Wednesday, 18 April 2018

KPMG Continues to Suffer in South Africa

South Africa is currently still reeling from the ‘Gupta scandal’, but in recent news one of the leading global auditors has come under intense fire for a number of aspects, including its links to the Gupta family. In this short post, we will review the recent news and examine the future for the auditor in the country in the wake of incredible action by the South African government.

On Tuesday, it was announced that South Africa has banned KPMG from auditing public companies within the country. The move comes on the back of a number of scandals involving the auditor, including its ties to the Gupta family and also the recent collapse of VBS, a South African bank that despite being given a clean bill of health by the auditor collapsed a short time later. It has been stated by KPMG that senior officials within the South African arm of the company have left the company before they could face disciplinary action for failing to declare a financial interest in the bank. Although KPMG had sent a number of high-ranking people to the unit to attempt to ward off this current outcome, it was to no avail, with the South African auditor-general stating that the company would benefit from no future contracts because of the ‘significant reputational risks’ associated with it in light of recent events. The Financial Times has reported that a number of South African financial institutions have since cut ties with the auditor, or are in the process of doing so, which serves only to deepen the crisis for KPMG further; the unit’s chairman declared that they had ‘reached the breaking point’, and it is likely that this recent and unprecedented action may see his statement proven correct. However, other auditors have been banned from auditing public companies in other jurisdictions (like India and Japan), so it is likely KPMG will be working on a strategy to clean up its act to the satisfaction of the South African authorities, but it is certainly a testing time for the auditor in the region.

However, as the author is based in the U.K. it cannot escape my attention that, as was noted by Professor Shah, ‘in the UK, there is not even a whiff of this kind of attitude from the government or the regulator’, which begs the obvious question – why? In the U.K., the massive failure of Carillion, which after investigation has been found to have auditors’ fingerprints all over it, is surely a vehicle for which this type of action may have been considered. But, as Shah says, there has not even been an inference that anything so impactful would be considered by those in power. In truth, this is perhaps a damning indictment of the situation within the U.K., a situation which portrays a continuing and systemic ‘capturing’ of the British authorities. It is often said that what may be required is a massive crisis to jolt the system and redress the balance somewhat, but this is not true because the Financial Crisis did not redress this balance; in fact, it probably created further imbalance. Thinking further still, it is potentially even more incriminating that suggestions such as public bans have not really been proposed, never mind instituted. Yesterday’s news casts a shadow over other regions who have suffered in a similar manner to South Africa but have not acted.

Keywords – audit, South Africa, KPMG, accountancy, UK, regulators, @finregmatters

Wednesday, 11 April 2018

The Financial Reporting Council Attempts to Fight Back

As usual here in Financial Regulation Matters, today’s post looks at something we have assessed on a number of occasions (which likely hints at the systemic and continued nature of these issues that are identified on a regular basis here). Today’s post focuses on the Financial Reporting Council (FRC) as pressure upon continues to increase. Its position, and future as a regulator, is being called into question more and more recently on the back accounting scandals (like that seen with Carillion), but recently the FRC has announced measures which it hopes will be seen as being representative of a proactive regulatory culture within the organisation.

The news came yesterday that the FRC is endeavouring to incorporate new procedures into its regulation of the audit industry, with the regulator taking specific aim at the so-called ‘Big Six’ (in reality it is probably a ‘Big Four’). The new approach dictates that when one of the six firms cited – KPMG, Deloitte, PwC, EY, Grant Thornton and BDO – want to make a senior appointment, the regulator will have to vet them first to examine the candidate’s “appreciation of a high quality audit’ and their ‘experience and knowledge of driving accountability structures through organisations’; this process will include those applying to be appointed for non-executive positions, heads of audit committees, and heads of ethics committees. The regulator has stated that its aim is to limit the risk of ‘systematic deficiencies’ within the sector, which some industry onlookers have described as ‘long overdue’. However, despite the regulator insisting that the proposed structure should be seen as a response to the recent criticism (which intensified when the performance and actions of the auditors in the Carillion collapse were brought to light), the criticism of the regulator and its attempts to establish its authority have continued unabated.

