Integrity of a capital market: Professionalism, audit quality and external auditors

Wednesday, 22 July 2020 00:15 -     - {{hitsCtrl.values.hits}}


This is the third in the series connected with the capital market in Sri Lanka. It is a sequel to the immediately preceding two, about corporate integrity and the role of the CFO, audit committees and auditors. 

The Thought Leadership Forum, first launched in November 2005, was re-launched, 24 June 2020 with the article on ‘The CSE and the need to leverage its abundant, yet unrealised potential’.

Aberdeen’s caution to investors of our ‘Frontier Market’

On 9 July, a Sri Lankan daily newspaper reported that “Sri Lanka was singled out on the world stage, when the leading global asset manager, Aberdeen Standard Investments advised investors to ‘be careful’ about frontier markets such as the island nation, even though Asia and emerging markets offer value at present.” 

“Lot of value” across a number of markets 

Pointing out that there is “a lot of value” across a number of markets, Aberdeen Standard Investments Asian Sovereign Debt and Fixed Income Asia Head Kenneth Akintewe stressed, “Frontier markets is an area the investors should be cautious of and a manifestation of that would be a country such as Sri Lanka. They started the year on the wrong foot,” while discussing the opportunities in Asian and emerging markets, in an interview with CNBC. 

“They had easy fiscal policy before the crisis hit and when the COVID-19 crisis did hit, they had to try and support the market. They really don’t have the fiscal space to do that and we are going to see debt-to-GDP rising above 90 percent as we go to next year,” he said. 

The IMF and delays

Akintewe pointed out that (what is) expected from policymakers is the announcement of a new International Monetary Fund (IMF) plan. “This is a key thing that we have been watching for. Unfortunately, that (announcement) has been delayed, by the political side. They don’t have that much time,” Akintewe said. 

He stated that it is a “dangerous” strategy by the policymakers, to wait for the elections for the announcement, even though the new IMF programme may not even fulfil the entire expectations, as the agency might be of the view that a debt restructuring is necessary. “It is going to be a long tough rolling. That is one of the markets that we are a little bit more cautious,” said Akintewe. 

The local daily further reported that “since the Colombo bourse recommenced trading on 11 May, after a 51-day break, the foreigners have been heavy net sellers while the local high-net-worth investors and institutional funds have been on the buying side.”

Sri Lanka – Not just any frontier market

I am reminded of the many times, rating agencies rated down the sovereign (Sri Lanka) and sound corporates automatically got rated down. We are in a similar situation. I will not however, comment on either Aberdeen’s caution, its rationale therefor, or the manner in which the local daily reported this news item. 

In the 24 June issue, I discussed the need to build “meat” or substance into our capital market. Yet, even as of now, beyond the size of our market, I will make bold to say that we are not just any frontier market. There are components of our market, which need to be showcased, and this needs the attention of our CSE, listed entities and my profession. 

A function of feeders and providers

The potential I speak of is a function of a long and well-established, resilient corporate community, that has acquired sophistication in strategy formulation and implementation, and growth-organically and through acquisitions. Our listed entities have generated earnings and been successful in share price maximisation. The quality of “reported” earnings, and compliance with no less than International Financial Reporting Standards-IFRS, is in turn a function of what the previous articles discussed – for example, the CFO, Audit Committees and Board Room Governance. 

The quality of external audits and external auditor independence are an integral part of this all. Many of our Big 5 plus firms in Sri Lanka focus on audit quality and are up to date. Many of our professionals and firms are second to none in the world. Nevertheless, there is room for improvement and my profession is certainly capable of progressing further. The aspect of auditor independence requires more attention. It is in the context of all of this, that I write. 

Enhancing and maintaining professionalism

What I described is a strong foundation. Many partners of firms, retired senior chartered accountants often urge me to discuss how the accounting and auditing standards infrastructure evolved to what it is today, if only to motivate the next generation of practitioners who do not adequately engage in public policy dialogue. A week ago, a few urged me to reproduce my own writings. I have therefore, decided to do so. 

Thoughts on professionalism – a few flashbacks

Might I add that my thoughts in this regard have been consistent and I have articulated these thoughts globally? Hence rather than simply restate them, let me reproduce them from their original publications:

Flashback! February 2002 Chronicle (Source: The CAPA Newsletter)

CAPA is by far the largest regional accountancy organisation with a geographical area, which spans half the globe, and a membership of approximately 700,000 members, from 34 accountancy organisations in 24 jurisdictions, 

February 2002

A message from the President

“The demise of Enron will call for changes in legislation and regulation, not only in the United States but also on a global and regional scale. These changes require to be designed and implemented, with the utmost urgency. More importantly, the changes will need to be practical and effective, if we are to regain the confidence of investors and employees.

