UK: Building Society Update- The Dawn Of A New Era

Welcome to the latest edition of the Building Society Update. As the edition goes to print, the world remains complex and uncertain as demonstrated by the results that are being reported across the sector, and the wider financial services community. Against this background, in this publication we have reviewed a number of matters which are presently being considered by building societies, and assessing the implications for the sector. These include:

• the impact of shared service centres for societies;

• the implications of the FSA's long awaited consultation paper, CP08/22 "strengthening Liquidity Standards";

• the planned new penalty regime for tax returns submitted on or after 1 April 2009, and its impact on the sector;

• thoughts on how to deal with fraud so as not to expose the society to undue risk – unfortunately this is likely to impact societies further in the year ahead in the present economic climate;

• an assessment of IFRS disclosures around risk and how these could be improved in order to at least allow better comparisons between societies and to understand further their relative risk appetites; and
• latest thinking on achieving a "combined assurance" framework, to improve assurance effectiveness and maximise the combined benefit from the expenditure.

Steve Williams

Head of Building Societies Practice

A NEW DAWN FOR RETAIL FINANCIAL SERVICES COMPANIES

Following months of turmoil, we are starting to see the redefinition of the retail lending and savings markets, as retail financial services firms start:

• looking for strategic bolt on acquisitions and divestments of non core activities to raise capital;

• considering the outsourcing of certain operations;

• putting into place liquidity structures and solvency ratios that work in this new paradigm; and

• establishing "good bank/bad bank" divisions, so that the good banks can go back out and start lending again.

In this environment, where renewed aggressive competition is fast approaching how does the building society sector sit?

In this new era, the building society sector must remain confident and must not forget that:

• many societies continue to retain a strong local presence through extensive branch networks;
• there are continuing strong links between building society brands and their local communities;
• societies have a continuing strength in core areas of mortgage and savings through significant market share;
• there is a continuing price advantage through not having to pay dividends to shareholders; and
• the mutual brand remains attractive as it largely retains customer trust.

However, at the same time there are longer term pressures on the building society business model. We must remember that it was competition in the building society sector's traditional markets in the past that led to parts of the sector looking to exploit new markets to improve their margin. This included building teams to move into commercial lending, sub prime and other non standard lending areas such as buy-to-let, and investing in higher margin treasury assets. All these areas have recently been under pressure and have led to a significant portion of the write offs of the past year.

Now that a number of societies are moving back to concentrate on their traditional market, the sector must not forget that the same pressures that caused this diversification are still present, or at least will shortly return.

At the same time new pressures are emerging. Most societies are heavily retail funded, so continued pressure on headline deposit rates will continue to reduce margins, as competitors compete for traditional sources of funding. In addition, who needs to be reminded that the economic downturn is already leading to higher arrears. Against this background societies are worried about the previously unthinkable; in particular what deflation and a low interest rate environment will mean. Do we really need to pay mortgage holders to have a mortgage with us?

However, one matter that has received less attention is the role of the FSA in this new era. A growing regulatory environment has always had a disproportionate impact on societies due to their size, but this is only likey to grow as the FSA now fully realises that in the present environment it is inherently difficult for societies to raise new capital outside the sector. In particular, societies may not have fully considered the impact of the impending liquidity requirements in terms of a one off cost, and as a long lasting dampening effect on profit. This is considered more fully later in this publication.

Finally, in the short term a number of one offs have damaged capital bases, such as exposures to Lehman Brothers and Icelandic banks, and though I am almost scared to mention the name, the dreaded FSCS levy.

Is there a silver bullet to this?

No, but what is clear is that the strategies that some took to move outside the traditional areas of business were driven by the need to improve margin and to build capital. These fundamental issues remain.

In this environment societies will need to:

• consider executing a cost reduction programme. This must be coupled with improving the customer experience and leaving the society best-fit for purpose through retaining control of customer facing activities, but relooking at outsourcing opportunities and shared service options. This option is considered more fully later;
• identify new ways of servicing customers – societies often do not look and feel so different, and service must move way beyond just being "nicer" to customers. It must include better training and investment in "behavioural scoring" technology, establishing the branch as genuinely central to the sense of community, and ensuring that service is increasingly flexible in terms of opening hours and location;
• find alliances and partnerships where the brand and the link to the community can be leveraged;
• be fleet-footed identifying niche markets quickly and profitably – shared ownership and Islamic lending offer possibilities to expand; and
• finally, societies must achieve the holy grail of crossselling because it actually knows which products its customers don't have, and is trusted enough building to tell them that it can provide a solution.

