11lt Financial Reporting Council

Stephen Haddrill Chief Executive Officer

Rt Hon Andrew Tyrie MP

Chairman of the Treasury Committee

House of Commons

Committee Office

14 Tothill Street

London SW1H 9NB

10 February 2016

Thank you for your letter of 3 February.

I appreciate this is a matter of significant public concern and welcome the opportunity to address the issues you have raised. Before addressing your specific questions I thought it might be helpful if I set out what our powers enable us to do. These have determined how we have taken forward our work.

Our principal power to investigate lies in the Accountancy Scheme, the provisions of which have until recently had to be agreed with the professional accountancy bodies. There are no statutory provisions. The Scheme requires individuals and firms who are members of the bodies to provide us with the information we seek. We have no power to require others to cooperate and for this reason it usually makes sense, in financial services cases, to make a request to the FCA or PRA for material on matters concerning a company, as opposed to an auditor, to be made available.

In order to mount an investigation the fRC's Conduct Committee must have reasonable grounds to suspect that there may have been conduct which falls significantly short of the standards reasonably to be expected at the time. It is because of this requirement that we usually seek information on an initial basis before launching a full investigation.

The details of our investigations are fully aired in proceedings before an Independent Tribunal but otherwise publication is restricted because, in accordance with the requirements of the Scheme, the information must be treated as confidential.

8th Floor. 125 London Wall, EC2Y 5AS Tel:+44 (0)20 7492 2300 Fax: +44 (0)20 7492 230 1 www.frc.org.uk

The Financial Reporting Council Limited is a company limited by guarantee. Registered in England number 2486368. Registered Office: as above.

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New legislation due in June to implement the recent EU Audit Regulation and Directive will introduce statutory backing and greater powers in relation to our investigations and enforcement in respect of the audit of public interest entities in the future.

Turning to your questions in order.

1. Did the FRC reach this preliminary enquiry stage when it first looked at the HBOS case in 2013?

Our review in 2013 was carried out under a supervisory inquiry. It focused on loan loss provisions because of the evidence emerging at the time from the FCA and the Parliamentary Commission on Banking Standards report on HBOS that this was an area of significant challenge to the preparation of true and fair financial statements. At that time the Scheme did not allow the FRC to use a preliminary enquiry as an initial investigative tool but it has subsequently been amended to do so. A supervisory inquiry is conducted with rigour but is not a process with formal information seeking powers. That said, KPMG voluntarily provided us access to the audit files we considered appropriate to our understanding of their work on loan loss provisions.

2. The FRC has chosen to focus on two particular elements of the auditing of HBOS rather than undertaking a broader review. How did the FRC decide on the particular terms of reference for its enquiries and will there be scope for these to be widened in future?

The focus of our enquiries has been influenced largely by both the results of the FCA/PRA review and our own assessment of the most likely areas of audit risk. We can expand the scope of our enquiries if new relevant evidence suggests this is appropriate.

3. The quality of the FCA/PRA review into the failure of HBOS was underpinned by the use of independent oversight. What provision will be made for independent and external oversight of the FRC's enquiries into the auditing of HBOS?

Our work now is part of a disciplinary process and the adequacy of our conclusions may end up being judged before an Independent Tribunal at a fair hearing. As noted in answer to question 5 we will publish a full report aside from the disciplinary process. We will be pleased to open our work on the preparation of our proposed full report to scrutiny if the Committee feels this to be appropriate once our disciplinary process is complete, subject to any confidentiality issues as required by law.

4. What is the deadline for these enquiries to report?

We will conduct our preliminary enquiries as quickly as possible but it is important that our findings are robust, especially if they are to be tested before a Tribunal. The timing of our report will depend on the evidence that we find . Nonetheless we would hope to be in a position to report our conclusions in the Spring.

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5. In your letter to me of 21 January, you confirm that the FRC will publish the conclusions of its preliminary enquiries. Will the FRC also publish a full report into the auditing of HBOS?

