Monday, 20 May 2019

European Auditing Regulations Begin to Take Effect

In 2016, a number of new rules regarding the auditing of large financial institutions within Europe were established. The regulations had a number of aims and we will discuss them in today’s post, but one of the major aims was to ensure further transparency when it came to the auditing of PIEs, or ‘Public-Interest Entities’. Interestingly, this designation allows the EU to capture financial institutions that hail from outside of the EU, and in today’s news the first test of those regulations was passed when Goldman Sachs announced that its new auditor from 2021, in complying with the rotational elements of the regulation, would be Mazars, marking the Bank’s first move outside the so-called ‘Big Four’ auditors in its history.

The regulations that came into force in 2016 have a number of aims including: ensuring further transparency; providing statutory auditors with a strong mandate to be independent; develop a more dynamic audit market; and to improve the supervision of auditors within the EU. There are, as one would imagine, a number of elements to the reforms, but we shall focus on one in particular and that is that PIEs need to change their statutory auditors every 10 years. The EU maintain that there are obvious risks with PIEs having links to the same auditors for 50 or 100 years, and that ‘mandatory rotation will hence contribute to a better audit quality’. There are variations that the EU allow for, like the ability for member states to reduce this period to 7 or 8 years, and allow for a maximum of an additional 10 years with the same auditor. The EU pair this with increased restrictions on the non-audit services an auditor can offer to a PIE whilst simultaneously performing auditory services. Quite rightly, these include aspects such as tax, consultancy, or advisory services, decisions that lead to the auditor playing any part in the management of the PIE, and also services linked to structuring, allocation, financing, and investment strategies. It was accepted that there would be a delay before we saw the actual effect of these reforms given that PIE-auditing contracts were due to be renewed on individual bases, and today we saw the first instance of these regulations taking effect.

One would assume that if a PIE would have to move away from the Big Four, then they would just filter down the accepted hierarchy within the industry. In the UK, the fifth player within the industry was, until recently, Grant Thornton. It has therefore caused huge interest within today’s business press that rather than acquire the services of Grant Thornton, Goldman Sachs has decided that its next contract for the auditing of its European Business will be with Mazars, not with Grant Thornton or BDO – now recognised as the fifth largest player - who many had imagined would be in the running. It has been suggested that this decision was not altogether voluntary, with it being reported that the Prudential Regulation Authority questioned Grant Thornton’s ability to conduct the audit, in what will be a massive blow to the company if this is true. Nevertheless, the Financial Times discusses how, via Professor Gordon of the University of Michigan, ‘it is a step forward… Mazars has the opportunity to dispel the myth that only the Big Four are capable of auditing the largest, most complex companies’. The business press have been clear that this is a massive coup for Mazars, who whilst recording revenues of €1 billion+, have still struggled to break the stranglehold of the Big Four.

For Goldman Sachs, the picture is arguably quite clear. It cannot select another member of the Big Four after PwC – with whom they have a historic connection – because all of the other members of the oligopoly currently provide a number of ancillary services. Yet, in moving down the list to Mazars – recognised as being the eighth largest firm – the Bank has potentially done something that it will fundamentally benefit from. All eyes will be on Mazars now to see how it performs, so its audits and the auditing process should be remarkably clean and above board. Goldman will also receive favour for engaging with the spirit of the regulation and leading the way for something which the EU has injected a lot of capital. Whether Mazars will step up to the plate and ‘dispel the myth’ only time will tell, but one imagines they will do. The question then will be how will the Big Four respond, because it has been reported that EY have already taken legal action against the EU in order to change, or postpone the reforms. History tells us they will not go down without a fight.


Keywords – audit, Goldman Sachs, Banking, Mazars, business, @finregmatters

Wednesday, 15 May 2019

Barclays and the Too-Big-to-Jail Myth

We have examined Barclays on a number of occasions here in Financial Regulation Matters, with a number of posts focusing on the Bank’s dealings with Qatar at the height of the Crisis. The approach taken by Barclays – to deal with Qatar for emergency funding during the height of the Crisis rather than seek Governmental support – has been the subject of a number of investigations since and has brought a number of regulatory bodies into the picture. In today’s post we will examine the interconnecting dynamic that exists between a number of British regulators and the economic, political, and societal factors that affect their ability to effectively regulate. We will not revisit the developments between Barclays and Qatar in any great detail here, as it has been covered before in the blog and by the business media. Rather, we will focus on developments detailed in today’s business press that suggest that the Bank of England, via its Prudential Regulation Authority body, argued to prosecutors at the Serious Fraud Office that criminal charges brought against the Bank ‘could destabilise Barclays’.

