Oireachtas Joint and Select Committees
Tuesday, 18 December 2012
Joint Oireachtas Committee on Jobs, Enterprise and Innovation
Irish Auditing and Accounting Supervisory Authority: Discussion with Chairman Designate
The purpose of this meeting is to discuss with the chairman designate of IAASA, Mr. Brendan Walsh, the approach he will take in his new role and his views on the challenges facing the authority. Members will be aware of the Government decision of May 2011 which put in place new arrangements for the appointment of persons to State boards and bodies. The committee welcomes the opportunity to meet with the chairman designate in public session to hear his views and trusts this provides greater transparency to the process of appointment to our State boards and bodies.
On behalf of the committee, I welcome Mr. Walsh and invite him to make his presentation.
Mr. Brendan Walsh:
I thank the committee for the opportunity to make this presentation. I am honoured to be considered for the position of chairman of IAASA. I have learned a great deal about the authority since 1.30 p.m. Needless to say, as an outsider to the authority and accounting profession, I am not that familiar with the work of the authority.
I understand the authority has an important role to play in rebuilding the public's confidence in the processes of financial reporting and statutory auditing and is doing so in the context of major changes in the European regulatory framework and supervisory structures following the establishment of the European Securities and Markets Authority and publication by the EU Commission of a Green Paper on reforms of the audit market, which were discussed at some length earlier by the committee.
As discussed, the authority is also facing a major expansion of its functions as it assumes responsibility for quality assurance of certain firms. These demands are on top of the authority's existing role of supervising the financial reporting of equity issuers and the regulatory and disciplinary activities of the prescribed accounting bodies. As mentioned during the earlier part of this meeting, this increase in the authority's workload comes at a time when resources available to public bodies are shrinking. Securing adequate resources commensurate with the increased responsibilities will be crucial to the authority's success in performing its expanding role. The statement of the outgoing chairman and review of the outgoing chief executive underline the commitment and professionalism of the authority's staff and provide me with great reassurance that IAASA will be able to meet the challenges its faces in effectively supervising the Irish financial reporting system. I believe it will receive the support of the Oireachtas in discharging this duty.
As I said, I come to the role of chairman as an outsider to the accounting and audit profession but as one who has had a lengthy involvement with this profession as a customer, particularly in the context of pensions funds and fund management industries where the role of auditing is crucial.
It is equally important in the very turbulent financial period since 2008. The expectations gap that was mentioned in the previous debate became very apparent to me as a member of a number of boards dealing with very large sums of money that suddenly became smaller in the course of 2008 and 2009 with grave implications for investors, members of pension funds and people looking forward to a retirement with some financial security. The debate that took place here was enlightening to me in regard to the expectations gap not just between the general public and the profession but also in regard to directors of companies, who rely on auditors to give them comfort and assurance that the accounts have been kept honestly in accordance with the law. Directors of companies can take reassurance from this. The expectations gap, as mentioned by Deputy Tóibín among others, is that we as directors cannot rely on this to discharge ourselves of responsibility for prudence and for the decisions that ultimately determine the performance of pension and investment funds.
I have an appreciation of the key role played by the auditing profession in maintaining confidence in the stability of the financial system, but I also have an awareness of the limitations that are placed on that by the way in which the systems in the accounting and the auditing profession operate. I am conscious of the need to strive for maximum transparency in areas that are often highly technical and obscure to the general public. It is also vital to maintain public confidence in the integrity and independence of the regulatory and disciplinary process. We had an extensive discussion in this regard earlier this afternoon and I have certainly obtained great clarification of the role of the authority with regard to indirect supervision but also with regard to direct supervision, as was clarified by some of the contributions.
The present system of self-regulation in the accounting and auditing profession gives increased significance to the supervisory role of IAASA. I am coming to this as an economist. Some people say that accountants are economists who could not stand the excitement and retired to the accounting profession. I am doing it the other way around. I thought of this in the context of the professional insights an economist should bring to the role of the supervisory authority. I am happy to say that most of the ideas I would suggest were mentioned in the previous discussion.
One of the areas in which economists have been sceptical about regulation and regulatory authorities is with regard to the concept, mentioned by Mr. Pat Houlihan, of regulatory capture - the idea that a regulator provides an opportunity for the people being regulated to enforce structures and rules that they themselves favour rather than acting as a genuinely independent supervisor of the profession. Regulatory capture has been a big concept in economics and a Nobel prize was awarded to the person who threw this idea out in the United States. It has given rise to a certain scepticism about supervisory and regulatory authorities. I have taken consolation from the earlier remarks that the way in which IAASA works has avoided any taint of regulatory capture. It is my ambition that this should continue to be the case during the years I am associated with it.
