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.
A. FREQUENCY
OF FSA MEETINGS
WITH EXTERNAL
AUDITORS OF
INDIVIDUAL FIRMS
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:
| Bank | Auditor
| 2006 | 2007
| 2008 |
| Northern Rock | PWC | —
| 1 meeting and 1 phone call. | 2 meetings and 4 phone calls.
|
| HBOS | KPMG | 1 phone call.
| 1 meeting. | 2 meetings. |
| RBS | Deloittes | 1 meeting.
| 1 meeting. | — |
| Bradford & Bingley | KPMG
| — | 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:
| Bank | Auditor
| 2009 | 2010 to date
|
| Northern Rock | PWC | 3 meetings and 1 phone call.
| 1 meeting. |
| Lloyds Banking Group (which includes HBOS) |
PWC | 2 meetings. | 3 meetings.
|
| RBS | Deloittes | 1 meeting.
| 2 meetings. |
| Bradford & Bingley | KPMG
| 3 meetings. | 1 meeting. |
B. WHEN THE
REGULAR PRACTICE
OF AUDITOR-SUPERVISOR
MEETINGS FELL
AWAY
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
| 2006-07 | 2007-08
| 2008-09 | 2009-10
| 2010-11 to date |
| Total | 18 | 30
| 56 | 88 | 90 |
| Banks or firms within banking groups | 3
| 2 | 5 | 11 |
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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