Auditors: Market concentration and their role - Economic Affairs Committee Contents

Supplementary memorandum by the Financial Services Authority (ADT 28)

  1.  This memorandum is submitted by the FSA as a follow-up to the oral evidence given by Sally Dewar, Managing Director of Risk, and Richard Thorpe, Head of Accounting and Audit, on 9 November.

  2. The memorandum provides further information in response to two questions that the Committee asked on:

    (a) the frequency of auditor-supervisor meetings in the period 2006-08; and

    (b) when and why the practice of auditor-supervisor meetings fell away.

  3. As the FSA has acknowledged on a number of occasions over the last two and a half years (including in our evidence to this Committee), in the run-up to the financial crisis the regulatory framework in the UK and globally and our supervision of major firms were inadequate in important respects. This was also true of our engagement with the auditors of individual large firms and with the audit profession as a whole.

  4. In April 2008, in response to the shortcomings we had identified in our report on our supervision of Northern Rock, we launched our Supervisory Enhancement Programme. As a result, we have overhauled both our supervisory philosophy and our capability to deliver it. The FSA is now a radically different organisation from that which existed prior to the summer of 2007. We have invested substantially in creating the capacity and capability needed to deliver this new intensive approach. For example, since April 2008 we have added 537 staff to our supervisory and specialist support areas, including accounting and auditing specialists. We have increased our engagement with auditors and investors to emphasise their role in the oversight of firms, and we now meet at least annually with the external auditors of high impact firms, and have regular high level meetings with the firms on key thematic issues.


  5.  The Committee asked how frequently we met with the external auditors of Northern Rock, Halifax Bank of Scotland (HBOS), Royal Bank of Scotland (RBS), and Bradford & Bingley, in the years 2006, 2007, and 2008. We had the following contacts:
BankAuditor 2006 2007 2008
Northern Rock PWC 1 meeting and 1 phone call. 2 meetings and 4 phone calls.
HBOSKPMG1 phone call. 1 meeting.2 meetings.
RBSDeloittes1 meeting. 1 meeting.
Bradford & BingleyKPMG 1 meeting.1 meeting.

  6. In line with our improved arrangements outlined in paragraph 4 above, in 2009 and 2010, we have met these banks' auditors with the following frequency:
BankAuditor 20092010 to date
Northern Rock PWC3 meetings and 1 phone call. 1 meeting.
Lloyds Banking Group (which includes HBOS) PWC2 meetings.3 meetings.
RBSDeloittes1 meeting. 2 meetings.
Bradford & BingleyKPMG 3 meetings.1 meeting.


  7.  The regular practice of auditor-supervisor meetings fell away gradually following the transition from the Bank of England to the FSA as banking supervisor.

  8.  Until 1998, banks were supervised by the Bank of England and auditor-supervisor interactions were governed by the Banking Act 1987. One element of the Bank's supervisory model was to rely on the work of external auditors to a greater extent than has been the case under our model. For example, the Bank commissioned auditors to undertake additional work to examine a firm's systems and controls, or to address thematic concerns. The Bank then held bilateral meetings with the auditor or trilateral meetings with both the auditor and the bank to discuss the results of this work.

  9.  In June 1998, the Banking Act 1998 transferred banking supervision from the Bank of England to the FSA. The Financial Services and Markets Act 2000 (FSMA) superseded the Banking Act as our legislative framework for banking supervision from 1 December 2001. FSMA established a wider, more comprehensive "regulatory toolbox" for our responsibilities, including our supervisory responsibilities over banks. Section 165 of FSMA gives us the power to require information from firms. Section 166 allows us to require firms to commission reports by skilled persons (including, but not limited to, auditors) on areas of concern.

  10.  With the transition to a new regulatory framework in 2001, we also adopted a different supervisory approach. For example, we established supervisory specialists in-house, supported by further in-house specialists in policy, risk and sector-specific areas. This in-house expertise was designed to reduce the need for regular reporting by auditors on supervisory matters relating to individual firms. One consequence was that, over time, meetings between supervisors and auditors also became less frequent. There were still cases where FSA supervisors continued to meet with the auditors at least once a year, but this happened on a less structured basis. In line with our supervisory philosophy of that time, we made less use of third parties (ie use of section 166 reports) and placed more reliance on what firms told us. As noted above, we now recognise that this approach was wrong.

  11. Following the crisis, we have committed to making greater use of our powers under section 166. We now form our own judgements on firms' judgements. The table below shows our increasing use of section 166 powers, and we expect this trend to continue in the coming year.
Number of s166 reports commissioned 2006-072007-08 2008-092009-10 2010-11 to date
Total1830 568890
Banks or firms within banking groups3 2511 16

  12.  We have used our section 166 powers to commission reports from a variety of skilled persons, in addition to the "big four" accounting and audit firms, ranging from mid-tier accounting firms to compliance consultants and lawyers. The reports examine regulatory concerns, such as review of past business and quality of advice, adequacy of systems and controls, corporate governance, capital requirements, and treating customers fairly.

  13.  Our specialist Accounting and Auditing Sector Team, established in 2005, co-ordinates our work with the national and international bodies that represent the profession and strengthens our relationship with the major auditing firms. This cross-sector and cross-firm engagement with auditors has also intensified in response to the crisis. It now includes high-level bilateral meetings with audit firm partners, technical bilateral meetings with audit firm directors and roundtable meetings with the largest firms to discuss key financial reporting and audit issues across sectors on a regular basis. In addition, last year we established an Accounting Review Team. This group of experienced accountants undertakes detailed analysis of the published accounts and the reports from auditors to management for high impact firms. Their primary role is to support supervisors on accounting and audit-related matters.

  14.  We are strongly committed to engaging more effectively with external auditors, in particular in our supervision of high-impact firms. We would expect this approach to continue under the proposed Prudential Regulation Authority (PRA). We are working closely with the Bank of England to plan this and other aspects of the PRA's supervisory philosophy and practice.

14 December 2010

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