What an economist can bring to any role such as this is the opportunity to consider the incentives that people in the profession face. Economists believe that people are ultimately driven by the incentives and the rewards they can reap from certain types of behaviour. It is important in the medical profession that the providers of medical care are driven by concern for their patients rather than by a concern for increasing the size of the profession or increasing their own incomes. In the same way, in this area, it is important that the incentives faced by auditors and accountants in regard to the firms in which they have an audit role are not tainted by any other incentives in regard to the firms with which they are dealing. The existence of a secondary motivation for going along with practices in a firm because of another relationship the auditor has with the firm is perilous and must be avoided at all costs. The incentives facing the profession have to be such as to minimise any conflict of interest that could arise, such as a conflict between the interests of the auditing bodies and the interests of the public and the shareholders of the companies.
A final concern that economists have in this regard - which needs to be mentioned, not just in the Irish context but also in the European context - is the question of cost. Excessive regulation, intervention and burdens of compliance on firms, including audit requirements, do ultimately make firms less competitive with jurisdictions in which these regulations and requirements are less onerous. This is an issue faced by Europe as a whole and to some extent by the United States in the wake of the crisis we have come through. We must be conscious that at the end of the day, firms are in business in order to meet consumers' wants. They must do this in a transparent and honest manner. They must comply with accounting regulations and with the law in this area but they also should not be burdened with excessive costs. I think there is a balancing act to be performed between the goals we have been emphasising - transparency, credit and trust and confidence in the auditing function - on the one hand and the danger, on the other hand, that firms will become choked by regulations that are onerous and costly.
Go raibh maith agat. I welcome Professor Walsh and wish him the best of luck in his new role. I was privileged to study national economics under Professor Walsh, because prior to his return in 1980 the standard was not brilliant.
The ordinary man and woman cannot believe the state the country is in, and the austerity programme that has resulted from this is a consequence of the behaviour of the banks. Many people, including me, find it difficult to accept that auditors could charge large fees to the then Anglo Irish Bank. How will we recreate credibility in companies?
In the United States, Enron, a company that was audited by Arthur Andersen, is an example of accountability. I know the legislation in the United States is different from Irish law. We must look at this. In the United States people are accountable. The system is transparent and one can finger a person and say that he or she did not do his or her work properly. I know there are investigations and that we must be circumspect. Day in, day out, the question is asked: why has no banker been held to account for what happened to the country?
Our recession is far more complex than that of any other country. What are we going to do? The witness mentioned that the council is in the process of financial reporting and statutory auditing and regulation. How is that going to be enforced? We appear to be useless in that regard. We are great at making laws - that is what I have learned here - but useless at implementing them. What will the witness do?
Mr. Brendan Walsh:
It would be premature to comment on what the outcome of the investigations and the steps that have been taken about the audit role in our particular mess will be. There was a discussion on that issue earlier where it was stated that there are proceedings that are not yet complete and it would be premature for the Irish Auditing and Accounting Supervisory Authority to comment on them. Some of these have shifted into the area of possible criminal prosecutions and one cannot prejudice those. Going back to the Senator's broader question, I think these things go in cycles to a certain extent. Just like the bubble in the housing market or in the stock market there tends to be a crash after which there is a period of soul searching and rebuilding of confidence slowly, perhaps, for five or ten years, and gradually the lessons of the past are forgotten and the same pressures build up again. To some extent, in this area, there were periods when standards were lax and crises developed that should have been averted and they have been followed by periods of reform. For example, in the US in the 1930s an immense amount of legislation was introduced, some of which was gradually relaxed in respect of ordinary banks getting involved in investment activity. After a while the lessons and the pain of the 1920s or early 1930s wore off, and some of the regulations were relaxed, the same tragedy was reiterated and we got into another crisis in the 1990s and the last decade partly through having forgotten what was learned during the previous crisis. To some extent there is a cycle and I think I know where we are in regard to that in this situation.
We have come through the worst financial crisis in our history as an independent country. We are still suffering the consequences of that in economic terms in terms of austerity, hardship and budgetary pain and we are desperately trying to prevent a recurrence. We are aided by the EU measures that have been discussed in which we will play an important role in trying to implement during the Irish Presidency. I see ourselves as moving back into a more cautious reformist period in regard to the substance of what this authority deals with. As outlined in the presentation by the outgoing-----
Mr. Brendan Walsh:
There was a discussion on what is direct and indirect supervision. It is clear that the authority is involved in both and, from my reading of the situation, it will become more involved in direct supervision as time goes by and that there will be a reform period which, I hope, will bear fruit and will not be short lived.
Mr. Brendan Walsh:
I think what will change there is that the regulation and the supervisory role will be much more alert and much more hands-on. A reassuring statistic was given about how few of the 30,000 plus professionals in the field have had complaints made against them over the years. The problem may have been that some of the outrageous faults were in very prominent companies and in very prominent situations. They also involved a certain amount of innovation on the part of the people involved which probably took regulators and the general public unawares. There is need for continuing vigilance on behalf of financial positions in companies to innovate to their own benefit and to the detriment of the public good and of the shareholders in the company. That is a very general statement but I have confidence in the professionalism of the body and its vigilance. It is a co-operative venture between the prescribed accounting bodies and this authority - the authority making sure that the prescribed accounting bodies are following their procedures as stated - the authority also having powers to vet, comment and, if necessary, to change the rules of those prescribed accounting bodies. I see it as a process that will bear fruit over the difficult period that we are going through and that this authority has come through.