The obvious question to ask on the back of this news is whether intervening in such a manner is appropriate. A number of prominent onlookers (including Professors Prem Sikka and Emilios Avgouleas) have commented today that today’s revelations demonstrate regulatory ineffectiveness, ultimately suggesting that such dynamics only serve to continue such destructive practices (referring to too-big-to-jail). According to the Financial Times, the BoE’s top banking supervisor spoke with David Green, the then-Director of the SFO, and warned that a criminal prosecution would result in ‘unpredictable consequences’ for the bank and, therefore, the sector. It is important to note that the source of this revelation has not been identified and that all parties concerned are refusing to comment as of yet, but the implications are extraordinary. The Financial Times continue by making the point that Barclays was charged by the SFO anyway, with there being very little effect to the position of the Bank as a result. This then brings into question the concept of using fear to lobby on the behalf of the regulated entities.

Admittedly, that concept sounds conspiratorial. The official understanding of the concept is much more subtle, with then-Deputy of the Bank of England Andrew Bailey – now in charge of the Financial Conduct Authority – explaining in 2014 that regulators around the world (meaning US regulators mainly) need to put their ‘cards on the table’ before penalising regulated entities so as not to cause systemic risks. This was the reasoning behind George Osborne, then-Chancellor of the Exchequer, writing to the US Federal Reserve to ‘express concern’ over the impact of charges against British-based Banks like HSBC. There are perhaps two schools of thought in this instance. One may suggest that regulators need to be concerned with systemic issues to avoid a repeat of the Financial Crisis and are justified, therefore, in considering the impact of large penalties against important entities within a given sector. This makes sense. However, there is an issue with the application of that approach.

If we consider the actions of the FCA regarding the release of an investigative report into the conduct of RBS (a majoritively state-owned Bank), then the intervention of the regulator to stop the publication of that report takes on a different meaning in light of today’s suggestions. The implications of understanding decisions from within this too-big-to-jail lens means that systemically-important financial entities can transgress without damaging consequences. Regulators, wary of systemic repercussions, will intervene on the regulated entities’ behalf. Whilst the case of Barclays may not necessarily be directly applicable, it is telling that there was very little effect to its position as a result of the prosecution (which has since been scrubbed). In reality, RBS has continued on pace through the GRG scandal. HSBC is surviving just fine irrespective of massive fines. There is enough evidence to suggest that penalties can be exacted (let us just stick with financial penalties for the time being) without there being a systemic risk. If we accept that to be true, then a reality comes to light which is a difficult one to accept, perhaps. That reality is that financial regulators protect the regulated entities, not the victims of their crimes. The rationale for that position is complicated however. Who is to say what the dominating factor is in a regulator’s decision-making process, but the pattern is certainly one of perpetrator-first, rather than victim-first. Perhaps, the rationale is irrelevant. The impact remains the same, and that impact permeates the economic cycle so that in good times the perpetrator is prioritised, and in bad times the perpetrator is prioritised. Perhaps that is a systemic reality that explains the majority of decisions that take place – the system is the most important aspect. That understanding fundamentally changes the concept of ‘systemic importance’.


Keywords – financial regulation; banking; UK; Business; @finregmatters

Monday, 6 May 2019

Kraft Heinz and its SEC Investigation Threatens to Impact Others

In February Kraft Heinz announced that the Securities and Exchange Commission was opening an investigation into its accounting practices. In this post, we will examine the potential scope and ramifications of that investigation as, although Kraft Heinz have not found any irregularities internally, there are a number of associated organisations who will potentially be embroiled in the scandal if it is found to exist.

We have discussed Kraft Heinz as a company before here in Financial Regulation Matters, mostly on account of its failed attempt to take over Unilever in 2017. Whilst the subpoena was announced in February of this year, it was actually received in October and the subpoena related to the firm’s ‘accounting policies, procedures, and internal controls’. The company then, in February, took a $15.4 billion impairment charge, or a ‘writedown’, and that is now believed to be something the SEC are also investigating. The company stated that the writedown reflected ‘lower margin expectations’, but this also ties into a concerted strategy to divest across the company on account of its growing $30.9 billion debt pile. This somewhat justifies the views taken in the previous blog posts regarding the differing styles of capitalism adopted by 3G and Berkshire Hathaway, and that of Unilever. Since that failed attempt and the rapturous attention Wall Street have given the company, 3G’s notorious approach for slashing the company to pieces has inevitably backfired, with the firm losing $75 billion from its value in just 2 years and the $15.4 billion writedown concluding that period. The exact same trend can be witnessed in 3G’s other businesses, like Anheuser-Busch InBev NV, the world’s largest brewer of alcohol.