We said last time that we should fantasise about a society that is genuinely focused on what its customers want and spends its money providing it. In our view this is now a necessity.

SHARED SERVICES FOR BUILDING SOCIETIES

There is a financial case for a back office shared service centre for Building Societies that delivers significant additional benefits.

The hypothesis

Our hypothesis is that there is a financial case based on cost reduction for a back office shared service for building societies. A business model for such a shared service is shown below.

The current situation

Financial services institutions have long faced significant pressure on margins due to increasing competition and an ever greater regulatory burden. Recent events are likely to increase costs further. Scale disadvantages mean that generally this pressure falls disproportionately on building societies causing them to lag behind banks in terms of their cost/income ratios.

Many building societies have used partnerships and outsourcing to keep costs down, and some provide white label services to other building societies and banks in order to supplement their income.

Recent events are likely to increase the regulatory burden and pressure for transparency while forcing a return to more conservative banking practices. Ultimately, those institutions that can respond while keeping costs down will be successful.

Recent events are likely to increase the regulatory burden and pressure for transparency while forcing a return to more conservative banking practices. Ultimately, those institutions that can respond while keeping costs down will be successful.

The case against

Although there appears to be a business case for an SSC for building societies, in our view there are still many obstacles which probably explain why this concept is not prevalent. The obstacles include:

• Lack of access to capital.
• Existing servicing contracts and/or recent investments in systems.
• Concerns over implementation risks, compounded by the sensitivity of our cost study to increased implementation costs.
• Concerns over perceived or actual loss of control during and after implementation. The model is sensitive to how the SSC is incorporated and its recharge model.

The future

Two factors could respectively reduce the obstacles to change and increase the pressure for change:

• A technology vendor offers a "bank in a box", covering the bulk of the functionality required for the SSC. With a number of migrations under its belt, this could significantly de-risk the implementation.
• Regulatory pressure for greater transparency could present very high costs to any single building society.

Conclusion

Our analysis has shown there is a business case for a jointly owner shared service centre for building societies. However, obstacles to achieving this remain.

PLUGGING THE GAP – THE IMPACT OF CP08/22 ON THE BUILDING SOCIEY MOVEMENT

On 4 December 2008 the FSA published its long awaited consultation paper, CP08/22 "Strengthening Liquidity Standards". The result of the consultation with the industry will be new rules, evidential provisions and guidance in the form of BIPRU 12. It is clear these will have a significant impact on the building society sector already dealing with the impact of the Financial Services Compensation Scheme ("FSCS") levy.

This article summarises the proposed new rules and explores what the consequences of these might be on building societies' profitability, solvency and ultimately their long term viability, and how balance sheets will need to be repositioned and strategies adopted in the future.

CP08/22 – Strengthening liquidity standards

The proposed new rules are founded on two core principles:

• adequate liquidity – A firm must at all times maintain liquidity resources which are adequate, both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due (BIPRU 12.2.1R(1)); and
• self-sufficiency – A firm may not include liquidity resources that can be made available by other members of its group (BIPRU 12.2.1 R (2) (a)), nor can it include liquidity resources that may be made available through emergency liquidity assistance from a central bank (including the European Central Bank).

These core principles will be implemented via new and detailed systems and controls requirements (BIPRU 12.3 and 12.4) together with a framework geared towards calculating minimum levels of liquidity on an entity by entity basis. Individual Liquidity Adequacy Standards ("ILAS") will entail the documentation of an Individual Liquidity Adequacy Assessment ("ILAA") by individual entities concerned subject to a Supervisory Liquidity Review Process ("SLRP") in much the same format as the FSA regulates under Pillar 2 of the Capital Requirements Directive (i.e. the ICAAP and SREP).

Last (but certainly not least) the FSA has proposed to implement a comprehensive suite of data items to be incorporated into its Integrated Regulatory Reporting ("IRR") regime. The FSA intends to consult separately on this matter during Q1, 2009.