I wish Mr. Brendan Walsh the best of luck in his new role. As he has worked as a professor in national economics for many years he would have witnessed some of the peaks and troughs in the past. That is why I was anxious to get the point across that we need to use an institution that is structured to ensure the next trough is reduced. He made the point that most of this has happened previously. While this is probably the biggest financial crisis in almost 100 years the main determinants are not all that new. It is the lack of institutional memory that is available to the system which is at fault. From my perspective one of the major problems was the clear over-exposure of the property market and the over-exposure of access of cheap credit which led to the weaknesses within these institutions and that was not captured as such at the time. The Regling Watson report said this was a homemade disaster and a disaster which focused on the weakness in supervision.
For citizens this is the biggest catastrophe that has happened to their generation. We are a number of years away from it now. I understand six years is the statutory time span for individuals to be brought before the courts. We are clear on the generalities of the problem but not on the specific issues of who did wrong and what exactly they did wrong. It is a major concern for Irish society that four years on we are still in that position. How can we use the system as a tool to prevent this happening again? How can we create an institutional memory, if that is possible? How can we identify expeditiously the individuals and the actions they did or did not take as soon as possible?
Mr. Brendan Walsh:
I thank the Deputy for his questions. To some extent he has echoed the issues raised by Senator Mary White. I will make one comment. There is a certain danger in seeking to identify particular individuals who acted recklessly or even in a criminal manner. Unfortunately, these crises recur with depressing regularity but, in fact, we have had relatively few of them in Ireland. However, it is clear from the history of financial institutions in the past 200 years that housing bubbles followed by reinforced by banking bubbles have recurred, perhaps, every ten or 15 years across the world and as the title of one recent authoritative study put it, This Time is Different. In each of these crises there are journalists, professionals, economists who gives reasons. They said Ireland was different because it had a young and dynamic growing population and an inflow of foreign direct investment, it needed all this extra housing and it was justified to advance loans on very small margins because of the buoyancy of the economy. That was the particular argument in Ireland. In America it was about sub-prime mortgages being extended to tranches of the population that could not otherwise afford housing.
There was a certain dressing this up as if it was altruism to bring lower income people into the housing market.
There will always be some rationalisation and some specious argument put forward on which to a certain extent it is the duty of the sceptical economist and journalist to throw cold water. It is difficult to do that. The Honohan report places a fair amount of emphasis on the psychology that develops, the psychological momentum behind these bubbles and how difficult it is for any one individual to buck the trend, to stand out and say the emperor has no clothes, that these arguments are invalid, that this time it is not different and that it will all end in tears the way it has the previous 120 times. It is difficult to do that.
I am not answering the Deputy's question immediately but digressing to say we must be aware that unfortunately there are forces in complex capitalist economies like ours that lead to these disasters periodically and we must try to restrain them in every way we can. Laws, such as the Glass-Steagall Act, were introduced in the United States to try to put the reins on investment banking but when things had settled down and people said profit opportunities could be availed of if the Act was relaxed, it was abolished and we know the consequences of that were disastrous. We must frame good laws for our banking structures to make sure that even though we operate within a European framework we still have some autonomy in regard to, for instance, the margins in which mortgages are advanced. We could have acted in that area earlier and more decisively than we did. I would emphasise the putting in place of institutional legislative constraints rather than necessarily identifying the people who were culprits. There were people who acted possibly illegally and I hope they will be brought to book, but I step back a little from that and point to there being a psychology here, a momentum that builds up and we must try to try to build institutions, which is not necessarily the role of the supervisory authority rather it is the role of the Oireachtas generally in terms of the framework within which the financial system and the banking system operate.
I think we have learned lessons. At European level, the move last week towards a European system of banking supervision is a very important step in that direction. Hopefully we will have learned lessons from this Irish and Europe-wide catastrophe that has hit us and we will be able to postpone the next crisis beyond the ten year cycle that, unfortunately, has been the pattern in many countries in the past.
Mr. Brendan Walsh:
It is a mixture. Obviously when the supervisory framework is lax and there is light touch regulation, there are people who will jump in and avail of that in a reckless way and perhaps in a criminal way. It is a mixture of keeping an eye on them but also, probably even more importantly, making sure the opportunities they have to act in that manner are closed off.
I will invite in the new chairman of the authority and his staff as often as I can. As the chairman will have noted, one could get a good few jobs if one comes in here and one might not have only the one job to do. We want to cover many more topics as well.
Unless Mr. Walsh wants to make any concluding comments, I would point out that it is important in terms of process that we agree that the committee will inform the Minister for Jobs, Enterprise and Innovation, Deputy Richard Bruton, that have we concluded our discussion with Mr. Walsh and that we will forward a copy of the transcript of this meeting to him for his information. Is that agreed? Agreed.
I thank Mr. Walsh for coming in today and I wish him well in his role. I understand he will take over as chairman of the authority on 2 January. I also wish his predecessor well in other developments.