Parliamentary Commission for Banking StandardsWritten evidence submitted by PricewaterhouseCoopers LLP (PwC)

Introduction

1. This memorandum is PwC’s response to the Call for Evidence issued in December 2012 by the Parliamentary Commission on Banking Standards’ Panel on tax, accounting and audit. This reflects our recognition that it is important to understand and learn lessons from the financial crisis.

2. Our expertise and experience is as auditors or as tax advisors to a number of banks and other financial institutions operating in the UK. We seek to provide practical insights to assist the panel based on our experience in those distinct roles. A number of the questions in the Call for Evidence (particularly Questions 1 and 2) focus principally on matters of macro-economic policy and, accordingly, we have not commented in detail on those aspects.

3. In relation to each of the areas of tax, accounting and audit which the panel is considering, we note that the landscape has changed considerably in the years since the financial crisis began, through a collective realisation by all participants in the financial community (including the banks, regulators, standard setters, auditors, tax advisors and others) that existing practices should be reviewed and, where necessary, improvements introduced. Previous Parliamentary inquiries into the financial crisis have been instrumental in helping to shape the debate.

4. Many of the standards that guide the industry are subject to processes of continuous improvement and numerous initiatives and enhancements have taken place in recent years (indeed some of these commenced prior to the financial crisis). We have been involved in many of these and we highlight here the following:

A growing self-awareness by the financial and business communities of the importance of reputation that has driven behavioural change and a greater focus on standards of business behaviour and ethics. This has in turn influenced public expectations and changes in areas such as regulatory and judicial interpretation.

Pressure from investors, regulators and politicians for greater transparency of public reporting by banks.

A growing consensus in the marketplace that, whilst tax remains an important cost factor, commercial transactions should not be driven by tax considerations. This view has been reinforced by the Code of Practice on Taxation.

Efforts by standard setters and regulators to review and where appropriate enhance their standards and rules (for example the IASB’s review of its standards on accounting for and disclosure of financial instruments).

Multi-stakeholder voluntary initiatives, both nationally and internationally, to work collectively to improve the quality and transparency of published corporate information (for example the Financial Stability Board-sponsored disclosure taskforce).

Protocols for enhanced communication and coordination between key players in the financial community in the public interest (for example the FSA Code of Practice for the relationship between the external auditor and the supervisor).

We comment further on these initiatives in our evidence.

5. The UK has already demonstrated a willingness to take a lead on these initiatives and has been able to influence international developments. For example the European Commission is proposing to base its own regime for dialogue between auditors and supervisors on the FSA Code of Practice.

6. We do not give specific examples or otherwise comment on client-related matters, because to do so would contravene our legal obligations to preserve client confidentiality.

Responses to questions in the Call for Evidence

Q1. How, if at all, does the tax system encourage leverage in banks? What is the effect of having tax relief for debt interest but not for dividends on equity? What effect does this have on the stability of the banking system?

7. In our experience, there are far wider commercial considerations driving decisions over equity vs debt financing than the deductibility of debt interest for tax purposes.

8. One area in the UK tax system that might usefully be considered is the dividing line in the tax rules between debt and equity. Our experience is that this borderline has been a major difficulty in practice and the lack of certainty has been disadvantageous to the UK in the past by virtue of discouraging certain types of business where tax was not a driver of the transactions (eg the development of the structured notes market). We also consider that the detail of existing tax rules which regulate the borderline between what is accepted as debt and equity can cloud discussions on appropriate tax policy. One recent example of this is the recent public consultation on new regulatory capital instruments in the light of the Basel III reforms for banks. Because of the complexity of the existing tax rules, that discussion from a tax perspective was more focussed on how to fit the Basel III regulatory capital instruments into detailed and complex rules than on the strategic tax policy issues that should be addressed in delivering an appropriately capitalised banking sector (eg as a matter of principle to what extent was it desirable to encourage banks to issue these instruments).

Q2. What are your views on alternative systems to level the playing field?