Another potential aspect is that PricewaterhouseCoopers, Kraft Heinz’s auditor, may become embroiled in the firm’s troubles. There has been very little suggestion of this in the business media, but the issue of accounting malpractice, if not uncovered by PwC in its auditing of the firm, will surely become an issue if the SEC find malpractice as part of their investigation. This would be particularly unwelcome for PwC, given that it has only just received a ‘record’ fine from British regulators (£6.5 million over it auditing of BHS), and much larger fines from US regulators ($335 million regarding the collapse of Colonial Bank). When we consider that there is a growing call to reform the industry and, essentially, dismantle the hegemony of the Big Four, yet another scandal could have massive effects for the future of the auditing industry (although it likely will not, given the power dynamics within that particular oligopolistic industry).

Kraft Heinz represents a particular mode of capitalism that is pure in its intention. It does not tolerate what it deems as inefficient (workers were recently denied ‘perks’ such as free cheesestring products whilst on duty), and its owners (3G in particular) are incredibly renowned for its brutal cost-slashing policy. However, even though the businessman who can do no wrong – Warren Buffet – chose to back 3G in a number of its endeavours, there are troubles ahead for that mode of capitalism. This is troubling for Buffet too as Berkshire Hathaway, his investment vehicle, starts readying itself for life without Buffet at the helm – it is almost certain that this will be a tumultuous time for the vehicle as investors cast scrutiny on the real company without its famous leader. The impact of this current investigation into Kraft Heinz could be far reaching indeed.

Keywords – Kraft Heinz, Capitalism, PwC, Business, Audit, Warren Buffet, @finregmatters

Thursday, 2 May 2019

An Update on Scope Ratings

In February of last year we looked at Scope Ratings, a new entrant to the credit rating marketplace, on the back of an article by this author in European Company Law. Since that date, there have been a number of positive developments for Scope so in today’s short post we will be updated on those developments.

Scope Ratings is a German-based rating outfit that has ambitions to challenge the hegemony of the Big Three – S&P, Moody’s, and Fitch Ratings. So far, since its inception in 2011, it is certainly not backing away from the challenge. Currently, the firm is Europe’s largest Credit Rating Agency (European-based, at least), and employs more than 200 staff across seven offices (Berlin, Frankfurt, London, Madrid, Milan, Oslo, and Paris). Recent successes, especially within the Structured Finance department, recently saw Guillaume Jolivet appointed to the agency’s Board, which founder Florian Schoeller suggested is an ideal fit as he is ‘ideally positioned to help the group become a leading provider of credit intelligence and Europe’s champion credit rating agency’. Additionally, Scope has recently appointed Ralf Garrn as Head of its Digital Development, with Garrn coming from Euler Hermes rating which he founded in 2001 (which is now co-owned by Moody’s). So, internally the agency is performing well and is on course to reach its aim of attempting to challenge the Big Three. Externally, they have received news recently that is a massive boon.

Two major German insurance companies have joined the growing list of investors who are supporting the firm. HDI, and Signal Iduna, are two of the major players within the German pension-fund marketplace and their joining of Scope now takes its investor base to nearly 70, which is impressive given this particular marketplace. To accentuate this recent growth spurt, the agency has been awarded its licence to perform rating services within Switzerland, which it sees as an area of growth following recent investments there. This is all incredibly positive. However, and only time will tell if this is true or not, the ‘tipping point’ has not been reached yet. That point refers to the moment when the agency truly comes into the Big Three’s (and in reality, it is the Big Two) sphere of influence and the leading oligopolistic agencies have the decision to make of whether to attempt a takeover, to directly challenge, or to allow the oligopoly to grow to four members. Oligopolies, of course, have no set number but there is usually a natural equilibrium and for the credit rating oligopoly it appears that three is the magic number. Therefore, Scope’s growth, whilst fantastic news for the sector and for investors, is charting a path that almost all other non-Big Three agencies take, and the results are always the same – be taken over, stop growing, or cease to exist. Hopefully Scope can buck this trend, but the theory of oligopolistic organisation, and also history, tells us that this may be a difficult task.