The Executive Director of Audit at the FRC – Melanie McLaren – stated that this approach is not a ‘direct response’ to the recent criticism, but a number of scholars have been clear in their scathing assessment of the regulator, with one describing the approach as a ‘defensive response’ which does not address the issues of accountability at all. Whilst that sentiment may be debated, the fact that the FRC has now power over the process, but can only ‘advise’ the companies on their recruitment, will not help the FRC’s cause as it strives for legitimacy in the face of private and public pressure. In a recent ‘sanctions review’, the FRC announced that the level of fine available to the regulator would rise to £10 million for ‘seriously poor audit work’, although it should perhaps come as no surprise that the instant response from onlookers was that the new tariff ‘may not have enough of a deterrent effect’; KPMG’s revenue last year stood at $26.4 billion.

With the news coming that two leading board members of the FRC have been ‘stood down’, with both having close ties with the regulated auditors, it is apparent that change is in the air at the FRC. However, whether it can survive this current storm is questionable. The criticism from academia is persistently ‘ramping up’, and now the political machine is seeking to ask serious questions of the role of the FRC after the auditors were identified as ‘feasting on the carcass’ of Carillion; a collapse which has brought the issue of public monies and private business sharply into the limelight. Perhaps there are only two ways the regulator can survive, with the first being the hope for them that something else dominates the political agenda so that their deficiencies are relegated against something much more pressing, or alternatively they change their strategy. There are many arguments for the approach of the FRC, but they are starting to be dominated by the criticism. For a regulator to be so heavily tied to their regulated entities, to be so reliant upon self-regulation, and to have their regulatory weaponry be so obviously blunted (£10 million is no deterrent whatsoever for the Big Four), the only thing that can save that regulator is a good track-record; the FRC, regrettably, does not have that. What it does have is a track record of facilitating the growth of the audit industry as it sought to incorporate the sentiment of prioritising high fees rather than accuracy, and for that the regulator will likely pay a heavy price.

Keywords – Financial Reporting Council, Audit, Accounting, Business, regulation, U.K., @finregmatters

Monday, 9 April 2018

More Warning Signs for the Auto Industry

In Financial Regulation Matters, we have looked at a number of issues within the automobile (hereafter ‘auto’) industry, ranging from the positive – the ever-growing expansion of the electric auto market – to the negative – concerns over the finance bubble which is continuing to grow within the sector. Today’s post looks at the latter issue, with news recently suggesting that the inevitable conclusion to the growing ‘bubble’ is drawing ever nearer.

In a post in May of last year, we discussed how the fears regarding a growing credit bubble in the auto industry were beginning to get louder and louder, with the Financial Conduct Authority and the Bank of England raising specific concerns over an increased rate of indebtedness within the sector. Now, in the United States, those same concerns have manifested in the first stages of a process we are all living the result of today. Only a few days ago Bloomberg reported that a ‘growing number of small subprime auto lenders are closing or shutting down after loan losses’, which the outlet had reported would come to fruition earlier on in February. Bloomberg had stated in February that ‘loans to American consumers with some of the patchiest credit histories are packaged into securities to be sold to big investors’, adding that ‘car-owners are increasingly falling behind on bigger loans with longer repayment terms made against depreciating assets’. That scenario has been confirmed now, and the diagrammatical data suggests the curve is only going one way:

There are a number of onlookers who have been quick to note the differences between this bubble and the bubble that exploded in 2007/8, with the common differentiator being that of size. It has been noted that this bursting of a credit bubble is expected to be much different because ‘auto lending is a smaller business relative to mortgages’, with the difference being cited as $280 billion outstanding for auto loans today compared to $1.3 trillion outstanding on mortgage loans at the height of the crisis. It has also been suggested that a decrease in lending within the sector, mostly based on increased competition and subsequently less margins, has sought to negate the continued expansion of the bubble, although that perhaps does not tell the whole story.