Key areas of focus include:

Systems and control requirements

The systems and controls requirements will replace those of SYSC 11, incorporating the Basel Committee on Banking Supervision's ("BCBS") "Principles for Sound Liquidity Risk Management and Supervision", published in September 2008. Key areas include:

• appropriate Governance of the Liquidity Risk Management Process – firms should expect questioning at Board level as part of the SLRP and directors should be able to provide reasoned explanations as to the level of liquidity risk assumed;
• driving business line behaviour through pricing mechanisms – incorporation of the cost of liquidity into product pricing, performance measurement and new product approval processes;
• tighter controls on funding and access to source of funds – funding diversification, funding limits, maintaining a presence in funding markets (including regular testing of the capacity to raise funds in chosen markets) and a process for the management of collateral;
• stress testing and contingency funding – The FSA reiterates its desire to see more rigorous stress testing undertaken by firms and to ensure that the potential mitigating actions available to the firm under each stress is given full and frank consideration within the contingency funding plan. The impact of stress testing on profitability and solvency, as well as liquidity, should be considered.

Individual Liquidity Adequacy Standards

ILAS BIPRU firms will be required to complete an Individual Liquidity Adequacy Assessment of the type and quality of liquid resources it believes should be held against the various sources of liquidity risk identified in the diagram above that could occur under certain stress scenarios:

• The idiosyncratic stress – an unforeseen name-specific shock liquidity stress, where the market and/or retail depositors perceive the firm to be unable to meet its liabilities as they fall due for a period of two weeks, followed by a longer-term stress of the severity of a multi-notch credit rating downgrade that results in liabilities linked to the firm's credit rating crystallising.
• The market wide stress – an unforeseen short-term market-wide dislocation that gradually evolves into a long-term market wide liquidity stress, where there are widespread concerns about the solvency of financial sector firms and uncertainty about the value of financial assets.
• The combination stress – a combination (rather than a summation) of the idiosyncratic and market-wide stresses.

To demonstrate compliance with the ILAS, firms will be required to hold sufficient liquid resources to enable them to survive the idiosyncratic stress. In the case of building societies that meet certain criteria, dispensation has been given by the FSA (under the standardised buffer ratio) to demonstrate compliance if holdings of short-dated UK Treasury Bills are in excess of (see Figure 2).

For those that choose the "Full ILAS" more discretion is permitted as to the composition of liquidity holdings which is extended to securities issued by or sight deposits with the central banks of certain governments rated Aa3 or above by Moody's. However, in doing so firms should expect the SLRP to take place (and individual liquidity guidance issued) sooner than might be the case if choosing the standardised buffer ratio. Irrespective of the route selected, the FSA liquidity buffers are expected to be sizeable compared to previous regimes.

Timescales for implementation

The FSA's original intention was to finalise the rules by April 2009 for implementation by October 2009. The latest indication is that the FSA is preparing to waive the quantitative requirements whilst the UK economy remains in recession.² This would appear to be a sensible decision at a time when banks and building societies are being encouraged to increase levels of lending. Nevertheless, the Systems and Controls elements of the CP will still, as far as we are aware, be required.

Assessing the impact

Individual firms will undoubtedly have undertaken their own impact analysis of the new regime. Our own analysis, based on figures reported by some of the top 10 societies (by assets) at the end of 2007, shows that liquidity held in government debt³ currently represents between 1% and 2% of firms' retail funding liabilities. The FSA estimates⁴ that "major UK banks will increase their holdings of government securities from an average of around 4.6% of total assets to between 6% and 10%." If this is replicated across the Building Society sector, this represents an increase of between £4.4 billion and £10 billion.⁵

The effects on profit are likely to be substantial given yields on government debt relative to those instruments that could previously be included within a firm's prudential liquidity portfolio. Using the FSA's own assumed difference in yield of 150 basis points, this equates to an increase in cost of between £66 million and £150 million.⁶ Though the full impact is not yet clear, this change in regulation is bound to put building societies at something of a competitive disadvantage to banks that have largely subscribed to the "Sterling Stock" liquidity regime and have therefore carried a larger volume of high grade government or supranational debt on their balance sheets.

The ability of particularly the smaller societies to remain competitive and adequately capitalised under this environment represents a significant challenge to the strategic direction of all concerned. At a time when an increase in credit available to consumers and businesses is being demanded from all quarters, the new policy appears to be counter-productive in meeting these demands.