Keywords – Business, credit rating agencies, Scope Ratings, @finregmatters

Wednesday, 1 May 2019

Edward Bramson Shines a Spotlight on the Concept of the Free Market

We have examined the potential reconfiguration at Barclays before in Financial Regulation Matters, and in today’s post we will pick up on some comments made in today’s business media ahead of Barclays’ AGM on Thursday. The focus and speculation surrounds that of Edward Bramson, a so-called activist investor who many believe is aiming to cause substantial change within the massive bank. In this post we will look at Bramson more closely, and then discuss a concept that is being advanced as a ‘norm’ but which calls into question the very nature of the marketplace.

Edward Bramson has held many positions as one might expect of a serious investor, but it is through his investment vehicle Sherborne and Company that he is making headlines at the moment. Through that vehicle he has amassed a 5.5% stake in the bank and it is being reported across the business media that, tomorrow (Thursday), he will ask shareholders to elect him to the Board of the bank. His stated reason for this is that he wants to scale back the Bank’s investment arm and force it to focus on areas of stability (and growth in part) in their commercial and credit card departments. However, whilst sections of the business press suggest that he is unlikely to be elected to the Board, it has been discussed that there are concerns around the performance of the investment arm and that his suggestions may carry more favour than people expect. It is indeed a battle for the ideology of the bank, with current CEO Jes Staley priming the bank to take on the Wall Street elite, and Bramson wanting to change the focus inwards. Yet, whilst the Financial Times made the interesting comparison between Bramson and the ‘Night King’ from HBO’s Game of Thrones, there is an underlying issue that has been brought into the limelight that forces us to ask what the economic reality is in today’s society.

Writing for the Financial Times, John Gapper states that, since the Crisis, ‘regulators are rightly cautious about how banks are run, and would look sceptically on an abrupt change of strategy pushed through by a maverick’. This declaration is interesting for a number of reasons. Firstly, yes it is right that regulators be cautious, but on the same day that regulators have allowed Lloyds to reduce their capital buffer, it is difficult to see complete consistency in this cautious approach. Yes, the two are very different, but the issue is that regulators are not necessarily equipped to run a multinational bank, so is it correct that they may have the opportunity to define the approach taken by one of those banks? Regular readers will know that the approach taken here in the blog is certainly not one of brazen free-market capitalism, but the suggestion made by Gapper is not insignificant. This is a leading financial media outlet supporting Staley’s view of taking Barclays further into Wall Street – but, is he right in doing so? The performance of the investment arm suggests not, but this is counteracted by the widely held belief that a diversified bank is better equipped to deal with storms. That may be widely believed, but that does not make it the only approach. It is unlikely that Bramson will be successful in the AGM, but the media coverage of this issue demonstrates a wider problem whereby massively impactful decisions are being guided by journalists and potentially rubber-stamped by regulators who may not, necessarily, have the expertise to make such decisions in the private bank’s business.


Keywords – Edward Bramson, Barclays, Banking, Business, @finregmatters

Monday, 8 April 2019

Fitch Ratings Receives a (European) Record Fine for yet another Conflict of Interest

In this short post, we will review the news from a couple of weeks ago that Fitch Ratings, the third member of the Credit Rating Agency oligopoly, has been fined by the European Securities and Markets Authority (ESMA) for breaching its conflict of interest-related rules, specifically with regards to its ownership.

Fitch Ratings is the third member of the rating oligopoly and, like S&P is not a public company. Therefore, its ownership structure is a little more opaque and difficult to accurately determine. We know that the firm is owned by the influential Hearst Group, but only after the Group increased its stake in the agency at the expense of previous majority shareholder, French conglomerate Fimalac, in 2014. It is in relation to the ownership of Fimalac that this current regulatory action relates. Yet, whilst most CRA-related transgressive behaviour revolves around weighted bias – weighted in relation to the power dynamics within the rating industry and its connection to issuers and investors – this particular transgression was far more obvious.

ESMA had been investigating Fitch’s ratings of a French Supermarket group called Casino. The investigation has now concluded that, in relation to its ratings of the Casino Group from 2013 to 2015, the agency had failed to ‘meet the special care expected from a credit-rating agency as a professional firm in the financial service sector’. This was because between 2013 to 2015, one of the supermarket’s Board – Marc Ladreit de LacharriĆ©re – also owned a stake in Fimalac. As Fimalac was a majority owner of Fitch at the time, this conflict should have been declared; this is based on rules established in 2013 that states that nay shareholder with more than 10% in the agency must not sit on the board of a company the agency then rates. For not declaring and then removing the conflict, ESMA has fined Fitch Ratings a record fine of €5.1 million. According to the Financial Times, that fine covered three other breaches for similar violations.

