APPENDIX 4: LETTER FROM MR ANDREW
BAILEY, EXECUTIVE DIRECTOR AND CHIEF CASHIER, BANKING SERVICES,
BANK OF ENGLAND (ADT 75)
At recent hearings of the House of Lords' Select
Committee on Economic Affairs into the role of auditors, a number
of references have been made to the Working Group that the Bank
and FSA established to consider the relationship between the external
auditor and the prudential supervisor and wider accounting disclosure
issues. I thought it would be helpful to provide you with some
background to the Working Group and to let you know where its
work currently stands.
The WG was established last September with the senior
partners of the big six audit firms, the Bank of England, FSA,
the Financial Reporting Council and the Institute of Chartered
Accountants in England and Wales (ICAEW). The aim was to get the
views of attendees on ways to improve the relationship and information
flows between the audit profession and the prudential supervisors
and to establish how publicly available information on firms could
be made more useful to end-users, with a particular focus on disclosures
around the valuation uncertainty of less liquid assets.
There was broad agreement at the meeting with the
view that the working relationship between external auditor and
the prudential supervisors had broken down in the period prior
to the financial crises. Prior to 2007, formal meetings between
supervisors and external auditors no longer formed part of the
routine supervisory framework and the informal channels of communication
that existed when the Bank had responsibility for supervision
had fallen away. The FSA had also in this period made much less
frequent use of skilled persons' reports as a routine supervisory
tool. The regular meetings that these had previously engendered
helpfully reinforced the links between the auditor and supervisor.
All agreed that the auditor has an important role to play in the
regulatory framework and that an effective relationship between
the two parties needed to be re-established. As part of their
new intensive supervisory approach, the FSA had established regular
meetings between the auditors and the supervisors; however, the
working group agreed that it was important both to codify this
new approach and to build on it further.
With this in mind, the Working Group has so far met
on three occasions to consider how the relationship between supervisor
and auditor could be improved in practical terms. It has met on
three occasions since September and has drawn up a draft 'Code
of Practice', which sets out principles that re-define the nature
of the relationship between supervisor and auditor, the form and
frequency that communication between the two parties should take,
and the responsibilities and scope for sharing information between
the two parties. The Code encourages both parties to foster an
open, cooperative and constructive relationship to create a positive
framework for effective input to the regulatory process. The intention
is to agree the Code early this month and for it to be adopted
by the FSA after a six week consultation period with affected
firms.
The Working Group is now focussing on the second
strand of its mandate. This is to consider enhanced disclosure
requirements around the valuations of banks' less liquid assets
to enable users to compare financial instrument valuations between
institutions. There is evidence to suggest that disparity exists
in the valuations applied to similar financial instruments across
firms, in part because complex/illiquid instruments are subject
to valuation uncertainty. Current financial statement disclosures
around asset valuations, despite being compliant with accounting
standards, are often not sufficiently granular or transparent
in respect of the critical valuation assumptions, and sensitivities
of those assumptions, to support users' understanding and meaningful
comparisons. It is arguable that this lack of transparency and
comparability undermines the operation of market discipline and
hinders the promotion of financial stability. The Working Group
is therefore looking at ways to improve these disclosures to enable
market participants to compare cross institutions on a common
basis. It aims to conclude its discussions on these issues by
end-June.
These initial objectives should be the start of a
better understanding between supervisors and auditors.
8 February 2011
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