Examination of Witnesses (Questions 1320
TUESDAY 4 DECEMBER 2007
Q1320 Mr Love: As I understand it,
as reported that takes a very tough line on the use of market
prices for making that valuation. We have just heard from four
of the large institutions. Do market prices exist for the particular
vehicles we are talking about?
Mr Sexton: We have not gone through
the audit period of 31 December 2007 which will undoubtedly be
a challenging period in relation to obtaining appropriate evidence.
The market values would have been looked at as at 31 December
2006. That market did exist. The models to which you refer and
the nature of the paper refer to the fact that the first port
of call ought to be market value. When market value does not exist
or there is no reasonable liquid market one needs to look to models
to establish what if any value can be placed on the assets.
Mr Hitchins: The paper was intended
to be a companion to a similar paper produced in the US under
USGAAP. Basically, it put together into one paper all the references
in the accounting literature on how to prepare fair value accounts
for financial instruments. It therefore goes through the fair
value hierarchy. If you do not have a quoted market price what
do you then do? What other sources of evidence do you obtain?
Q1321 Mr Love: One of your colleagues,
Pauline Wallace of PwC, who is leading the production of this
report has said that it was there not to provide guidance but
context. What does she mean by that?
Mr Sexton: Pauline Wallis is one
of our technical specialists in that area in PwC. The intent of
her comment is that it is there to alert the market as a whole
to this being a significant issue and to reinforce the need for
people to consider the valuations very carefully.
Mr Hitchins: It is not intended
to provide new interpretations of accounting standards because
that is not the job of the big accounting firms. If that is needed
it should be done by those who set accounting standards.
Q1322 Mr Love: I am interested in
the view expressed about the so-called model-based calculations.
If you were here earlier and listened to the discussion you would
have heard that there are obviously very different models, assumptions
and calculations. To what extent will this paper bring consistency
Mr Sexton: We cannot dictate to
the market or those who prepare those models what assumptions
they should make. Our job is to make sure they have gone through
a very thorough process and that their assumptions are reasonable
and based on supportable information wherever available.
Q1323 Mr Love: The obvious question
to arise from that is whether you can find yourself auditing two
different large financial institutions with very similar vehicles
which have used very different assumptions and models and therefore
have arrived at very different valuations and you then agree with
their decisions on these matters?
Mr Sexton: Whether or not we would
agree with them is a matter for the future, but we can certainly
come across the circumstance where different institutions use
different models, as they do. That is absolutely the case.
Q1324 Mr Love: How confident are
you that by the use of this report we will get more confidence
and trust in the marketplace? There is a lot of concern that there
is not just a lack of transparency about the valuations but where
there are valuations they differ so much that nobody can have
any confidence in them. Do you think this will make a contribution
towards restoring confidence?
Mr Sexton: I think that if financial
institutions ensure they provide appropriate and detailed disclosures
where they use those models it will provide greater transparency
so everybody can understand exactly what is going on.
Q1325 Mr Love: You mentioned earlier
in response to Mr Fallon that a lot of the work you do is not
concerned with just standard auditing procedures; you are brought
in by companies for a whole variety of interim auditing purposes.
Why has there not been a large-scale move among financial institutions
to bring in auditors to look at the valuations? There is a great
deal of talk among all of them about the need for transparency
but a total lack of preparedness to be transparent themselves.
Why is that happening?
Mr Sexton: The only way I can
answer that is to refer to the amount of disclosure that is mandated
under international financial reporting standards IAS 39 and IFRS
7 as recently reissued which are required to be put into the financial
statements. The banks of their own accord will go about their
valuations and employ a lot of people to do them.
Q1326 Mr Love: I am minded to ask
you for a value judgment about international financial accounting
standards because that seems to be the response to all of these
questions but I shall not do so. Have you been advising your clients
on the need for transparency and suggesting to them that they
might wish to undertake some interim auditing procedure in order
to get out into the marketplace the best estimated true valuation
of some of their vehicles?