We will publish a full report drawn from all of our work in relation to HBOS and bank auditing. This will include the findings from our supervisory inquiry in 2013; the conclusions from inspections of bank audits over many years including our thematic review of the audit of loan loss provisions; the work on going concern led for us by Lord Sharman; and our work on auditor scepticism. I have included further details on this extensive programme of work in the annex attached to this letter. These actions and outcomes are all in the public domain.

Stephen Haddrill Chief Executive DOI : 020 7 492 2390

Email : s.haddrill@frc.org.uk

1p9 Financial Reporting Council

Annex:

The FRC has undertaken the following actions during and since the financial crisis to alert those responsible for corporate reporting and audit firms to emerging issues and to address concerns exposed by the crisis.

1. Action taken in response to the crisis

• In December 2008 the FRC published a bulletin to highlight going concern issues during the then current economic conditions.

• In 2010 the UK Corporate Governance Code was updated with new measures to improve the effectiveness of Boards and their accountability to shareholders. The measures included the annual election of directors and regular reviews of Board effectiveness.

• Updates to the Corporate Governance Code in 2012 required annual reports and accounts to be 'fair, balanced and understandable', increased the responsibility and transparency of audit committees, and introduced extended auditors reports to enhance the scope and transparency of audit. This revision of the Code also introduced the requirement for audit contracts to be put to tender every 10 years.

• We encouraged the move to an expected loss model in international accounting standards. This has now been introduced by the IASB in its IFRS9 accounting standard and we are encouraging its adoption in Europe for use by banks in line with the international timetable.

• We undertook an inquiry, led by Lord Sharman, to identify lessons for companies and auditors addressing going concern and liquidity risks. That enquiry reported its findings in 2012 which led to separate going concern guidance for banks.

• In 2014 we updated the UK Corporate Governance Code to increase Boards' focus on risk and viability over the longer term.

• We maintain regular liaison meetings with the FPC and have agreed Memoranda of Understanding with the PRA and the FCA to aid collaboration between our organisations.

• In 2015 we developed with the FCA a standard to cover the work of auditors when reporting to the Financial Conduct Authority (FCA) on the compliance by financial services firms, with the FCA's Client Asset (CASS) rules. These provide for the effective safekeeping of client assets and client monies.

2. Action taken to increase FRC supervision

• In our annual regime of audit monitoring we have, since the crisis, increased the scope of financial institutions monitored, focused on the degree of auditor scepticism and increased our focus on inspecting bank and building society

• Financial Reporting Council ........................................... audits, including reporting specifically on our findings regarding these institutions.

• From 2010/11 we have reported separately within our annual audit inspection report findings from our inspections of bank audits.

• In January 2011 we enhanced our liaison with the then FSA leading to a Memorandum of Understanding and better sharing of information between our two organisations.

• In 2013 we initiated a thematic review of the auditing of banks and building societies over our concerns that the audits of these institutions were not showing as much improvement as the audits of other types of entities. The subsequent report published in 2014 was able to report that audit firms had taken on board our feedback and had improved their work in this sector.

3. Disciplinary action where the auditor of a bank or building society or an accountant in the business may be guilty of misconduct.

The FRC has brought a number of disciplinary cases for misconduct against auditors and accountants since the crisis . Some of the outcomes of these cases involving financial institutions include:

• An admission of misconduct by PwC in 2011 in respect of the preparation of Client Asset reports to the FSA regarding JP Morgan Securities Limited.

• The exclusion from practice as accountants of two finance directors of Cattles PLC by the Independent Tribunal in 2013

• A settlement agreed in 2014 against the former finance director of Bradford & Bingley pie over financial information and its relevance to the rights issue being planned by B&B and for failing to advise the Board appropriately.

• A settlement agreed in 2015 against Grant Thornton and two of its audit engagement partners and the finance director of the building society in relation to accounting issues at Manchester Building Society

• A settlement agreed in 2015 in relation to the actions of a member of the Institute of Chartered Accountants in Ireland regarding the financial statements of the Presbyterian Mutual Society.

Ongoing investigations involving events at financial institutions include:

• PwC for its role in events at Cattles pie • KPMG Audit Pie and The Co-operative Bank pie • KPMG and the audit of compliance with the client assets rules at BNY Mellon • PWC and the audit of compliance with the client assets rules at Barclays

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