Whilst lending in the sector has decreased somewhat, and the relative size to the housing bubble is much smaller, this does not necessarily mean that the effect will be much less dramatic. The environment that this bubble is expanded within is a much different environment that the housing bubble expanded within, with the potential for contagion and the associated effects being particularly acute in the post-Crisis era. Also, whilst onlookers are keen to play down the exposure of the elite financial institutions to this bubble, it is not the case that they are not involved. Goldman Sachs, as just one example, has been noted to be involved in the underwriting of these securities (as one would expect), as to have Wells Fargo and JPMorgan Chase. Furthermore, underneath all of the excessively complicated financial data, the same aspects of the Financial Crisis can be witnessed here, with examples of fraud and predatory lending being cited as growing in response to the tightening margins; this is not surprising in the least, and has been suggested as being representative of the same Ponzi-scheme-like process that we witnessed in the lead-up to 2007/8.

Ultimately, there are issues raised within the current news cycle that can be extrapolated to paint a picture of the regulatory framework’s failures in the post-Crisis era. It has been noted that many of the protections that were designed in the wake of the Crisis do not apply to the auto industry, which suggest a narrow-mindedness on behalf of the legislators and regulators. Alternatively however, perhaps it represents something else. Perhaps it represents the constant gamification of the financial arena where the regulators and legislators are inherently one step behind, always reacting. If this is the case, then it is difficult to see how these bubbles can ever be prevented; it is in the modern finance entity’s nature to chase profits and margins, and superimposing a ‘system’ onto a different sector was perhaps the easiest way within which they could achieve the same objectives. There is plenty of blame to go around, as usual, but perhaps it is worth taking a step back for a moment. Rather than looking at financial practice, or the reactionary stance of the regulatory framework, perhaps a fundamental recalibration of the understanding of money is required; the answer to the Crisis within many jurisdictions was to make credit available at all costs, and to increase the availability of credit to consumers as quickly and efficiently as possible. It is arguable that this is the epitome of short-termism, because that system of credit is, essentially, what allows this ‘ponzi-scheme-like’ system to work; what if, and it may sound like a fanciful theory admittedly, the sentiment and narrative was altered to one of saving and responsible purchasing? This revised narrative would work and would have a demonstrable effect upon the ability of high finance to manipulate the system, but perhaps that view is too simplistic. Rather, there is an argument to say that the flow of credit has become a vital component because of the stagnation in wage growth, relatively speaking, or the continued effects of the era of austerity upon many segments of the population – perhaps people’s standard of living would be decimated without the availability of credit, even more so than the devastating effects of austerity? There are then many aspects to this issue, with no clear answer in sight, but what is clear is that there is a game in play in which many within society will pay the cost, and that is unfortunately becoming an understanding that is being more normalised by the day.

Keywords – Auto industry, subprime auto loans, finance, business, banking, investing, @finregmatters

Sunday, 8 April 2018

Barclays’ Redevelopment Continues to Falter

We have looked at Barclays on quite a few occasions here in Financial Regulation Matters, and today’s post continues with that theme. Following on from developments surrounding financial penalties for the firm, and also the scandal involving Jes Staley and his attempts to uncover a whistleblower, recent news regarding the potential future for the Bank deserve to be discussed as it continues to attempt to redevelop itself within the post-Crisis era.