Mr Sexton: We have encouraged
all of our audit teams to talk to their clients over the period
about the need to look at the valuations of their assets and liabilities,
be that in the banking or corporate environment.
Q1327 Mr Love: As I understand it,
for most firms the accounting year will end either at the end
of this year or early next year. That means you will not get fully
audited accounts for some considerable period. Are you giving
your firms any advice on bringing forward valuations in order
to get them into the marketplace?
Mr Sexton: Perhaps I may answer
that in two parts. First, you are absolutely correct that the
tradition in the financial services world is to have a 31 December
year end. Typically, they would issue preliminary results reasonably
early in January through the month of January. Indeed, if one
uses Northern Rock as an example its interim announcement in relation
to 2006 was on 24 January and for most financial institutions
the audited financial statements followed approximately a month
later. There are also continuing obligations under regulation
in the UK for all listed institutions to keep the market informed
of material developments. That is outside the scope of the work
of auditors, but it is a continuing obligation on those companies.
Q1328 Jim Cousins: How much do you
charge for writing a comfort letter?
Mr Sexton: That depends very much
on the nature and volume of the information required.
Q1329 Jim Cousins: You appear to
have received fees of £500,000 for auditing Northern Rock
and £700,000 for writing comfort letters. How much per comfort
letter did you charge?
Mr Sexton: As I have explained,
that depends entirely on the scope of the specific comfort letter.
Q1330 Jim Cousins: How many comfort
letters did you write?
Mr Sexton: There were a number
of comfort letters in 2007.
Q1331 Jim Cousins: How many?
Mr Sexton: No more than 10.
Q1332 Jim Cousins: You charged £70,000
for a comfort letter. Therefore, there is more money in writing
comfort letters than in auditing the company?
Mr Sexton: When we are requested
and required to provide things like comfort letters we provide
that service to our clients. I am not sure we would look at it
on the basis that there is more money in providing comfort letters
to the client. That depends entirely on their level of activity
in relation to those particular matters.
Q1333 Jim Cousins: You have to agree
that in the wider world it would seem pretty extraordinary that
your fee for auditing the company was £500,000 and your fee
for writing 10 comfort letters was £700,000.
Mr Sexton: As I have explained,
the £500,000 is for a statutory disclosure in connection
with the fee for auditing the company Northern Rock Plc. There
are additional subsidiary companies within Northern Rock that
are subject to audit and regulatory responsibilities that fall
on the company that must be fulfilled. If you take those numbers
together what you see is that we charged fees of £1.1 million
as statutory auditors to Northern Rock and £700,000 in connection
with comfort letters and securitisation.
Q1334 Jim Cousins: In your discussions
with the FSA about Northern Rock what did you tell them that was
material to your function as auditor?
Mr Sexton: I do not have a transcript
of the precise comments made to the FSA by the audit partner at
the tripartite meeting.
Q1335 Jim Cousins: Just give us the
general flavour. When you talked to the FSA what sorts of things
did you tell them?
Mr Hitchins: The first point here
is that which I referred to earlier in terms of our duty to report
when we become aware of something that is material to the FSA.
I am not aware of when or how we had those discussions with the
Q1336 Jim Cousins: Did you report
anything to the FSA about Northern Rock?
Mr Sexton: We would have had normal
conversations as part of tripartite meetings with the FSA, with
Northern Rock management and the regulator.
Q1337 Jim Cousins: Could you charge
£300,000 for that?
Mr Sexton: The work that we provide
to the regulator as statutory auditor is mandated by the FSA and
subject to the very competitive marketplace to which you have
Q1338 Jim Cousins: In the tripartite
discussions that you had with the FSA, about which you have not
really been able to tell us anything, where did your duties lie?
Mr Hitchins: I do not know whether
there was a tripartite meeting. They do not happen every year
but only at the FSA's request.
Q1339 Jim Cousins: Did any happen?
Mr Hitchins: I do not know.