9. As we have said in our introduction, this is not something that can be answered other than in the context of a wide discussion on macro-economic policy.

10. As a general matter, we would not favour a radically different approach to taxing banks, however defined, as this may well create new distortions. We discuss this further in our response to Question 7.

Q3. Do banks’ attitudes to tax planning affect banking standards and culture and does this have any effect on the wider economy?

11. In the banking sector there has been a very wide range of attitudes to tax planning and therefore it is difficult to address the question for “banks” generically. However, over the last few years it is our experience that, for a number of cultural, operational and legislative reasons, such activity has been considerably reduced and is continuing to reduce.

Q4. Do you have any views on the role and purpose of structure capital markets teams in banks? Does the volume and type of structured tax transactions have any effect on bank stability, and did this play a part in the banking crisis?

12. The role and purpose of structuring teams within banks can vary significantly (as can the extent to which such groups focus on tax). The aim of tax-focussed structuring groups is to optimise either the bank’s own or their clients’ tax position and profitability by drawing on features of the tax systems in transactions that are entered into. Such activity can be seen in banks and non-bank financial sector entities but, as noted above, such activity by banks is in our experience now much reduced.

13. With regard to the second question, it is evident that, prior to the financial crisis, there had been in the banking sector significant complexity in the design of many financial products such as CDOs, CMOs, etc. In our view, tax has played no appreciable role in causing the design complexity in these financial products. We believe that complexity may have been driven by other factors such as the use of financial engineering employed to achieve different returns from certain less liquid asset classes (such as residential mortgages); investor demands for certain product features, etc.

14. We also recognise that tax-driven structured products can in some cases be highly complex. Our understanding is that the OECD, based on their work in recent years on tax and the financial crisis, has concluded that complexity of tax-driven structures did not play any material role in causing the banking crisis. We agree with this conclusion.

Q5. What are your views on the effectiveness of the Code of Practice on Taxation for banks? Would the Code benefit from having sanctions and if so what should these be?

15. Given the intense focus of the tax authorities on tax avoidance and the wide variety of anti-avoidance measures in recent years (in particular, the disclosure rules, remedial legislation, “closer working” with HMRC etc), it is hard to gauge the effect of the Code judged in isolation. However, it is clear that in the period since the Code has been introduced, tax structuring activity of banks has materially reduced with the various measures referred to above having already achieved an appreciable shift in behaviour. We consider it is very likely that the Code has played some role in this reduction.

Q6. How effective has the Senior Accounting Officer legislation been with particular regard to banking standards and culture?

16. We understand that HMRC viewed the SAO legislation on its introduction as codifying the requirements that might be expected to operate already within large taxpayers such as banks. In our experience this has been the case in the banking sector.

Q7. Do we need a special tax regime for banks? If so, what would this look like and what would be priorities for change? Should tax continue to follow accounting with respect to banks? Should the tax system actively seek to influence banking standards and culture?

17. There are already areas where general tax rules are applied differently in the financial sector (eg VAT) or where tax rules are applied only in the financial sector (eg the bank levy). We do not consider that a broader special tax regime for banks alone is required given the material similarities in the range of activity carried on by banks and non-banks in the financial sector. The position is to be contrasted with the insurance sector where much of the relevant activity is very specific to insurance companies.

18. However, the specialist industry expertise and resources of HMRC focused on the financial sector could be enhanced to contribute in the long term to the development of better tax rules and to deliver better operation of the tax system given the persistent areas of difficulty that have been experienced in the past (eg the debt equity borderline referred to earlier).

19. We consider that the continued alignment of accounting and tax is desirable because it reduces complexity, improves transparency and facilitates effective commercial transactions.

20. With regard to the wider use of the tax system to influence standards and culture in the banking sector, we believe that efforts to influence banks’ cultures can be carried out much more effectively by the financial regulators, through their policy making and supervisory efforts. Indeed the FSA has indicated that the Prudential Regulation Authority and the Financial Conduct Authority will focus on this issue in the future.

Q8. Are banks exploiting regulatory and information arbitrage between FSA, HMRC and auditors? If so what is needed to address this?

