In the aftermath of the financial crisis, the question on many people’s minds was: where were the auditors? There were clearly lessons to be learned. Banks were not giving enough information about the risks they faced. Investors were unclear about the work the auditors were doing. Dialogue between bank supervisors and auditors was lacking. So in 2010 we set out proposals on what must change. And earlier this month, we published a report card on progress to date and where we should go now.
The purpose of audit is to give confidence in financial information through an independent opinion of its truth and fairness. This in turn delivers confidence in the resilience of the banking system, as it shows that the numbers, governance, processes and judgements underpinning everything are right. This is how audit, at its best, should work. Yet audit also happens behind closed doors and, as a result, it is not necessarily obvious when it is working well.
Nevertheless, there have been massive improvements in bank reporting and auditing since the crisis. There are new enhanced auditor and audit committee reports that tell the outside world what risks auditors and audit committees examined and what they consider material. An audit report is no longer a pass-fail opinion surrounded by boiler-plate statements.
Communication between auditors and bank supervisors was not working properly, so we worked with regulators to agree a code of practice to make it more effective. Alongside better individual engagement, there are also meetings focused on whole-sector issues where the largest audit firms share their views. In light of the Libor scandal, we developed a framework for providing assurance over the most important benchmarks.
The reporting standard IFRS 9 Financial Instruments will change the way banks measure financial instruments – so they will have to make provision for expected losses rather than only recognising losses when loans go bad. This will mean losses are recognised earlier and the public has more forward-looking information.
Importantly, many improvements have been voluntary. UK banks have been among the leaders in implementing the Enhanced Disclosure Task Force principles for better-quality, more transparent risk disclosures, an initiative which brought together banks, investors, analysts and auditors. These principles include recommendations to help markets prepare for IFRS 9 adoption.
The advantage of market-led solutions is that they can be put in place more quickly than new regulations or standards. The reality is it takes time to get rules right. IFRS 9 is a good example – it took over a decade to develop, and the implementation date is January 2018.
There is another challenge. The sheer volume of change has stretched thinly the people tasked with delivering it. There are only so many projects the best people can work on, and only so much time that boards can spend on the regulatory agenda. Implementing such big change programmes – to demanding timetables – often requires pragmatic work-arounds which create the risk of errors. Banks need a period of stable rules – if for no other reason than to review their implementation so they can identify and fix any glitches.
This may be where auditors have a greater role to play. Through all the expansions of regulation and reporting, the basic audit report has not changed much in the last century. A lot of processes and disclosures, including the capital ratio, are not covered. Auditing is a cornerstone of confidence in financial markets so, to remain relevant, it too must keep pace as those markets evolve. That is why we are developing a framework for assurance on banks’ capital ratios.
While there have been many improvements in bank reporting and auditing over the last five years, it is more important to look to the future. Reporting must provide the information people want and auditors must provide the assurance that they need. Technological advances mean that people can process more data, faster. People will still need reliable information but the idea of this being provided in an annual report may seem as out of date to future generations as leather-bound, handwritten ledgers do to current ones.
Financial statements and auditing cannot remain set in stone, but change is likely to come in small steps. To get there, the accountancy profession must continue to challenge itself to respond to what people want and need from the information published by banks.
Iain Coke is head of ICAEW’s financial services faculty.