Modest proposals will not make the audit process any more watertight

Modest proposals will not make the audit process any more watertight

Andrew Tyrie’s report recognises the value of more competition, but tinkering at the edges won’t make it happen

A Carillion sign at a construction site in central London

A thorough audit is seen as particularly important since the collapse of Carillion last year.
Photograph: Yui Mok/PA

Companies go out of business all the time, but big companies should be an exception. They have responsibilities to the communities where they operate. They employ lots of people and perform economically essential tasks. So they need to be resilient and have the capacity to adapt.

So what part does a financial audit play in keeping such a corporate ship afloat? It’s a question the Competition and Markets Authority (CMA), run by former Tory MP and Treasury select committee chair Andrew Tyrie, attempted to answer last week in a report that asked how greater competition might improve audit quality.

It is a question that ministers have asked Sir Donald Brydon, a City grandee who is currently chair of the London Stock Exchange, to address in his forthcoming review of the “quality and effectiveness of audit”. This followed an initial recommendation for a revamped audit watchdog by Sir John Kingman, a former Treasury official who is now chairman of Legal & General.

Clearly, after the collapse of Carillion last year, parliament sees a thorough annual audit of a firm’s financial accounts as important in keeping a business seaworthy.

Unfortunately, most auditors approach their work as if checking a piece of machinery, albeit one with more moving parts. Audits work like a health check by a private doctor who knows that their patient might well cover up symptoms of what will later become a life-threatening condition – either out of embarrassment or, more importantly, to limit the costs of treatment.

An executive may want to cover up mistakes or wrongdoing for the same reason. The “doctor” needs to ask some probing questions before declaring the patient fit.

The CMA has considered the topic in line with its remit, which focused on the structure of the audit market. It has demanded only limited reforms. One is that companies commission two audit firms to check their books if one of the firms they use is a member of the Big Four – KPMG, PwC, Deloitte or EY.

This move should, according to Tyrie, empower smaller firms of auditors to gain a bigger foothold in the market and therefore provide a greater challenge to the big four. He argues that with competition comes greater quality.

Tyrie also wants audit departments within the larger accountancy firms to adopt Chinese walls to prevent their work being used as a calling card for more lucrative consultancy contracts.

Timid is the best description of these proposals, because only a separate audit industry, cut free from tax and management consultancy work, can ever be truly independent. Beefing up smaller firms is something the government needs to be actively involved in facilitating, because expecting auditors to treat the idea of joint working with anything other than disdain is naive.

So the CMA’s efforts amount to little more than the kind of window-dressing the audit industry has managed to maintain ever since Arthur Andersen perished following the collapse of Enron in 2002.

From that point onwards, auditors have repeatedly told ministers that imposing too many rules will only lead to another accountancy firm dying under the weight of unjustified compensation claims (Arthur Andersen was cleared of wrongdoing by the US courts).

Should we expect any better from Brydon, given that his report will be from the perspective of shareholders and shareholder representatives, with only Alison Hopkinson, the chief operating officer of Oxfam, to represent the interests of wider society? Not really.

Only a more fundamental shake-up will prevent managements from sinking companies, like they did at Carillion. Business minister Greg Clark should take note.

The gold standard for policing

The price of gold has been going down in recent weeks and is currently at its lowest level since the turn of the year. And that means Asian families may be able to sleep a little easier this weekend.

Why? Because research presented to the annual conference of the Royal Economic Society says burglars believe there is a higher likelihood of finding gold – normally in the form of jewellery – in Asian homes, and increase their larcenous behaviour when the price of the precious metal is high.

Researchers Nils Braakmann, Arnaud Chevalier and Tanya Wilson used the link between gold and burglary rates to test whether criminals are economically rational. In 1968, the late Nobel prize-winning economist Gary Becker wrote that individuals would turn to crime only if the expected proceeds, once adjusted for the risk of getting caught, outweighed the returns from living within the law.

If Becker’s theory is correct, districts with a high proportion of Asian households should see an increase in the burglary rate when the gold price goes up, because that changes the supposed risk-reward equation for potential burglars.

And this was supported by the evidence from England and Wales. The researchers drilled down into neighbourhood-level crime data and found that an increase in the gold price by £100 an ounce led to a 1% increase in burglaries, with a greater share of Asian households affected. In neighbourhoods with the highest share of Asian households, the number almost tripled.

There were, of course, two sides to the original Becker thesis: expected returns and the risk of getting caught. When the gold price is rising, the police should step up visible patrols in districts with a high proportion of Asian households, because that would act as a deterrent to would-be burglars.

A Tesla showroom in Miami, Florida.

A Tesla showroom in Miami, Florida. Photograph: Joe Raedle/Getty Images

Fiat-Tesla deal leaves both of them under a cloud

The end of the age of the internal combustion engine looms – and unexpectedly soon too, as carbon limits and the prospect of outright bans put big carmakers on alert that they need to change rapidly.