21. We have not seen any evidence to support this suggestion from an audit, tax or regulatory perspective. In particular, over the last few years we have seen improvements in information exchange and dialogue between the auditors and the FSA.

22. From an audit perspective, the FSA has complete access to all relevant information that we as auditors see and use and have access to our reports to the bank as well as formal trilateral meetings and informal bilateral meetings. The FSA can and does also meet with bank officials and inspect the bank, attend key governance meetings, make presentations to the board, etc.

23. In our view, working relationships between HMRC, taxpayers and their advisors have improved in recent years leading to a more cooperative approach to compliance and one in which HMRC’s access to information has also been improved.

Q9. Should there be a “safe environment” in which the tax authority, regulator, and auditors can share confidential information and concerns, possibly on varying levels of seniority?

24. A safe environment already exists for communication between the auditors and the prudential regulators. There is provision in the FSMA 2000 and FSMA 2000 (Communications by Auditors) Regulations 2001 requiring auditors to communicate with the FSA in certain circumstances. The Act also provides protection to the auditor and FSA. The requirement of the Act has been enhanced under the Code of Practice for the relationship between the external auditor and the supervisor (“the Code”). More effective two-way dialogue is already occurring.

25. While the auditor and supervisor relationship is an established one, the benefits of the Code could be leveraged further by both sides giving more emphasis to the Code in training, and through the sharing of examples of good practice in implementation.

26. From a tax perspective, the combination of the existing disclosure rules for tax schemes, the Code of Practice on Taxation which applies to banks, the SAO regime and the enhanced relationship between large businesses and their Customer Relationship Managers (CRMs) at HMRC, together provide appropriate information channels for HMRC.

Q10. What was the role of accounting standards and reliance on fair value principles in the banking crisis? What does a “true and fair view” really represent to the market?

27. The major UK banks are required to prepare financial statements that show a true and fair view in accordance with International Financial Reporting Standards (IFRS). IFRS as a framework seeks to report economic performance as it happens—economic performance tends to be volatile and it is inappropriate to expect an accounting framework to be designed to be capable of smoothing this impact out. Attempts to do so in the past have always involved a loss of transparency through the use of mechanisms such as hidden reserves or general provisions for doubtful loans which can vary from year to year—these do not allow the transparent reporting of results and financial position.

28. There has been a debate over whether IFRS requirements for fair valuing financial instruments (unless held to maturity in accordance with strict conditions in the standards) contributed to the crisis. Some argue that recording fair value movements in profit and loss before the crisis resulted in “unrealised” profits being recorded and paid out in bonuses and dividends. Others argue that fair value write downs during the crisis created excessive strain on financial institution balance sheets leading to distress sales and further write downs, causing a spiral of downward pressure on prices and ever reducing liquidity in the marketplace. However, it is the case that fair value write downs provided early warning signals that led to corrective actions sooner than otherwise would have been the case if such losses had not been recognised.

29. The valuation of assets immediately prior to the crisis was based on actual prices achieved in the market from real transactions. “Real transactions in unreal markets” is how one analyst has described it. Without the benefit of hindsight, it is almost impossible to distinguish between a buoyant market and an “unreal” one. Once in the crisis it was also clear there that were substantial falls in asset values which could not be ignored in preparing financial statements. However, in our work, we have not identified evidence to support the allegation of systemic overvaluation of assets prior to the crisis. There is no reliable mechanism for separating out “true” loss from “unreal” loss caused by the lack of liquidity in stressed market conditions.

30. The Commons Treasury Select Committee examined the role of accounting and audit in its 2009 Report on the Banking Crisis and noted that fair value accounting had resulted in greater transparency and exposed the over-inflation and subsequent correction of asset prices, and done so more quickly than other accounting measurement methods. It concluded “we do not consider fair value accounting to be a suitable scapegoat for the hubris, poor risk controls and bad decisions of the banking sector.”

