FCA warns auditors over client asset reporting

Audit firms’ performance has come under fire from the new head of the Financial Conduct Authority (FCA), who has said audit quality needs to improve ‘urgently’ and warned that some firms are failing to produce adequate reporting on client assets

Charles Randell, who took over the top role at the financial regulator in April, was speaking on the eve of the tenth anniversary of the collapse of the two US mortgage lenders, which marked the start of the global crash and was followed shortly afterwards by the failure of Lehman Brothers.

Stating that the ‘audited financial statements of a financial firm are the cornerstone on which the additional regulatory processes are built’, Randell said ‘we need accountants to deliver high quality audited financial statements for firms.’

‘It was, therefore, very disappointing to see that the Financial Reporting Council’s (FRC) announcement of its 2017/18 Audit Quality Review highlighted a decline in the audit quality for the Big Four audit firms and specifically a decline in the quality of bank audits. 

‘Whatever the outcome of the current review of the Financial Reporting Council which is being undertaken by Sir John Kingman, the profession needs to address audit quality as a matter of urgency,’ he said.

Randell called for the accounting profession ‘to step up its game’ in ensuring there is robust scepticism and challenge.

‘Disclosures in the financial statements should properly reflect the risks which are revealed by that process, including the Internal Capital Adequacy Assessment Process (ICAAP) or other stress scenarios.

‘It is perhaps an interesting thought experiment to ask whether, if the regulatory capital numbers were subject to external audit, that would increase the focus of auditors on these risks,’ he said. Randell was explicitly critical of audit reporting on client assets, saying that while this had improved significantly over the last five years, since the introduction of the FRC standard on providing assurance on client assets to the FCA, the regulator continues to see report that are ‘just not good enough’.

He said the FCA has concerns that some audit firms have not invested sufficiently in building their knowledge and understanding of the client asset sourcebook (CASS) rules and the FRC standard.

Randell said: ‘We continue to monitor this area but be warned: we have a very low tolerance for CASS failings, because of the significant customer detriment these can cause, and we expect auditors to identify CASS failings when they report to us.’

In his speech the FCA chair highlighted what he called ‘information asymmetries’, resulting from the continuing limitations of the historical cost or current value approach of financial reporting standards, which he said leads to regulatory requirements for financial firms to keep what amounts to multiple sets of books.

Randell said that IFRS 9, accounting for financial instruments, addresses the limitations of the historical cost and current value approaches, to a certain extent.

‘It’s now up to the accounting profession to make IFRS 9 work and, critically, to ensure that the standard is applied in such a way that investors can make meaningful comparisons between different firms,’ he said.

He also emphasised the importance of business model reporting, which he said should drive disclosures about performance indicators and risk and be linked to remuneration policies.

Randell said: ‘I think it is fair to say, firstly, that business model disclosure and the long-term viability statement have not yet reached maturity in all quoted financial firms and, secondly, that firms to which these requirements do not apply have not all recognised the benefits of voluntarily adopting them as best practice. 

‘The accounting profession can help to guide firms to put business model analysis and consideration of long-term viability at the heart of their corporate reporting.’

He concluded his speech by saying: ‘The accounting profession needs to ensure that firms embed the changes which have been introduced since the financial crisis, including disclosure and analysis of business models and long-term viability and consistent and comparable reporting of credit loss provisions.

‘But after that we need to continue to debate whether financial statements or other disclosures can provide better guidance about future risks and reduce the information asymmetries which still exist between management, investors and creditors and regulators.’

Ten Years after Lehman: How Accountants Can Make Finance Safer is here

Report by Pat Sweet

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