The British, or should that be the English, and in particular those living South of the M25, have developed a bit of a reputation in recent years. Well probably many reputations. What we’re thinking of is their inclination to be reticent about speaking their mind on issues which aggravate them. To be more exact, the English have developed a fondness for “off the record briefings” with journalists and regulators on issues which they feel strongly about.

There could of course be many reasons for this: a) being naturally shy and retiring;  b) not wanting to ruffle feathers/rock the boat in case it reflects badly on them or their organisation; c) not wishing to be seen as rude or overly forward. Fair enough, the social niceties of business have a place – up to a point. BUT there comes a point when holding back is profoundly damaging as the enforced (but well-intended) silence can be misconstrued as indifference. Yet, we all know that there are many hot issues that the governance community are highly vocal about –  in private. So what is this week’s hot but silent topic? The EU Green Paper on Audit – “Lessons from the Crisis”.

It’s been quite a year for auditor bashing, the House of Lords is running it’s own investigation, there’s been no shortage of press commentary on some of the more contentious aspects of accounting standards, Big 4 auditor dominance etc. And we’d agree, it’s a tough issue, not every-one’s favourite ESG subject.

Dry or not, accounting and audit are key issues for investors and asset owners and investors really need to tell the EU what they think – and go on the record about it. The Commission simply cannot use lobby briefings, while that might work in the UK regulatory environment, it’s not the way that Europe does things. And here’s another surprise, while investors are busy hiding their lights under a bushel, the investment banking and accounting fraternity are not. Quite the contrary, they are sending in their heavy battallions, so much so that the EU’s view of the world is now that of the investment banks and the big 4. In the absence of any other views, is that surprising?

The auditor’s role is to be a watchdog and an advocate for the share and bond holders, not the directors who contract with them and pay the bills and not the investment bankers. As the owners’ eyes and ears it’s seems reasonable for them to get an unencumbered true and fair view of what’s going on in the company. But it won’t happen unless shareholders use their voice and give the EU clear and unambiguous direction.

For the past five years the ESG team at Aviva have put a great deal of thought and effort into this key shareholder protection. They, like all of us, are time-constrained, particularly with so many consultations running at once. But that’s not really an excuse if we want governance to succeed. So we could do no worse than take a leaf out of Aviva Investor’s book and consider raising the unencumbered true and and fair view concept by answering the Green Paper’s Question 3 and 6 (please feel free to copy/paste).

(3) Do you believe that the general level of “audit quality” could be further enhanced?

Given the importance of the audit as a vital shareholder protection, it is worth noting that the audit and its outputs are, for the most part, lacking in transparency. Share and bond holders, as opposed to wider stakeholders, have a particularly special place as the audit customer as it is they who are the providers of capital; the capital markets merely provide a conduit to that capital. It is not just the audit opinion itself but also the reporting of matters of emphasis, accounting records and distributions which help investors come to a fully informed judgement of the company’s true position.

The move towards rules-based accounting standards, as embodied in IFRS, has created a false sense of comfort. There is a strong perception of a tick-box formulaic approach to audit which is compliance-oriented and serves the needs of trading markets rather than owners. In turn this leads to concerns about the impact of a compliance culture on the application of an “Unencumbered True & Fair View”, namely that there is real substance over form and prudence, as it is substance which  is the cornerstone of effective audit and thus protection of owners.

(6) Should “professional scepticism” be reinforced? How could this be achieved?

Without doubt, “professional scepticism” should be reinforced and properly embedded within the auditing role. However, without solid foundations and clear purpose this would achieve nothing. In order for the full impact of the concept to be felt, it should be contextualised with reference to the “True & Fair View, substance over form and prudence” principles.

There is an implied view in the Green Paper that IAS1 encapsulates the True & Fair View. There is also considerable emphasis on fair presentation being achieved by “compliance with applicable IFRSs” with deviations from standards being ‘allowed’ “in the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements”…..

In light of the current emphasis on tick-box, compliance oriented audits, we strongly encourage the EU to re-examine the issue closely and review its current position.

 It’s very convenient to blame the auditors for the banking crisis and all our economic woes, everyone else gets a handy “Get out of jail free” card. But that’s not entirely fair given that they are working within a framework of investors’ own creation and approval. Investors should not simply assume that they are going to get the audits they deserve unless they are actively involved in crafting the new regulatory and behavioural framework.

As neuroscientists would say: ” The way we talk about things changes the way we and others think about them” such is the power of language.  But if we don’t talk, nothing changes.

The consultation closes on 8th December. Responses can be sent by email to: markt-greenpaper-audit@ec.europa.eu

Last Updated: 2 December 2010