Corporate governance: Scotch and wry – should the FSA regulate all companies?

It is very good, in these days of interminable bleating from
economists about what the Queen should understand about the crash, or fantastic
quantities of whitewash being splashed about by bankers, to have someone around
who can place an index finger on the precise point and make themselves
understood by everyone in the land.

Scotsmen have not done well in the current troubles. But one of their number,
Paul Boyle, outgoing chief executive at the Financial Reporting Council, has
managed to make the issues as plain as they can be made for those who wish to
listen.

Boyle had a first go at it earlier in the year. He was alerting people to the
dangers of politicians suddenly developing an interest in accounting. “One of
the indicators of a financial crisis is a sharp increase in the number of
references to accounting techniques in newspaper columns,” he said. “One of the
indicators of a serious financial crisis is a sharp increase in the number of
references to accounting techniques in speeches by politicians.”

In high summer, Boyle turned his attention to the way banking regulators have
been trying to divert attention away from their appalling failures by heaping
blame for the results of those failures on the accountancy profession. This has
turned up in two ways: first, the regulators have started suggesting that,
instead of financial reporting reflecting the undoubted volatility in a
company’s financial fortunes, the accounting rules should be altered to produce
a soothing story of reduced volatility. And then, as if that were not enough
nonsense, they started suggesting that financial reporting should not be about
providing information, but instead should have an aim of creating a general
feeling of stability in the air.

Above all, banking regulators have been bullying their way towards the idea
that nothing that comes out of the disciplines of financial reporting or
accounting should frighten the horses. It is astonishing that the people who
landed us in the mess we are currently up to our knees in, should think they can
get away with this. But they have an easy target. The public may loathe bankers,
but they also do not understand accountants, or precisely what they do. So if
the banking community needs to divert the fear and loathing elsewhere, it is an
easy ploy.

Boyle puts it simply: “It is not surprising that banks report substantial
profits when the economy is doing well and reduced profits, or even losses, when
the economy is doing badly”, he points out. “This is accounting reflecting the
economic cycle, which is a good characteristic of a financial measurement
system”. It was a statement of the blindingly obvious. But we live in strange
times.

Would it not be odd if we carried the suggested principle through to other
areas, he went on to suggest. “It could be argued, for example, that
unemployment statistics have damaging pro-cyclical effects”, he said. “Low
unemployment numbers make consumers feel confident, thus encouraging them to
borrow and spend at levels which might prove unsustainable. High unemployment
numbers make consumers worried, causing them to reduce their spending and pay
off debts, with the undesirable consequence of even greater unemployment. Yet no
one seriously argues that it would be in the public interest for the
unemployment statistics to be adjusted in the interests of financial stability.”

Or to take another example: “One could also argue that house price statistics
are pro-cyclical; reports of rising prices encourage consumers to make more
purchases at higher values, thereby driving up prices further,” Boyle suggested.
“Reports of falling prices have the opposite effect. I have not heard pleas that
the national statistics agencies should intervene to prevent these seditious
numbers being disclosed to a public who cannot be trusted to react in a way
consistent with financial stability.”

This is the value of an organisation such as the Financial Reporting Council.
It a useful mix ­ independent, but full of practitioners. It can give people
within the business a very hard time. Yet it also understands the issues from a
practical standpoint. People will, largely, accept its judgement.

It is the sort of culture which should be preserved. Yet the shadow
Chancellor of the Exchequer, George Osborne, is in tinkering mood. His recent
suggestion is that the FRC, the Takeover Panel and the markets and securities
bits of the Financial Services Authority should be bundled into one body.
Currently, the birth of companies is supervised by the FSA, corporate life by
the FRC and their death invariably by the Takeover Panel.

What might make more sense would be to come at it from a different angle.
Perhaps the FRC should simply regulate companies, listed and unlisted, and their
operations.

But what we need to retain is the culture of explaining corporate and
financial reporting issues clearly whenever there is a threat from obfuscating
bullies.