The FSA acknowledges that the proposed new prudential rules are tough and they make no apology for this. They accept that "... current agreements and practices will have to be reviewed and the status quo may no longer be acceptable" and note that "the increased costs could be passed onto borrowers in the form of higher interest rates". Courses of action that might be considered are:

• Determine which approach is more suitable – Firms should initially address the pros and cons of adopting the Standardised Buffer regime against the full ILAS approach. The standardised buffer ratio brings with it the advantage of a lower level of supervisory scrutiny over the adequacy of the liquid assets buffer. If adopting the full ILAS approach the supervisory scrutiny will increase (along with ILG) but firms are afforded a higher degree of flexibility in a) assessing fully their own liquidity risk and b) composing the liquid assets buffer. Any project to implement BIPRU 12 should begin with an impact analysis that takes into account these factors.
• Increase the cost to borrowers – the cost of borrowing has come under the spotlight in recent times as lenders have not passed on the full impact of falling Bank of England base rates. Nevertheless, such a course of action appears inevitable in the short term since funding strategies cannot be changed overnight.
• Fund using longer term borrowings – this is clearly more difficult with a sector that is funded (in some cases exclusively) from retail savings accounts. In an interest rate environment where the risk of a gradual outflow of funds is significantly higher, the ability of firms to reduce rates paid to savings customers is essentially nonexistent. On new savings accounts societies may look to remove any early withdrawal optionality in return for a higher rate to depositors though quite how this fits with the FSA's "Treating Customers Fairly" agenda would need to be carefully explored.
• Access medium term wholesale markets – bond issuance, potentially in the form of private placement debt, might be considered as a viable means of diversifying the funding base and accessing a source of longer term funding. The legal, accounting and rating agency costs associated with entering into such markets would need to be given careful consideration and clearly, the size of some societies is such that this alternative could never be a viable one.

Conclusion

The proposed new liquidity regime represents the first raft of far-reaching changes to the regulatory environment that societies will be bound by. The timescales within which these changes are to be implemented are such that the demands on management will be greater than ever, and the impacts will be enduring on the long term profitability of current business models.

MAJOR CHANGE

The new penalty regime for tax returns submitted on or after 1 April 2009 is a major change in HMRC policy and will have a dramatic impact on the way penalties are levied. The changes potentially put even the most diligent of taxpayers at risk of incurring a penalty where tax is misdeclared. Businesses should therefore review their current tax return processes to ensure the risk of a penalty is minimised.

Introduction

The Finance Act 2007 introduced a complete change to penalties for incorrect tax returns and accounts relating to corporation tax, income tax, PAYE, VAT and National Insurance Contributions.

The new law is intended to introduce a uniform regime for penalties for incorrect tax returns across the most important taxes for which HMRC are responsible. It is also intended to provide an incentive to disclose errors, cooperate with HMRC and encourage compliance generally. The new regime, in conjunction with risk assessment, brings added impetus for companies to review the effectiveness of their tax systems and data management processes.

Until now a number of different regimes for penalties for incorrect tax returns have applied across the many taxes that HMRC is responsible for. The 2007 changes were driven in part by the integration between the former Inland Revenue and HM Customs and Excise. Each had operated a number of very different penalty regimes. The new penalties for incorrect tax returns for HMRC's main taxes are intended to provide greater clarity to the public, as they are intended to be uniform, whether the tax be corporation tax, income tax, VAT or National Insurance Contributions.

Under the new regime penalties will be levied according to perceived carelessness and deliberate offences. Companies which are able to demonstrate to HMRC that they have taken reasonable care, even where an error occurs, will receive reduced penalties and, in the longer term, should receive less focus from HMRC, freeing up time to work on managing the business.

New penalties

As part of a review of its powers, HMRC evaluated the aims and effects of the existing penalties in force. Penalties were intended not only as a punishment for non compliance, but also included a flexible element to encourage disclosure and co-operation. HMRC's view was that in reality penalties were too low to encourage taxpayers to file correct tax returns. Also, the percentage penalty charged differed too little between careless errors and deliberate concealment of liability. The new regime aims to change this and to encourage behavioural change. It does this by classifying errors on tax returns by reference to behaviour, ranging from simple mistake to deliberate concealment, and by much reducing the scope for discretion exercised in the application of penalties.

Determining the penalties

Where the error gives rise to additional tax the penalty will, as now, be calculated as a percentage of the additional tax but will be linked to the taxpayer's 'behaviour'. This could range from nil where the taxpayer has made a mistake without carelessness to 100% where there has been deliberate error with concealment. There will be reductions for unprompted disclosure of the error, and lower reductions for prompted disclosure, as illustrated in Figure 1.

It is likely that, in defining "careless", HMRC will rely on an earlier definition of neglect as 'the omission to do something which a reasonable man... would do, or doing something which a prudent and reasonable man would not do'.

Under the new regime, where an HMRC check leads to additional tax because of a careless or deliberate error, the error's disclosure is very likely to be "prompted". If so the minimum penalty will be 15%. This is likely to result in an increase in the level of penalties from those imposed previously.