31. The use of fair value has been carefully reviewed and retuned by the IASB since the crisis and some new or revised standards have been issued (for example IFRS 9—Classification and Measurement), though not all of these have yet been adopted for use in the EU.

Q11. What are your views on the current incurred loss impairment model and its role in the banking crisis? Do you consider that proposals to move to an expected loss model will address criticisms of the current accounting rules?

32. The financial crisis highlighted shortcomings in the incurred loss impairment model for assets held at amortised cost and led in particular to banks recording loan losses on what has been described by some commentators as a “too little too late” basis. The IASB has recognised this and is developing an expected loss model as part of its financial instrument revision project.

33. An impairment loss model based on expected losses more closely reflects the economics of lending and results in a more timely recognition of the effect of impairment. We have consistently supported the IASB’s decision to develop such a model and have encouraged the Board to investigate the practical operational advantages and disadvantages of different approaches to an expected loss model.

34. The final publication by IASB of an expected loss impairment standard that carries the support of a wide range of stakeholders would deal with one of the most significant criticisms of the accounting rules during the financial crisis.

Q12. What is the best method of accounting for profits and losses in trading instruments? Are there any alternatives to mark-to-market or mark-to-model that might better represent a “true and fair view”?

35. Trading assets are held for the short term and fair value accounting reflects the best estimate of the cash flows that are likely to be realised from them in the day to day operations of the bank. It for this reason that UK GAAP moved to fair value from the lower of cost and net realisable value before the introduction of IFRS.

36. At any time when trading volumes decline significantly and trading assets cease to be liquid, as happened during the financial crisis, it can be legitimate to argue that as the assets are no longer held for short term gain they should be reclassified to amortised cost. However, an arbitrary application of this approach has the effect of reducing transparency and could lead investors to question balance sheet values. We therefore support the IASB’s development of a business model approach to the classification and measurement of financial instruments in IFRS 9, which requires financial assets to be carried at fair value where they are held with a view to realisation through day to day trading. Subsequent reclassification is required where the business model changes from one of day to day trading to one of holding for long term realisation of income and “capital gain”, with full disclosure of the rationale for, and the effect of, the change.

Q13. Did IFRS accounting standards contribute to a box-ticking culture to the exclusion of promoting transparency and a “true and fair view” of the business?

37. IFRS is a principles-based accounting framework that requires judgments to be given careful thought and consideration. It does not reduce the need to exercise judgment or to provide transparent information.

38. Some commentators have highlighted that the IASB conceptual framework no longer refers to “prudence” as a concept, claiming that as a result IFRS is now in some way imprudent and that as a result it does not provide a “true and fair view”.

39. It is worth noting that the concept of prudence was deliberately removed by the IASB in part to rule out the sort of “big bath provisioning” that the prudence concept was often used to justify. Instead the IASB introduced the notion of “faithful representation” (one of the qualitative characteristics of useful financial information set out in the IFRS Conceptual Framework). Economic information to capital markets needs to be free from bias. Faithful representation implies neutrality and the absence of bias but in no way implies imprudence.

40. The current IASB chairman, Hans Hoogervorst, noted in a major speech that the British Government had recently stated in its May 2011 response to the Lords’ Economic Affairs Committee that it “does not accept that IFRS has led to a loss of prudence”, saying “the concept of prudence continues to permeate accounting standards”, and that he believed this to be an appropriate conclusion.

41. The fact that IFRS is a principles-based framework explicitly allows companies the flexibility to address emerging issues and to provide additional information where necessary for a true and fair view. The treatment of sovereign debt is one recent example of the application of this flexibility in practice where banks, auditors and regulators ensured that the accounting and disclosure appropriately reflected the evolving situation. The FSA have also been encouraging UK banks to make additional disclosures under the “straw-man disclosures” agreed with the British Bankers Association.

Q14. Do we need a special accounting regime for banks? If so, what should it look like?

42. As indicated in our response to the Sharman Panel of Inquiry on Going Concern set up by the FRC we do not believe that it would be beneficial to have separate financial reporting and auditing regimes for banks.

