Why we need a regulator with clout to hold the big accountants to account

 

Has the Competition Commission caved in to one of the more cynical lobbying campaigns conducted in the City of London (and let’s face it the bar is not very high  on this front)?

The big four accountancy firms certainly have good reason for feeling chipper with the abandonment of some of the commission’s more radical proposals, such as forcing companies to regularly change the firms which scrutinise their books, or clamping down on the non-audit work they are allowed to do for their audit clients.

Ernst & Young went as far as to suggest that the debate on mandatory rotation of auditors has been “laid to rest – for now” as if this were a thoroughly good thing.

Costly and disruptive was the view of virtually everyone who ventured to respond to the commission’s suggestion that mandatory rotation might be a good idea.

Many of those responses read remarkably similarly. At least one of the expert organisations that produced a variation on this theme, the Corporate Reporting Users Forum, has very close links to one of the big four, PricewaterhouseCoopers, which as we revealed last week conducts its administration, supplies meeting rooms, and lays on the tea, coffee and digestive biscuits when those meetings are held.

Scratch beneath the surface and you will find that an awful lot of the other organisations which commented on the Competition Commission’s ideas to shake up the audit market have similarly cosy relationships with accountants.

One of the measures the commission has proposed is to bolster the power of audit committees. They will have a greater role in selecting auditors, tenders will have to be put out every five years, and so on.

But here’s the thing, many big companies hire former partners in accountancy firms as non-executive directors and have them sitting on audit committees.  So it is no wonder that strengthening audit committees was one measure the big four were quite keen on … audit committees which could be said to be as much of a problem as the auditors who signed off on the accounts of banks which promptly went bust.

Another measure which will get the go-ahead is that banks will be banned from inserting clauses in loan agreements demanding that a customer be audited by a member of the big four. Which looks like a good idea in principle. In practice, however, bankers will still make clear what they expect to see and companies, wanting to ensure a good relationship with them, will do what is required of them, hiring their mates at big four accountancy firms to ensure that is the case. So the new requirement isn’t as good as it looks.

The commission’s report is a disappointment, but it’s basically caught in a bit of a bind, with a veritable army of negative opinion and interlinked lobbying power arrayed against it. The big four don’t just dominate in Britain, they dominate globally. To force real change upon them it needs a regulator with global clout to act.

Here’s a new case to test the mettle of the FCA

Yet again it seems that shining a light into the City’s dark corners reveals something ugly with a London link, American watchdogs (well, one of them anyway) on the warpath, and the Financial Conduct Authority trying to work out how it should proceed.

The New York Times’ revelations about the involvement of Wall Street banks – and in particular (drum roll please) Goldman Sachs – in the metal supply chain through cornering the ownership of warehouses is troubling in the extreme. Through the creation of vast backlogs, in part by moving metal between their own warehouses, the supply chain is interrupted, the price rises, the banks reap huge profits from rental fees, and perhaps from other means too.

To the consumer the impact seems fairly small, a miniscule increase in, say, the price of the cans which contain their daily fix of cola.  But the sheer number of cans sold means the banks can turn a truly vast profit. As for the economic impact (this affects far more than just coke cans), it can just go hang.

It should be said that there doesn’t appear to be anything illegal in what the banks have been doing, although the US Commodity Futures Trading Commission has fired the first shot across their bows, demanding they keep files and emails, which should keep its people in jobs for the next couple of years while they wade through them.

If they can find anything resembling a smoking gun – ie anything which violates one of the CFTC’s rules – there may be a settlement down the line, with a gaudy looking penalty imposed (which will probably amount to a couple of days’ profit in reality) without the banks involved admitting any wrongdoing.

If that’s the case, the FCA may follow up with a fine of its own. The problem it faces is that while it regulates the London Metal Exchange, and metals-based derivatives, it doesn’t have any power over the physical market. That is overseen by the London Metal Exchange, and while the latter is consulting on changes, an earlier set of reforms could have contributed to the current situation by insisting that metal is swiftly moved from a warehouse, without defining where to.

The LME also takes a small cut of the rent, leaving it with a rather obvious conflict of interest.

In the past few weeks we’ve also seen scandals emerging in a number of energy markets – the FCA fined a trader yesterday – and then there was Libor, also unregulated until recently.  Where next? Foreign exchange? Precious metals?

It is increasingly becoming clear that the FCA’s remit is inadequate and it needs the scope to be able to take swift action where problems emerge in any of these areas. Because, as has become all too evident, anywhere you find investment banks you find sharp practice. The regulator needs  better knives.

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