In the aftermath of the banking crisis it was inevitable, and appropriate, that part of the clean up would involve looking at the quality and effectiveness of the auditing and financial reporting of the banks and other associated financial institutions. The fall-out from this process is now starting to hit home with several major reports and consultations reaching a critical stage.
One of these is the investigation carried out by Lord Sharman into the concept of going concern. He was charged by the FRC to investigate whether, in the light of the financial crisis, it was time to reconsider the nature and use of going concern and liquidity risks and any lessons for company directors, investors and auditors and whether they were equally well served by current arrangements.
His inquiry reported back at the end of last year and was broadly welcomed as a sensible piece of work that asked important questions and raised interesting issues for debate. He suggested a number of subtle shifts in the use of going concern, pointing out a need for greater consideration to be given to solvency risk as well as liquidity risk, asking whether more information should be available on the way boards had reached a view on going concern (and especially any assumptions made in the process). But he was equally clear that there was no need to create a special regime for banks and other financial institutions.
In January the FRC revealed how it intended to implement Lord Sharman’s proposals when it released revised guidance on going concern for consultation. The reaction of almost everyone I have spoken to about that guidance has been one of alarm, apart from those who were either shocked or appalled at the prospect. The FRC appears to have adopted the sort of over-implementation more commonly seen when the UK government reacts to a European directive.
Considering the reasoning for his initial investigation, it is alarming to consider that while it’s unlikely much will change in the boardrooms of the UK’s largest financial institutions as a result of the new guidance, the boardrooms of almost every other business are in for something of a shock. Thanks to actions elsewhere in the regulatory universe, banks and financial institutions are already required to pay much closer attention to long-term solvency and liquidity risks and to look further ahead to try and spot and avoid potential future shocks. And for these financial few there is always the backstop of government or central bank support, with bailouts now apparently so normal a part of life that it’s OK for a bank requiring one to be considered a going concern.
Leaving aside the overly optimistic (some might say impetuous) timetable the FRC set for implementation of its guidance, under which the new system is effectively already in play (having kicked in for financial years starting last October, even if they aren’t due to actually report until later this year), there are also doubts being raised about the way the questions for consultation were framed. In January, Scottish Electoral Commissioner John McCormick forced the Scottish National Party to rephrase the wording of the question for the referendum on independence. Apparently voters felt that a question starting “Do you agree…” wasn’t neutral enough. A read of the FRC consultation shows that all but the last of 15 questions is potentially similarly positively loaded.
Doubtless with the best of intentions, the FRC has blundered into Britain’s boardrooms and set out a series of potentially very difficult tests for the directors. Whether directors should be asking themselves these tough questions is one thing, but whether they should be mandated to do so through the corporate governance code (even one built around a comply or explain model) is another. Likewise whether auditors should be thinking again about these issues in greater depth is up for debate, particularly given the wider questions on the future and value of audit. But again whether this is the right time, place or method to introduce such concepts is again questionable.
Above all, these proposals raise a question of who should pay the price for the failures to more accurately predict and deal with the financial crisis. The current FRC guidance seems to suggest that the most effective way to prevent a repeat is to place further complex burdens on those running small and medium-sized businesses and to make it harder than ever for them to access the vital funding and finance from investors. If there is one lesson from the financial crisis and the long, slow and fragile recovery from it is that we should be doing all we can to build confidence across all sectors of the UK economy. The greatest long-term risk to all investors and businesses is not their inherent liquidity or solvency but rather whether there will be a decent and growing market for their goods and services. These proposals will do little to assist that and potentially will be ultimately self-defeating as a result.
The only good news is that however loaded the consultation, the proposed guidance is still just a proposal. There is a public meeting at the FRC next Thursday morning to discuss the pros and cons of the proposals and consultation. Let’s hope that through the force of feedback and constructive discussion we might yet arrive at more sensible implementation of Lord Sharman’s suggestions.