Industry response

Our response to guidance consultation on updated code of practice between the external auditor and the FCA supervisor

Introduction

The Building Societies Association represents mutual lenders and deposit takers in the UK including all 46 UK building societies.  Mutual lenders and deposit takers have total assets of over £375 billion and, together with their subsidiaries, hold residential mortgages of £245 billion, 20% of the total outstanding in the UK. They hold more than £250 billion of retail deposits, accounting for 22% of all such deposits in the UK. Mutual deposit takers account for 31% of cash ISA balances. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.

General

We agree that the external auditor has an important role to play in the regulatory framework.  We also think it is good practice for a supervisor to liaise with the external auditor as this strengthens the communication channels – so long as it does not lead to duplication of work.  The external auditor is appointed by the members to act in the best interests of the firm - in our case, a mutual.  This relationship between the external auditor and supervisor could therefore lead to conflicts of interest if not managed properly.

The FCA says that the external auditor’s role in the regulatory framework requires an open, co-operative and constructive relationship between the supervisor and the auditor so that they both provide effective input to the regulatory process.  We agree.  The regulator goes on to say that it is important that the terms and scope of this relationship are therefore clearly defined and understood by both parties. We argue that that it is equally important that the regulated firm also understands this relationship.

The FSA website says that the “changes ….. mainly align the Code with FCA’s statutory objectives, rather than significantly changing the nature of interactions with the auditors”. However, we note, for example, there are now five principles when previously there were four, changed emphasis in principles 1 and 2 and the inclusion of thematic discussions with auditors of C2 and P2 firms.  It would have been helpful to have had the proposed changes from the original code laid out clearly for stakeholders, as has happened with changes to the FSA handbook.

Comment

1. Reports by skilled persons (also known as section 166 reports)

The annex to the proposed revised code of practice provides guidance on the content of auditor/ supervisor bilateral meetings with dual regulated C1 firms (and P1 firms).  We note two mentions of section 166 reports:

  • discuss recent supervisory risk assessments, skilled persons’ report findings and      other supervisory reviews.
  • plans for potential skilled persons’ reviews in the coming year.

We are, of course, aware that both FCA and PRA intend to make more use of these reports but including them so prominently in the guide of discussion topics strongly suggests that the FCA expects C1 firms at least, to be subject to these reports on a regular basis.

The FCA will know of our concern about the increasing scope and extent of the use of section 166 of the FSMA to demand these reports on more day-to-day matters, even in circumstances where there is no evidence of any wrongdoing on the part of the firm.  While we recognise that this move reflects the regulators’ commitment to a more intrusive approach to financial services regulation, such tools should be used appropriately and proportionately.  Our response to the Joint Committee on the Draft Financial Services Bill questioned the use of this third party reporting to, for instance, verify regulatory returns. 

We are concerned that such reports are proving extremely costly (£31 million in 2011/12) and that the effect of using section 166 at present is to shift significant regulatory costs from the regulator itself (as the firm has to pay for the report), and thus - in effect - conceal them. We argue that the total burden of regulatory costs can neither be controlled nor scrutinised while this indirect route is used.

In view of the increased regulatory powers implemented under the Financial Services Act 2012, it is important that the FCA is open and transparent in respect of process matters such as the selection of skilled persons (including relative costs); consultation with firms in respect of their particular businesses; the suitability of the subject matter for a section 166 report; arrangements for addressing potential conflict of interests; and FCA accountability regarding the number, scale, nature etc of such reports.

2. Principle 4

We welcome the reduction in frequency of bilateral meetings and reduced prescription of attendees.

3. Prudential Regulation Authority

We note the PRA is to issue its own code.  While we appreciate the FCA and PRA have different statutory objectives, we urge both not to try and develop entirely separate codes of practice.  Not only is that unhelpful - even confusing - for dual regulated firms such as mutuals but also expensive: external auditors’ services have to be paid for.  

A far better approach in this matter would have been for both regulators to have issued their codes of practice simultaneously with differences between each other, and proposed changes from the earlier code, marked clearly.

BSA policy brief on developments in external audit (members only)

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