43. One of the difficulties with such a distinction would be how to draw the boundaries around a bank, when very often the entity is not a stand-alone bank, but a part of a broader financial conglomerate or other enterprise. For example, if a major supermarket group has a retail banking business, is the group considered a bank? If different financial reporting requirements are applied only to the banking division and not to the wider group, how does that integrate with group reporting?

44. The principal points of difference in a separate financial reporting regime for banks might lie around the use of “hidden reserves” and the use of “dynamic” or countercyclical provisioning methods for impairment of financial assets. Our view is that these techniques should not be used in the financial statements prepared for capital market investors, because they mask the underlying financial performance of the entity concerned. These or similar techniques are more appropriate to the setting of prudential capital requirements—which is already possible under the existing Pillar II requirements.

45. There is a case for the banking industry developing specific industry disclosures that would illustrate how the IFRS disclosure requirements should be applied for a bank. However there is a need for flexibility in the development of guidance and for efforts to encourage the spread of good practices. The Enhanced Disclosure Task Force (EDTF), established by the Financial Stability Board (FSB) and bringing together different stakeholders from the banking and investor communities, has already done most, if not all, of the work needed with the recent publication of “Enhancing the risk disclosure of banks”. As noted in response to Question 13, the FSA is actively engaged in promoting improved disclosure by UK banks.

46. We note that one of the EDTF recommendations is a reconciliation of regulatory capital to accounting capital in order to give transparency to investors and we support this.

Q15. Are there any interim measures (such as mandatory disclosure) which could be introduced in the meantime?

47. As indicated in our response to Question 14, for the purpose of financial reporting to shareholders and the capital markets we do not believe that a separate, special accounting regime is required for banks.

48. We regularly encourage our bank clients to provide additional disclosure alongside the financial statements on matters such as disclosure of the components of regulatory capital and risk-weighted assets. While banks, like other listed companies, are required to prepare statutory financial statements in accordance with IFRS, there is nothing to prevent them from providing additional disclosures and “non-GAAP” information alongside the statutorily required financial information.

49. In providing additional disclosures, UK banks and regulators should have regard to international developments in this area. For example the FSB has recommended enhanced public risk disclosures as noted in our response to Question 14.

50. Some banks are starting to experiment with providing additional data and disclosure on risk-weighted assets. We believe it is helpful to encourage innovation in this area—banks should be permitted to experiment with disclosures and investors and other market participants should judge how helpful the data is. It is also worth noting that there are also extensive disclosures made by banks under the Pillar III rules.

Q16. How likely are current proposals for improving disclosure and dialogue to be successful (with particular reference to discussion papers issued by the FSA/FRC)?

16.1. Should there be enhanced powers to better align auditors’ incentives to those of the regulator?

51. This matter was addressed in the June 2010 joint FSA-FRC Discussion Paper 10/3 “Enhancing the auditor’s contribution to the prudential regulation” which we welcomed as a significant contribution to the debate among all stakeholders to learn lessons in the wake of the financial crisis.

52. We support a number of proposals in that paper, in particular a greater level of dialogue between financial institutions, auditors and regulators. However, the dialogue between the auditor and the regulator must be a two-way process, with the FSA also sharing its insight and current concerns regarding the institution and the industry. A genuine two-way dialogue would better enable each party to understand the perspective of the other. This proposal has already been incorporated in the Code referred to in our response to Question 9 above.

53. In relation to the proposals for enhanced powers for the FRC and FSA in respect of auditors (paragraph 4.32 et seq in Paper 10/3), we consider the FRC’s extant framework of monitoring and investigative powers to be appropriate and do not believe an enhanced range of audit enforcement tools for the FSA is needed.

16.2. Should auditors of banks be obliged to have a primary responsibility to the regulator, rather than the client?

54. Our responsibilities as auditors are clearly set out in statute and our primary duty is to report to the shareholders—not the management or directors of the audited institution. We already have a duty to report relevant matters to the FSA under FSMA 2000. The requirement to report to the FSA has been further codified under the Code referred to in Question 9.

