Financial services: The changing auditor-supervisor relationship

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By Ian Dewing and Peter Russell

28 July 2015

Ian Dewing and Peter Russell welcome moves to re-invigorate the relationship between auditors and supervisors of financial services firms, following the financial crisis.

The financial crisis called into question the role of auditors, supervisors and the nature of financial risk.

Auditors were criticised for giving no warning of the financial crisis, for failing to communicate with supervisors, and for not exercising a sufficient degree of professional scepticism.

Supervisors were criticised for a lack of communication with auditors and, more fundamentally, for inadequate supervision of financial services firms.

Concerns were raised about auditors' and supervisors' assessments of risk and about the risk governance of financial institutions.

Our research investigated the role of auditors and supervisors in the system of UK and EU financial services supervision as it emerged after the financial crisis. We conducted interviews with audit partners and with executive directors, non-executive directors and senior managers from financial services firms. Interviews were conducted in the UK, Belgium and the Netherlands.

UK audit partners

For UK audit partners interviewed we found that the major change since the financial crisis was the re-establishment of ongoing links with supervisors. This enabled a sharing of views. The best meetings were described as a "two-way" process with auditors and supervisors contributing equally to discussions.

Audit partners were very much aware of the growth of the risk management function in firms. This frequently involved the appointment of a chief risk officer and establishment of a risk committee separate from the audit committee, but with overlapping membership to ensure that all risks were covered across the two committees. Some partners attended risk committee meetings as well as audit committee meetings.

UK financial services firms

The views of UK finance, risk and internal audit executives, and of non-executive directors, provided an interesting counterpoint to the views of UK audit partners. We found that interviewees from firms were aware of, and welcomed, the re-introduction of liaison between auditors and supervisors.

Recognising that the process was new and would take time to settle down, the main concern of these interviewees was that the dialogue should be appropriately structured and that supervisors accepted accounting and auditing judgements ultimately rested with the firm and its auditors.

Interviewees confirmed the rapid growth and strengthening in financial services firms of the risk management function based around the three lines of defence model.

European findings 

In Belgium and the Netherlands the auditor-supervisor liaison had been maintained. While the relationship changed and became more intensive during and after the financial crisis, it did not have to be re-invented as in the UK.

Interviewees from Belgium and the Netherlands echoed remarks made by UK counterparts. However, as both Belgium and the Netherlands are members of the Eurozone, a further set of regulations apply, including direct supervision of important banks by the European Central Bank, and the crisis over the euro created further uncertainty.

Recent UK developments 

An important development is the Prudential Regulation Authority's (PRA) consultation on improving engagement between auditors and supervisors. This proposes that auditors of the largest UK banks and building societies should provide written reports to the PRA as part of the statutory audit cycle. Interviews with audit partners indicated that initiatives to enhance the quality of the auditor-supervisor dialogue would be welcomed.

We believe that these reports are a constructive way forward for further improving auditor-supervisor engagement. We also suggest that more information about the auditor-supervisor dialogue should be disclosed to investors and other stakeholders by including a discussion in the new extended auditor's report.

The relationship between auditors, supervisors and risk explored in this project has changed significantly since the financial crisis, and the intensity of that relationship seems set only to grow.

Audit, supervision and risk in financial services is published by ICAS and available to download free of charge.

About the authors

  • Ian Dewing is a professor at Norwich Business School, University of East Anglia.
  • Peter Russell is a senior lecturer in accounbting at Norwich Business School, University of East Anglia.

This article first appeared in the August 2015 edition of The CA magazine.

Topics

  • Research
  • CA Magazine

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