Earlier this month, the Bank made the headlines for successfully ‘ring-fencing’ their consumer-focused element of the company, which the Bank described as ‘the biggest banking start-up ever’. In responding to the British Government’s insistence that ‘the largest UK banks must separate core retail banking from investment banking’, the bank successfully completed the transfer of more than 24 million customer accounts, which equated to more than £250 billion worth of assets. In addition, which is extremely topical, the ring-fencing system also means that the ring-fenced bank i.e. the element that is not subjected to the travails of the risk-taking investment banking arm, will now be the vehicle to work with SMEs who have an annual turnover of less than £6.5m. The move has been heralded by onlookers (and the bank itself), with the bank stating that the separation represents a ‘seismic’ but positive change, and external analysts suggesting that the divestment would allow for ‘greater balance sheet certainty’. However, a wider look at the fortunes of the massive British-based bank suggest that challenging times lay ahead.

There are a number of potentially negative elements currently affecting the bank, with each contributing to a negative outlook. Firstly, the search is underway to replace outgoing Chairman John McFarlane, which whilst significant in itself is perhaps magnified with the increased stake taken by the activist investor Edward Bramson; Bramson is renowned for involving himself in the businesses within which he invests, which provides for uncertainty in relation to the current issues faced by Barclays. With regards to its leadership, Barclays CEO Jes Staley is still under investigation for his alleged attempts to uncover the identity of a whistle-blower, which although there has been some support for Staley in the media with regards to his position on the matter, continues to be a dark cloud hanging over the bank – if found guilty, it is possible that Staley will be made to be an example (potentially). Additionally, Staley has been praised for his handling of the charges emanating from the US, with the Bank’s settlement with the DoJ for $2 billion being regarded as a positive result for the bank. Yet, others have not been so positive, and it has been argued that the bank’s restructuring plans (strongly attributed to Staley) have not been successful so far; one onlooker suggests that Bramson’s appearance on the scene at Barclays is evidence of this restructuring attempt failing. Furthermore, Barclays’ own audit committee is continuing to raise fears over the culture of compliance within the firm, which point towards a much larger issue. Yet, those issues were all compounded recently by movement from the credit rating agencies, whom we know so well here in Financial Regulation Matters.

Earlier this week, the Credit Rating giant Moody’s downgraded Barclays to just one level above its so-called ‘junk status’. The agency cited the ring-fencing manoeuvre as its biggest concern, suggesting that whilst it believed the ring-fencing is positive, it has made the bank riskier overall; there was a specific focus on the impact upon the investment banking arm of the bank, which the agency believes could cause the company serious harm if it suffers from the ring-fencing system. The business media has been quick to note that a. the downgrade was expected and b. it is having very little effect upon the perceptions of investors towards the bank. However, there are wider implications in that the pressure summarily increases on Staley at a time where he needs anything but. Yet, it is fair to say that the bank is at somewhat of a crossroads, and its development from this point could have a major impact upon its long-term future.

There are a number of elements that will be concerning the bank, but a few stand out. The credit rating downgrade makes for bad ‘optics’, but the damage to the bank will likely be minimal before it is inevitably raised to a ‘normal’ level. However, the two most concerning elements for the bank are the emergence of Bramson, and the continuing investigation into Staley. With Bramson increasing his stake, the possibility of this notorious investor inserting himself into the business of the bank to satisfy his objectives continue to increase, and that is not a positive for the bank; the bank really needs to develop a longer-term focus to its operations, and many have suggested that Bramson will look to do the exact opposite. For Staley, the argument put forward in his defence (that the whistle-blower was not an employee of the bank) may stand up under legal scrutiny, but is a poor defence when one considers the effect of his actions upon the concept of whistle-blowing more generally; not to re-hash an old post, but with the prospect of ‘amnesia’ setting in within the financial arena as we oscillate further away from the Crisis being a real possibility, there is an acute need to champion the role of a whistle-blower – the question is will allowing Staley to avoid sanction for his actions encourage such a thing? The answer is no, and the effect of that will be massive. Yet, for Barclays, their future is plagued by uncertainty at the moment, and it is important that the bank’s development is kept in focus as it plots a way out of its current malaise.

Keywords – Barclays, Banking, Business, UK, ring-fencing, @finregmatters