55. Our audit responsibilities are established in the context of the statutory requirement that UK financial statements show a true and fair view. Accounting standards underpin the preparation of those financial statements and are promulgated with the objective of reporting on financial performance so that shareholders and investors can take economic decisions.

56. The FSA (and its successors) may have other objectives, including financial stability, and may be looking for a level of detail from financial statements and the audit that may be appropriate in the context of prudential regulation but which is not within the scope of accounting standards or of a financial statement audit in accordance with Auditing Standards. If the regulator requires additional work to be undertaken by the auditor it has the power to request that work under S.166 FSMA 2000.

16.3. Should regulatory returns be audited?

57. The quality of regulatory returns varies due to the complexity of some of the returns and the differences in the quality of data, systems and controls that banks have in place to support the reporting process. In many cases firms aggregate the data for consolidated returns from a range of different IT systems that were not originally designed specifically to collect data of the sort or format required in the regulatory returns.

58. We believe that the overall quality of regulatory returns across the industry can and should be improved but we consider that the FSA already has the necessary powers to achieve this. Requiring all banks’ regulatory returns to be audited would not be the most effective or efficient way to improve quality.

59. For example, a better solution would be for the regulator to carry out thematic work periodically to check the quality of reporting accuracy and systems, to give guidance to the banks on improvements. Also, the FSA already has the power under S.166 of FSMA to require auditors (or other skilled persons) to verify information contained in a bank’s regulatory returns or to report on the systems and processes used by the bank to produce the returns.

60. An enhanced dialogue between the banks and supervisors that draws out any recurring issues in the preparation of regulatory returns as seen by the FSA would be of benefit to both sides. The banks could then place more emphasis on the quality and controls processes around the returns where particular issues arise, and would also have the opportunity to explain to the regulator any particular difficulties of preparing a return. In addition, the supervisors would have an opportunity to help the banks understand the regulator’s purpose of gathering the information through the returns and the reliance they place on them. We believe that improving understanding and focus by both sides is more likely to generate significant improvement in the quality of regulatory returns than that which could be achieved by imposing an audit requirement.

Q17. Is there a problem arising from the difficulty of qualifying the accounts of a bank? Should auditors be able to “grade” accounts—from AAA down? What would be the effect of this?

61. The commonly held view has been that a qualification or warning by auditors in their report on the financial statements of a bank risks causing a loss of confidence and, in extremis, a run on the bank (the “self-fulfilling prophesy”). The Sharman inquiry report helpfully highlighted the dilemma of going concern reporting in relation to banks, where there are legitimate, but potentially mutually-inconsistent, public interest objectives of market transparency and financial stability.

62. For banks, the normal approach to going concern adopted in a non-bank corporate entity is not appropriate, as for a bank the assets on their balance sheet have longer maturities on average than their liabilities (the so called “borrow short lend long” strategy). The key aspects of the going concern assessment by the directors that are then subject to audit are the adequacy of regulatory capital and liquidity.

63. Banking has always operated on the basis of confidence. Provided that there is confidence in a particular bank, depositors will not withdraw their funds (even though contractually many could do so on demand) and the bank will be able to refinance its wholesale borrowings as and when they fall due and maintain adequate liquidity. Banks have sophisticated models based on past behaviour to predict their liquidity and also have access (providing they have adequate regulatory capital) to facilities offered by central banks (eg the Bank of England). Historically, management and auditors have signed off on the going concern assumption in banks on the grounds that there is no evidence that there is any lack of confidence in the bank or any lack of liquidity, and that such a deterioration in confidence or sudden loss of liquidity would be a remote event. In the recent financial crisis this became more difficult as circumstances could change in an unforeseen way (eg the collapse of Lehmans in September 2008 and the consequent impact of its collapse in the financial markets were not generally foreseen by commentators even as late as August that year).