The adequacy of skill and experience of boards of directors, effectiveness of governance structures and systems, which include audit committees, will increasingly be questioned. Accounting and auditing firms, will be challenged, to objectively review and strengthen their quality control procedures, to match professional knowledge and skill with complexities of assignments and to demonstrate that they work with the highest levels of independence, objectivity and integrity. The chief financial officers, corporate secretaries, corporate legal officers and outside legal counsel will require to perform their roles with far greater professionalism and vigilance.

But let me also add, that those who monitor Corporates from the outside, such as Financial Analysts, Stock Brokers and Credit Rating Agencies, will require to strengthen their independence, deploy appropriate skills, and enhance the depth and breadth of their analysis, if they are to be respected by those who depend upon them.

In the aftermath of the East Asian Financial Crisis, Western nations in particular and corporate leaders, regulators, scholars and authors of the West, were critical of the East and South East Asian nations, their statutory and regulatory systems, the auditing profession in these countries, accounting and auditing standards and compliance therewith. Their criticism was liberal and in many respects justified. But what is more important I think is whether regulators, professions and corporate Boards of even the developed nations in the West, are yet as vigilant as the global society inherently expects them to be. 

One might argue however and quite correctly, that systems and procedures, legislation and regulation, alone, will not always be potent enough to prevent a major corporate collapse. A necessary ingredient then is ethics and discipline. Personal values and corporate values of the highest acceptable level must converge and become the driving philosophy by which we live and work. In essence there has to be a restoration of values. 

I believe that it is possible to realise a vision of a far more respected environment of corporate values, professional values and personal values. We would be naïve of course, if we expect changes overnight, but I submit that we would be irresponsible, if each one of us institutionally and individually do not incrementally and progressively work towards that desirable new frontier of superior business performance driven by good governance, simultaneously with a robust and respected profession driven by ethics and discipline.

Over time, the collective endeavours of business and the profession will contribute towards sustainability of business, respectability of our profession and stability of families and homes. The collapse of the economies of nations – such as what happened four years ago in East and South East Asia, or the collapse of corporates – such as what happened in none other than North America, a few months ago, can be disruptive. It can devastate what otherwise could have been only a continuation of a simple and less than extravagant life style for many who are less privileged than those at the higher levels of governance who are typically better cushioned to absorb the shock and disruptions these events bring. It is this segment of society that I particularly wish to identify and empathise with, since it is only through them that we realise the gravity of the implications of sub-par professionalism or poor governance. 

As a regional organisation, we must, together with our member bodies and on behalf of our 700,000 plus membership, work together with the other regional organisations in the Americas, Europe and Africa, as well as with IFAC, the IASB, IFAD and the multilateral funding agencies and regional development banks, the UN and related bodies who are already working with IFAD, in order to collectively build a robust and sustainable future for business and the profession. 

Let us all place this on the top of our agenda for the future.

Ranel T. Wijesinha 

President, Confederation of Asian & Pacific Accountants

February 2002

Thoughts at CA Sri Lanka’s jubilee celebrations – 2009

When we at CA Sri Lanka (incorporated by an Act of Parliament in 1959) celebrated our jubilee anniversary in 2009, the Chairman of the Jubilee Anniversary Committee, Lal Nanayakkara, urged me to contribute an article. I promised, but was on assignment overseas and returned a month later. 

Lal was persistent. He was also the President of CA Sri Lanka, when I was Vice President and we had served Council for 10 years. Thus, I had to deliver on my promise. 

I toiled on many a dawn and produced what is captioned below. These thoughts were not published outside our profession and even within our profession, many have yet to read the two-volume publication – ‘A Saga of an Enduring Journey’. Here are extracts of the introduction and key sections:

Re-earning public confidence, regaining credibility

What should our posture be? Defensive, offensive or progressive?

I said: “We have a challenge. It is a formidable challenge. That challenge is to re-earn the trust and confidence of the public and to regain the credibility of our profession. It is a challenge for all-whether local or global, in public practice or outside it. It is a challenge for all our members, in every territory.”

Private and public sectors

“The challenge is not in the private sector alone, where personal and corporate values have deteriorated; corporate governance structures and systems have collapsed; internal controls, systems and procedures have been inadequate or ineffective; the scope, approach and methodology of assurance services have been found wanting, and much more. The challenge is also in the public sector, where members of our profession perform statutory, regulatory, and supervisory oversight roles as well as in ministries, government agencies and State-Owned Enterprises throughout the world, where they are faced with issues of accountability and transparency in the areas of public financial management.” 

