This should be required reading for investors. Kudos to Caroline Escott and Chris Hodge. Audit underpins market integrity, yet there is strong evidence that it is failing. The US regulator’s latest inspections bring this to life (https://lnkd.in/eVxwrhkZ): 34% of reviewed audits by six global firms lacked evidence to support their opinions. High rates of audit deficiencies are repeated globally (International Forum of Independent Audit Regulators (IFIAR). Two points I’d highlight on the back of this report: 1. Investors should use their votes Of the steps that Railpen points to, one that investors can immediately action is their vote. Despite audit failings, investors keep reappointing auditors and audit committees. Auditors in the UK received an average 99% support in 2023. In the US, the figure was 98%. Investor indifference permits poor audit quality. Please see my article on the need for robust voting: https://lnkd.in/epsep6WK 2. Poor audit quality is a risk to capital protection One insidious consequence of audit weakness is not getting the attention it should. Auditors appear to be failing to check company compliance with capital maintenance rules, opening the door to over-distribution, weaker capital buffers and heightened risk of failure. Auditors generally have a role in policing capital maintenance rules (not the same as accounting standards – https://lnkd.in/eWzBy3_7). Critically, companies generally mustn’t distribute (i.e. pay dividends / share buybacks) out of unrealised (e.g. mark-to-market) gains. It is not clear, however, that this is being enforced. This was a key conclusion of the UK’s BEIS Select Committee 2019 inquiry into audit (https://lnkd.in/e8vqGGBd), chaired by Rt Hon Rachel Reeves, now Chancellor. The Committee called for urgent action to enforce capital maintenance rules. Recent research by Andy Haldane (https://lnkd.in/ecqct3Tj) and Adam Leaver (https://lnkd.in/ev43tNP6) underlines ongoing problems of overdistribution. As the UK advances its Audit and Corporate Governance Reform Bill, it should return to the Select Committee’s original proposals. Companies should publish in full their distributable reserves and a breakdown of their unrealised and realised profits, taking away the veil which can enable over-distribution. Auditors should be held accountable for ensuring this is done. Of the options on the table to boost growth, this has the advantage of being fiscally neutral. For their part, investors should start holding auditors and audit committees accountable for capital maintenance.
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"Acting on Audit - an investor stewardship perspective" - our Railpen report with Chris Hodge of Governance Perspectives Ltd. - is out today 🥳 Investors need accounts that present a true and fair view of a firm's financial health to support effective investment decisions. However, regulators in the UK, US and elsewhere are still finding a concerning number of audit deficiencies, while the high-profile collapses of #Carillion, #Wirecard, #PatisserieValerie and others indicate that we're not where we need to be on audit quality just yet - despite the significant steps taken by regulators worldwide. It's been five years since the various UK policy and government reviews on the topic (#Brydon, the #CMA, the #Kingman Review of the FRC and more). And we currently have a Draft Audit Reform and Corporate Governance Bill going through Parliament. So we thought it was a good time to produce a paper which explores audit from a **#stewardship** perspective: ✔️ The evidence on the financial materiality of a high-quality audit to investors ✔️ The policy and market landscape for audit in the US, UK and EU - and how it's evolving ✔️What investor stewards are currently doing on audit ✔️Recommendations for investors, the audit profession, companies and policymakers to improve the market for a high-quality audit Our paper draws upon academic research and interviews with experts from across the investment, audit and corporate ecosystem, as well as from Railpen's own learnings from our engagements with companies on audit issues. I'm deeply grateful to the wonderful and expert Chris Hodge for his work, as well as to interviewees and the Railpen team supporting this. In the paper, Railpen commits to improving our own work on audit. However, as with many market-wide issues, we recognise that we can't do this alone. We hope that the report is a useful contribution to the debate, and look forward to hearing feedback and perspectives from others. The paper can be found at: https://lnkd.in/efNQy_jK (link also in comments below) Shane McCullagh, CFA Rients Abma Katharine Bagshaw Alex Russell Peter van Veen Jocelyn Brown Fiona Ellard Sallie Pilot Tracy Gordon Charles Henderson David Herbinet Guy Jubb Andy Kemp Paul Lee Sarah Legg Jon Lukomnik Jeff Mahoney Liz Murrall Andrew Ninian Emma Barry Paul O'Donnell Becks Goodman Scott Harrison
A super step forward—well done all. But I’d imagine this still assumes even a fraction of a degree of belief and faith in the integrity of the leaders of the Big 4. Remove that and you see those leaders for what they really are. A small group of men who took decisions in the Summer of 2002 to stop accounting for reality and have worked very hard to keep that silent since. Happy to share more offline Natasha Landell-Mills, CFA, Adam Leaver Caroline Escott Chris Hodge
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1moAudit is a key provider of market transparency and aligner of executive incentives. Yet is it clear whether the auditors act for the long-term asset owners? Why has it been so arduous to get basic transparency such as TCFD is arduous, surely the auditors should simply insist its their duty to provide this disclosures to shareholders? A further level up, why has there been such resistance to information such as pricing basis and assumptions in fossil fuel reserves? Moreover, why have so few asset managers supported Natasha Landell-Mills, CFA in her efforts to get this addressed? And finally, the current accounting sustainability Daddy is IAS37 incorporating a companies commitment to the transition into the accounts. Putting words into the finances will show the net zero commitments are material not just words. Andrew Watson Caroline Escott