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Fresh focus on audit quality

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The campaign the Local Authority Pension Fund Forum (LAPFF) has been leading on the accountability and responsibilities of auditors might seem like an arcane irrelevance to the average local government employee or manager waiting with trepidation to find out what cuts carnage the post-election landscape will bring.

The campaign the Local Authority Pension Fund Forum (LAPFF) has been leading on the accountability and responsibilities of auditors might seem like an arcane irrelevance to the average local government employee or manager waiting with trepidation to find out what cuts carnage the post-election landscape will bring.

But in fact, with the spotlight for the next few years likely to be firmly on local government finances, pension ‘black holes’ and deficits, the imperative to rein in spending and make what investment there is go as far as possible (and certainly not lose money), makes this an extremely relevant debate.

The agenda the LAPFF has been pursuing in the wake of the banking and economic crisis, through a series of papers, is for the development of a new, tougher, oversight regime around company auditing and financial reporting.

Part of the momentum behind this has been a desire for local authorities, as investors, should never again to have to experience anything like the fall-out that followed the Icelandic banking collapse.

But the forum has also argued that, as part of the post-credit crunch banking reform landscape, the opaque or sometimes blurred separation between auditor and audited is something that needs to be examined.

As LAPFF chairman and Bradford city councillor Ian Greenwood (Lab) has argued: “Understandably much of the post-crisis reform effort has focused on issues like the functioning of boards and the way they are paid.

“But financial reporting remains a key concern, and an area in which the forum continues to be very active. We believe there are relatively modest reforms available that could greatly improve shareholder oversight to the benefit of all parties.”

What the LAPFF would like to see (see box) is increased openness and accountability about how and what companies report financially, more transparency and separation in how audit firms work with companies they audit, particularly when they also carry out non-audit work, and the establishment of a statutory shareholder vote on audit committee reports – or in other words giving shareholders increased clout and ability of censure around the work of audit committees.

It has also called for the creation in the UK of a database similar to the EDGAR (Electronic Data Gathering, Analysis, and Retrieval) one run in the US by the Securities and Exchange Commission, where all companies, foreign or domestic, are required to file registration statements, periodic reports, and other forms electronically, and which can be accessed and downloaded for free.

Yet, while no one would dispute that any push towards openness and transparency is a good thing, Tony Bromell, head of integrity and markets at the Institute of Chartered Accountants in England and Wales, worries whether, in the current climate, there is a risk of an auditing ‘expectation gap’ developing and of the pendulum swinging too far the other way.

“We take the view, for example, that there can be some very good reasons why auditors could be providing other services, for instance if there was a need to carry out a review of interim financial information or for work around regulatory reporting,” he points out.

“Both these are areas that are related to audit, but are not audit. But it would be enormously more time-consuming and costly for it to be done elsewhere, as the auditors will already have all the relevant information with them.”

Similarly, while there have clearly been some important questions raised over audit and oversight pre-crisis, it also has to be recognised that sometimes even the most scrupulously audited companies fail.

“Sometimes companies fail because people have done something very, very, wrong, and that can sometimes raise questions about audit quality. But sometimes they fail just because that is how markets work and companies go out of business. But transparency is something that no one is going to object to, so in that sense it is a good development,” Mr Bromell argues.

However, the LAPFF’s view does chime with that of consultancy PricewaterhouseCoopers, which in March brought out a report on this area. Its Integrated reporting: What does your reporting say about you? analysis of  the FTSE-350 companies’ reporting concluded that, while the majority were ticking all the right boxes to meet regulatory requirements, they nevertheless often struggled to communicate clearly to key stakeholders what they really needed to know in areas such as their performance, risk appetite, governance and delivering on their strategy.

It argued there that was a need for companies to re-establish themselves as trusted sources of relevant and reliable information, with perhaps one model for internal and one model for external reporting. Reporting performance needed to move away from an over-reliance on bare financial information and try to give a more holistic, more strategic picture.

Such more integrated reporting - or reporting that stressed the interdependencies between various areas in any business, such as external drivers, strategic priorities, business models and performance, and which created a picture that considered each aspect in the context of the others rather than in isolation, -would be beneficial to all investors, whether public or private sector, argues David Phillips, the firm’s senior corporate reporting partner.

“At the most basic level, we would hope that a more integrated approach to reporting will help people have a much better appreciation of the risk than they have had in the past. But, and it should not be forgotten, it should also give investors a better understanding of the opportunities,” he says.

The focus on affordability around local authority pensions in the coming years is going to make the issue of how and where pensions are invested one of increasing debate, agrees Rachel Vahey, head of pensions development at investment firm Aegon, which in April launched a pensions manifesto to create a more “sustainable savings culture”.

To this end, there will be an even greater imperative for local government pension schemes to be (and be seen to be) as transparent and open as possible, and for trustees to understand as clearly as they can how and where money is being invested.

Ms Vahey says: “The knowledge and experience of the trustees who take those investment decisions is a critically important role. They have to understand the issues at stake and understand the investment issues.”

In some respects, with value creation an imperative but also public money at stake, it is not that surprising it is local government fund managers who are leading the charge in this area.

Ultimately, while the minutiae of the debate may seem desperately dry and arcane, it is an important issue unlikely to go away anytime soon, Mr Phillips argues.

“There is going to be enormous pressure on the public sector to justify how it is spending and saving money and to justify its return on investment,” he says.

What the LAPFF would like to see:

A prohibition on non-audit services by the firm that undertakes the statutory audit.

A statutory shareholder vote on audit committee reports.

Annual election of all directors.

Continued distribution to shareholders of both the statement from the auditor and from the company as to the circumstances around the departure of auditors (the government has been considering reform).

Greater emphasis on effectively “representing uncertainty” within corporate numbers, rather than simply a focus on reducing complexity.

Creation of a UK equivalent to America’s EDGAR database to assist companies to comply with disclosure requirements at the lowest possible cost.

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