The accelerating transition has caught out some manufacturers. According to analysis by Jato Dynamics, based on 2018 data, only Tesla and Smart – out of 50 major manufacturers – will currently avoid steep European commission penalties planned for carmakers whose vehicles emit more than an average 95g of carbon dioxide per kilometre.

The penalties come into force from 2021, but some of the most polluting carmakers selling in Europe are now fighting to avoid the fines. And rather than upgrading to cleaner technology, they are instead seizing on legal loopholes.

Under the EU rules, carmakers can pool emissions across brands. But they can also buddy up with other manufacturers to make “open pools”. Japan’s Toyota has teamed up with Mazda, which it part-owns, but Fiat Chrysler has paired with Tesla.

Fiat is understood to be paying hundreds of millions of euros to average its emissions alongside Tesla’s zero-emission cars, thus dodging hefty fines. Fiat insists it is committed to reducing emissions but is entitled to “optimise the options for compliance that the regulations offer”.

It is a grubby deal on both sides. Tesla founder Elon Musk proclaims that he wants to “accelerate the advent of sustainable transport”, and a ticking counter on Tesla’s website says its vehicles have so far saved 3.6 million tonnes of CO2 emissions. Those green ambitions appear to have disappeared when faced with a pile of cash.

The compromises of putting a monetary price on pollution are often uneasy and sometimes necessary, but Fiat’s approach leaves a noxious taste: economically wasteful, unfair on competitors investing in greener factories, and against the spirit of environmental protection.

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Financial market ‘pause party’ makes Fed rate cut less likely

WASHINGTON/NEW YORK (Reuters) – Risk-taking has been the rage since the Federal Reserve quit hiking interest rates at the end of last year. U.S. stocks are back near record highs and investors are stockpiling the lowest-grade corporate bonds with only a smidgen of extra compensation for the added risk.

Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., April 18, 2019. REUTERS/Brendan McDermid

That rebounding mood on Wall Street may be welcomed by a president that has been demanding the Fed cut rates after markets fell sharply last year, and complaining that even pausing at the current level is the wrong call.

But if anything the ‘pause party’ on Wall Street makes it even less likely that the U.S. central bank will cut rates. Recent positive news on retail sales and exports, which have eased concerns of a sharply slowing economy, makes the case for a rate cut even weaker.

Investors at least have gotten the message, and shifted from projecting a rate cut later this year to now putting the odds at only 50-50 that the Fed will move lower by early 2020.

Wall Street celebrates the Fed’s ‘pause here.jpg

The state of financial markets, say some analysts, is evidence the Fed’s rate increases last year were on point, allowing the economy to continue growing while keeping risks in check. A rate cut at this stage would only be courting problems.

“The argument for why they should keep the possibility of a rate hike on the table is because of financial stability,” Citi chief economist Catherine Mann said in remarks on Wednesday to a conference on financial stability at the Levy Economics Institute of Bard College.

After a decade of near zero interest rates, “moving toward a constellation of asset prices that embodies risks is critical for getting us to a more stable financial market,” she said, noting that both equity prices and low-grade bond yields show a market that remains too sanguine.

In their critiques of the Fed, U.S. President Donald Trump, White House chief economic adviser Larry Kudlow, and possible Fed nominee Stephen Moore have argued that lower rates would allow faster growth and be in line with Trump’s economic plans. They contend that, with the risk of inflation low, the central bank does not need to maintain ‘insurance’ against it by keeping rates where they are.

     Overlooked in that analysis are the financial stability concerns steadily integrated into Fed policymaking since the 2007 to 2009 financial crisis. Mann spoke at a conference named in honor of economist Hyman Minsky, who explored how financial excess can build during good times, and unwind in catastrophic fashion. The downturn a decade ago showed just how deeply that dynamic can scar the real economy.

     Financial stability isn’t a formal mandate for the Fed, which under congressional legislation is supposed to maintain the twin goals of maximum employment and stable prices. But since the crisis the central bank has concluded that keeping financial markets on an even keel is a necessary condition for achieving the other two aims.

    That doesn’t mean an end of volatility or a guarantee of profits, but rather that risks are properly priced and that the use of leverage – investments made with borrowed money – is kept within safe limits.

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     That’s a key reason why even policymakers focused on maintaining high levels of employment, like Boston Fed president Eric Rosengren, at times have taken on a hawkish tone in favor of rate increases. The worse outcome for workers, Rosengren and others have said, would be to let markets inflate too much, and crash again, even if that means risking a bit higher unemployment in the interim. 

Markets are currently “a little rich,” Rosengren said in recent remarks at Davidson College in North Carolina.

Though not enough to warrant a rate increase, he said, it does argue against a rate reduction. Overall, Fed officials including Chairman Jerome Powell say they feel financial risks are within a manageable range, something policymakers feel has been helped along by the rate increases to date.

The state of financial markets is “something that the Fed has to wrestle with,” Rosengren said. “It’s appropriate for interest rates to be paused right now.”

Corporate bond valuations look frothy here.jpg

Reporting by Howard Schneider and Trevor Hunnicut; Editing by Dan Burns and Andrea Ricci

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