Arguments presented, acknowledgements made

In the arguments I presented, I acknowledged that there were crashes, crises and bailouts - but they were not without precedent and that we were not alone in this quagmire, but that there are feeders and providers in the value chain of our services. 

I spoke of the need for ‘Regulatory Effectiveness Audits’ given that for example, the collapse of a finance company is not due to poor auditing alone, but due to lax regulation and supervision by the Non-Bank Financial Institution Supervision Department of the Central Bank, the absence of timely intervention by the CSE and the SEC, and perhaps also the SLAASMB. Nevertheless, I acknowledged, that a share of the responsibility of corporate collapses is ours. 

Quo vadis – Where do we go from here? 

“We have a choice,” I said. “We can be defensive and fold up, build hedges around us and retreat into the woodwork. We can live in an imaginary world of the comfort zones of an era gone by, when we were better known as bespectacled accountants, in the “back rooms of business” who literally counted beans and gave an opinion on a balance sheet as at a particular date. But we passed that stage and passed it relatively well, and went beyond the bottom line.” 

Static and traditional, to proactive and dynamic 

“We progressed from expressing an opinion in a static and traditional manner to an era when we now express opinions based on performing assurance services in a proactive and dynamic manner. We invested considerable hours and funds into developing more sophisticated approaches, we leveraged our core discipline to perform a wide variety of value added services in almost every industry and relating to almost every aspect where our core discipline could have been of benefit, and we did so in almost every country in the world. We can take pride in the fact that we are better represented than any other profession throughout the world.” 

Retreating into the woodwork is not an option 

“Hence retreating into the woodwork is not an option. Alternatively, we can adopt an aggressive, offensive, ‘shoot the messenger’ syndrome. This will however, be entirely incompatible with our ‘raison d’être’, would distract from the good work we can and will do, and will result in our losing credibility rather than regaining it. Public confidence will erode and our profession will stagnate and decline. Others outside our profession will then enter and engage in activities, which could have remained the domain, of our profession.”

I have a challenge for our critics

“I have a challenge for our critics. It is a challenge to imagine a world without basic rules of record keeping, double entry, trial balances and financial statements, internal controls, systems and procedures, accounting and auditing standards, chief financial officers and finance directors, internal and external auditors and perhaps all those roles in the private and public sectors in public practice or in industry, agriculture or services and much more. It would also be a world without audit committees and external audits, accounting firms and auditing firms - in essence a world without assurance. If we had a global financial crisis, what kind of crisis would we have had and, if so, who would we have pointed the finger at in this imaginary world?”

Comparisons with other professions

“Engineers build bridges, which collapse, but for every bridge that may collapse, there may be hundreds of thousands or more that don’t. Doctors administer medicine and perform surgery. Sadly, some do not survive, but for every one who does not survive, there would be hundreds of thousands who are saved. Aircraft engineers build aircraft and there will be an air crash, either due to mechanical fault or pilot error. But the very airline that crashed and the very pilot who perished with it along with his crew and passengers, may have moved millions of people and families around the world – so it is with trains, buses and cars. Have we ever critiqued Boeing and Airbus, Siemens, Tata or Toyota as much as we critiqued Arthur Anderson or today’s Big 4?” 

“The Titanic sank but did we close down the Belfast shipyard, stop shipbuilding or cruising the high seas? In each of these cases, there were lives that were lost but a job that is lost can be regained. A corporate that has collapsed can be bailed out. However, there is no remedy at all for a twenty year old, who dies because the medicine that was prescribed was not that which was administered. Or because the leg that was amputated was the healthy one rather than the one that should have been removed.” 

I have a message for our profession

“We must recognise that there is a threshold beyond which, we as a profession need not bow our heads, mop up the “debris” of others or sweep their weaknesses or ours under the carpet as it were. Instead, if there is an expectation gap, we must bridge it. If there is a technical knowledge gap, we must fill it. If there is a resource gap, we must resource it. If there is a technology gap, we must acquire it.” End of extracts of the 2009 publication.

A revisit of the ‘Frontier Label’?

We have been relabelled and LMI-A Lower Middle Income country. Last year I said that the definition of “upper middle income country” needed a revisit since we became ineligible for what I believed to be justifiable concessional funds! In much a similar manner, global funds need to revisit “The Frontier Market” definition, beyond size. Nevertheless, at an apex national level, I remain optimistic. 

I am firm in my belief that we have the potential to progress beyond the “Frontier Market Label.” At the very core of that belief is my assertion that we have the capacity to enhance and maintain professionalism, and a responsibility towards ethics and discipline. The “Big 5”, and long and well-established SMPs – Small and Medium Practices, and senior individual practitioners, have examples to set, and roles to play.

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