophisticated measures of income. Greater focus on net cash flow, particularly net cash flow from operations, would increase focus on the importance of prudence in financial analysis.
  • The quality of management, particularly audit committees, is also crucial. Challenge must be informed and well based; non-executives on audit committee need to be ready to walk away rather than be tied in by their expectation of fees. Rotation may not be the only, or the best, way to ensure their independence from executive management. Consideration could be given to audit committees consisting of a majority of members who are not also directors of the company
  • The Competition Commission missed an opportunity in 2013. The CMA should seriously consider a break-up of the Big 4, or an ownership division between the provision of audit and non-audit services in the FTSE350/PIE sector of the market. 
  • Regulation is geared more to preventing exit of big firms than to encouraging entry into the FTSE350/PIE market. Market caps may not be the whole answer. Mid-tier audit firms need to ensure that partners and managers receive training that would fully equip them to audit companies in the FTSE/PIE sector.
  • It was noted that KPMG was to discontinue the provision of non-audit services to audit clients.(Reported in FT of 9th November). Other firms might follow. The degree of separation, whether ownership separation or ring-fencing, would be an important policy issue.
  • Concern was expressed that some IFRS’s did not enhance the clarity or purpose of the financial accounts and were the cause of accounts 'drifting too far from the cash book of a company'.

Tom McMorrow wrapped-up the discussion by thanking participants for many useful contributions which would be recorded in an unattributed record, which could be used for further debates.