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


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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