FSA and FRC look to enhance auditors' contribution to prudential regulation

The Financial Services Authority (FSA) and the Financial Reporting Council (FRC) have today issued a discussion paper which considers ways of enhancing auditors' contribution to regulation.

High quality corporate reporting, audit and assurance support effective governance and underpin market confidence and market discipline. Together with effective communication between the FSA, regulated firms and their auditors, they are critical to achieving the FSA's objectives relating to market confidence, financial stability and consumer protection. They are also central to the FRC's complementary objectives in promoting high quality corporate governance and reporting to foster investment.

The purpose of the paper is to stimulate debate on the role of auditors following the financial crisis. The paper, therefore, explores how the FSA, the FRC and auditors can work together more effectively to enhance auditors' contribution to prudential regulation.

The paper:

• Questions aspects of the quality of audit work relevant to prudential regulation - in particular, whether the auditor has always been sufficiently sceptical and has paid sufficient attention to indicators of management bias when examining key areas of financial accounting and disclosure which depend critically on management judgement;
• Outlines the FSA's concerns about auditors' work on client assets and how auditors fulfil their legal obligation to report to the FSA;
• Explores a variety of ways in which changes are being made and further changes could be made by the FSA, the FRC and auditors to increase the effectiveness with which auditors undertake their work; and
• Examines the regulatory environment in which auditors operate more widely and suggests measures to enhance how auditors contribute to prudential supervision.

Paul Sharma, FSA director of prudential policy, said:

"Our experience has indicated that, at times, auditors have focused too much on gathering and accepting evidence to support firms' assertions rather than exercising sufficient professional scepticism in their approach - this falls far short of what the FSA - and society at large - expects from auditors.

"We have learnt the lessons of the financial crisis and continue to enhance all aspects of our approach to prudential regulation of firms. It is time for the auditing profession to demonstrate that they have also learnt from the crisis. This paper is an important step in the debate that needs to be had around the role of auditors."

Stephen Haddrill, chief executive of the FRC, said:

"Raising the bar for auditors on the application of professional scepticism has been high on our agenda for some time. Investors have a right to expect a more robust approach from auditors in challenging management's judgements and related disclosures. The auditor's ability to carry through their challenge is also important and proposals in this paper for improved engagement and information sharing between auditors and the FSA will facilitate appropriate improvements.

"We see significant improvements in disclosures about credit exposures, risks and uncertainties provided by banks in their most recent financial statements. Much of this follows from guidance issued by various bodies in the regulatory community. These improvements should have been achieved earlier and with less intervention. This is a key lesson we believe auditors can help firms respond to as disclosures required in relation to critical risks and judgements evolve."

The deadline for responses to the discussion paper is 29 September 2010.