64. The requirement for management to assess, and auditors to review, a bank’s status as a going concern is within the context of selecting an appropriate accounting basis for items within the accounts. In particular, auditing standards are explicit that a review of going concern status is not undertaken in order to provide shareholders with any guarantee that a company will continue to survive. Where circumstances dictate that we should, based on the evidence available at the time, include a qualification or emphasis of matter paragraph in the report on a bank, we would do so. However, in such cases, we would first raise and discuss the matter with the appropriate regulator.

65. In most cases, the scope for potential going concern problems will be reduced if a better assessment of regulatory capital and liquidity risks is performed by the directors on a regular basis and built into the bank’s normal control processes—together with enhanced internal reporting routines and enhanced external disclosure. In our experience this is now a common feature of the governance and reporting of major UK banks. Enhanced narrative reporting and a focus on liquidity and solvency testing were central recommendations of the Sharman inquiry—which we endorse.

66. We believe a combination of improved reporting and emphasis by management on liquidity and regulatory capital, and discussion of potential problems between auditors and regulators is superior to the suggestion that auditors “grade” the accounts of banks.

67. We do not agree with any form of “grading” by auditors as it would result in inconsistencies between banks that would reduce rather than increase transparency—this would be confusing to users of financial statements and detract from the principal objective of an audit which is to allow the independent auditor to express an opinion on the financial accounting information issued by a company to the public. In our view this would not enhance the value of the audit to users for the following reasons: (i) including in auditor reporting information that is itself subjective or variable will not contribute to market confidence; (ii) it will potentially confuse readers by providing competing views of an entity’s underlying position and performance to that presented by management; and (iii) it risks undermining the effectiveness of relationships and communication with audit committees and management, which are important to the effectiveness of the audit itself.

Q18. Should the scope of audit be widened so that auditors can better express a broader view of the business? For example should auditors comment specifically on issues such as remuneration policy, valuation models or risk?

68. Users have expressed an appetite for auditor involvement with a wide range of other information reported by entities, both in content and in how it is communicated. Such involvement could serve to improve the quality and reliability of information communicated.

69. Many of the risk disclosures made by UK banks are already subject to audit, to the extent they contain information required by accounting standards. Parts of the remuneration report are audited, as required by the Combined Code and the listing rules. We do not see the benefit in reporting on valuation models as the results of the models included in the financial statements are already subject to audit in accordance with the guidance included in Auditing Standards for such items.

70. Each of the areas suggested in the question would be a step change from today’s audit. They would therefore be longer term propositions, as they would require changes to the corporate reporting model and the development of frameworks for reporting by management, including criteria or benchmarks, as well as consideration of the nature of auditor reporting that would be cost effective and meaningful. Therefore, shareholders and other users need to be convinced that the benefits of the additional information exceed the costs.

71. The primary role of financial reporting and audit is to assist in the provision of financial information to the capital markets—while it also supports other prudential objectives such as financial stability these are not its primary purpose. Efforts are being made to improve the information provided by banks on risk profile and risk weighted assets (for example as recommended by the FSB’s Enhanced Disclosure Task Force, as noted in relation to Question 14 above) but these should be allowed to develop in a flexible manner.

72. In the shorter term, therefore, we are supportive of the FRC’s approach of placing emphasis first on enhancing narrative reporting. Investors say they want to hear primarily from management on their view of the business and key risks, so efforts should be directed in this area first.

Q19. What would be the effect of using return on assets as a performance measure in banks, as opposed to return on equity?

73. We consider the use of a balanced set of performance measures is appropriate and preferable to a focus on a single performance measure. However, given that performance measures are predominantly prepared for investors, this is primarily a question for them to address.

Q20. Are amendments to the Financial Services and Markets Act 2000 regarding dialogue between regulator and auditor sufficient, or does further work need to be done in this area?

74. The proposed amendments to FSMA 2000 that are currently before Parliament are sufficient but, as noted in our response to Question 9, we consider it will be important to analyse how the 2011 FSA Code is working, to share examples of best practice, and to encourage further awareness and training by both auditors and regulators where appropriate.

4 January 2013

Prepared 24th June 2013