What this episode does is bring into the limelight the potential for transgressive behaviour within the credit rating industry – it is not agency specific. In 2015 S&P was fined a record $1.5 billion, whilst Moody’s was fined $864 million. First time observers may think that this demonstrates this behaviour as only existing at the very top of the industry and, thus, creating a ‘duopoly’ instead of the oft-cited ‘oligopoly’. However, the truth is that Fitch provided documentary evidence detailing the transgressions of the other two instead of settling with CalPERS – the Californian pension fund that initiated the legal action against the Big Two – which tells us that they were not entirely guilt-free, but possessed the evidence needed to avoid being caught up with the Big Two. This current story tells us that it is the modern version of a ‘rating agency’ which is actually the transgressive vehicle, and not one particular agency. Fitch Ratings said, in response to the fine, that they are well aware of the European Regulations and acted in good faith. If this is true, then a record fine would not have followed. There are many transgressive industries within the financial sector, but the sheer consistency of transgressive behaviour from within the credit rating industry is remarkable, and shows no sign of abating.


Keywords – Credit rating, Financial Services, oligopoly, EU, @finregmatters

Tuesday, 2 April 2019

The Acuris Sale as an Indicator

In today’s short post we will look at the news recently that important players within the financial marketplace are jostling for position with regards to the sale of a company that specialises in providing particular information to the financial world. The emergence of NewsCorp and the so-called ‘Big Three’ credit rating agencies as potential purchasers of Acuris suggest that this is a potentially important sale. However, the question for this brief post is whether the sale acts as an indicator for a much larger, and much more important sentiment.

Acuris, formerly the Mergermarket Group, is a ‘media company’ that specialises in providing financial information to the marketplace. More specifically, it has been noted for its excellence in providing information on Mergers & Acquisitions (M&A) to its subscriber base. Although its current owners BC Partners only purchased the company in 2013 for £382 million including debt, it is now widely rumoured that the company is for sale. That proposed sale is drawing in some of the largest players in the sphere, with News Corp and the so-called ‘Big Three’ credit rating agencies supposedly circling the company which onlookers suggest could go for more than £1 billion. However, there have been a number of reasons put forward as to why there is so much interest in the company, with those reasons ranging from the reliable subscriber base that the company enjoys, to the company’s year-on-year growth. Yet, one element that may be the case is that the potential purchasers are of the strong belief that the post-Crisis financial landscape will settle more than it has. One of the reasons why this potential sale suggests that is a theory put forward by the popular press and a leading audit firm: a relaxed financial environment results in improved M&A markets.

Bonamie et al find that what they call ‘policy uncertainty’ does negatively affect M&A activity. Lee agrees but in respect of cross-border M&A activity, which is obviously a major factor in the M&A marketplace owing to the globalised nature of the market; the Financial Times reported at the end of last year that global M&A activity for 2018 had eclipsed a previous record set on the eve of the Financial Crisis. So, there is evidence to suggest that global M&A activity is increasing and that the trend may continue. How do we know the trend may continue? One clear indicator of that being the case is the feverish speculation surrounding the sale of Acuris and, particularly, who is interested in buying the company. News Corp, S&P, Moody’s, Fitch, and private equity firms like KKR do not invest on sentiment, and it is their business to foresee trends. The credit rating agencies in particular work tirelessly in building a vast network of information services to take advantage of future trends, a fact evidenced by Moody’s relatively recent purchase of Bureau Van Dijk. If we accept that these market-leading players foresee some increased level of stability within the marketplace, then the question becomes is the regulatory framework strong enough, post-Financial Crisis, to constrain such companies from taking advantage of their position that they are currently jostling for position for? Has the credit rating regulation been improved enough so that the inherent conflicts of interest that remain within their business model do not affect the M&A market negatively in relation to this potential sale? The answer remains to be seen, but given the deregulatory sentiment on offer in the U.S. and the potential for a regulatory race-to-the-bottom post-Brexit, we may already have the answer now.


Keywords – Acuris, Credit rating agencies, M&A, NewsCorp, Business