Finance directors must be looking back nostalgically to what now seems like the halcyon days: those times when risk was important and seemingly under control. Yards of documentation went up to the board, with risk matrixes in voluminous quantity and colour-coded differences of priority. The risks were all good boilerplate stuff: easy to identify and then show that actions would be, or had been, taken to minimise the danger.
Then came the great financial crisis of 2008 and all that risk preparation stuff went out the window. None of the priorities that had been identified were the disasters that ensued. The leftfield had not been factored in, or even considered.
This great failure of the comfortable risk industry which had grown up has changed the thinking – and two recent events have clarified it further. First, the Financial Reporting Council (FRC) started the new year by issuing an important paper. Its boring title, Effective Company Stewardship, is not going to startle the horses, but its subtitle, Enhancing Corporate Reporting and Audit, should.
The second event was part of the lengthy examination of the world of audit, which the House of Lords Economic Affairs Committee has been carrying out. The atmosphere in Committee Room One has been out of keeping with its neo-gothic splendour and views across the Thames. Real issues have been tackled and problems teased out. But the day that four members of the Hundred Group of Finance Directors were called in to give evidence, the room was changed. Across the corridor in more mundane – and perhaps more corporate – surroundings, the topic of risk again came to the fore.
These FDs, which included outgoing BG Group FD Ashley Almanza, were asked if – despite saying in their written evidence that they got a good service from their auditors, and one with which they were satisfied – they had a fear lurking in the back of their minds that auditors are not as capable as they might seem.
It was Robin Freestone, CFO at Financial Times publisher Pearson, who answered. He pointed out that companies were focused on risk and spent significant amounts of time assessing risk, applying principles, looking at probabilities and how the risk could be mitigated. The results were encapsulated, he said, “in a relatively small, somewhat unread, section of the annual report, Risk and Uncertainty”. He said he thought that when a risk issue arises, people would look at that section and ask whether that risk had been suitably flagged. “Now it may be that that section is not as prominent as it should be,” he said. “It may be that the probabilities of risk and how management is managing that risk is not always talked about in the way it should. But I think it is up to the management to define the risks and uncertainties and manage those, and for the auditors to comment upon them.”
It was the effectiveness of the auditors in commenting that was exercising their Lordships. But the FRC report may provide an element of the cavalry riding to the rescue. It suggests the entire annual report and accounts should, to use the terminology of the Companies Act, be balanced and fair. This would result in the auditors agreeing the whole document rather than the current situation in which auditors ignore the chairman’s bit of the annual accounts.
In the words of Ian Wright, the FRC’s feisty director of corporate reporting, this would radically improve the disclosure of risk. It would remove the current practice of, as he puts it, listing 44 risks, nearly all of them boilerplate. Instead, it would drive greater explanation and more disclosure to “focus on what keeps people awake at night”. This would slowly shift the nature of the annual report and accounts, says Wright, towards providing “the full story and the ugly bits”. And more of that type of ugliness would be much more useful.
The UK’s imminent exit from the EU that may now put the audit committee to the ultimate test
Audit tendering has turned from good practice to legal practice under the EU audit reforms
Businesses will have to think more strategically about where they can source those non-audit services in the future
The FRC has raised concerns that the FTSE 350 audit market remains highly concentrated among the Big Four despite high levels of tendering and rotation