Penalties where no tax due

In the past, groups of companies could often reduce or eliminate penalties by surrendering group relief to reduce the additional tax paid by the company which made the error. In most cases this will no longer be the case. If the error is careless or deliberate and its disclosure is prompted then the minimum penalty will be 15% of the tax lost before group relief. Normally, however it should be possible to reduce the penalty to nil if the group makes an overall loss for the period.

The new legislation also introduces penalties in most cases where a careless or deliberate error has led to a loss being overstated. However, no penalty will be imposed on an overstatement of a loss if there is 'no reasonable prospect of the loss being used' to reduce a tax liability.

This is a significant change from the previous regime for direct tax where a penalty would only be imposed if additional tax arose as a result of an incorrect return. The introduction of the potential for penalties for overstated losses and profits covered by group relief is likely to result in fewer compromise agreements and more protracted correspondence in relevant cases.

In addition, the legislation provides no interpretation of a 'reasonable prospect of the loss being used' and this could be an area for debate and disagreement.

Suspended penalties

The new legislation also brings in the new concept for tax of "Suspended penalties" for careless errors. This is intended to encourage behavioural change. The suspension can be for all or part of a penalty. Conditions can and in practice will be imposed by HMRC to help the taxpayer avoid becoming liable to further penalties for careless errors.

If HMRC are satisfied that the conditions have been complied with, then the suspended penalty will be cancelled. However, if during the period of suspension the taxpayer becomes liable to another penalty for inaccuracy, or if the taxpayer fails to satisfy HMRC that the conditions have been complied with, then the suspended penalty becomes payable in full.

No further details of conditions are known at present but HMRC publications suggest as an example that a condition might require a taxpayer to replace inadequate IT or record-keeping systems.

Conclusions

These changes are expected to have a significant effect. Companies who do not take reasonable care in preparing tax returns could find themselves the object of much increased scrutiny by HMRC. Penalties could be due if errors are made. Those companies that are able to demonstrate to HMRC that they have taken reasonable care should be able to build an enhanced relationship with HMRC, as they look to deploy their time and resource to areas where there is considered to be a higher risk.

Conversely, those businesses that aren't able to demonstrate that they have taken reasonable care in preparing tax returns may well find the new penalty regime an additional and costly burden. It is therefore imperative that businesses take pre-emptive steps to increase assurance of their tax systems and processes AND take those steps before submitting any tax returns after 31 March 2009.

FRAUD INVESTIGATIONS PLAN TO AVOID DISASTER

The reduction in financial crime is a key objective of the FSA and recent communications have made it clear that this is an area which they expect senior management to take very seriously. At the same time the level of fraud, both internal and external has been increasing, often correlated to the present economic environment.

In response, many financial institutions have been investing significant time and money in improving and enhancing their response to fraud and fraud risk to avoid the associated reputational damage and financial loss.

But how much thought have management given to the operational reality of conducting an investigation into a suspected financial fraud?

When a serious incident of financial fraud is identified, perhaps through an unexplained accounting anomaly or anonymous tip-off, the first minutes and hours following discovery tend to be characterised by confusion, a dawning realisation that a significant problem must be dealt with and simple disbelief.

These early moments are vitally important and there are plenty of pitfalls for the unwary. If appropriate protocols have not been agreed in advance to deal with the risk of conflicts of interest, information leaks and employee rights, or if they are not followed in the heat of the moment, there is the prospect that decisions taken in the first 24 hours of an investigation may prejudice the interests of the society, its employees and others.

What can go wrong?

There is a need to act quickly after discovering a fraud in order to secure evidence, avoid further loss and initiate recovery proceedings, but all too often it is in the immediate aftermath of discovery that management start to ask some of the questions that they may wish they had addressed earlier like:

What are the aims of the investigation?

It is essential to be clear about what you want to achieve from the investigation at the outset. The investigation strategy will drive the response.

Who has control of the response?

If the wrong person is given control of the investigation there is a risk that key avenues of enquiry may be deliberately ignored. Conflicts of interest can also result in precipitous or prejudicial responses that might later be regretted.

How do we investigate the fraud and prevent further loss?

As with any complex project, a fraud investigation requires careful planning, including the level of experienced resources required, who will be conducting the interviews and how they will be conducted. If the team immediately launches into a detailed investigation there is a danger that time will be wasted and evidence lost.

How do we secure evidence from our IT systems?

IT systems, including an individual's PC, will often hold valuable information for the fraud investigator but vital data could be destroyed unless appropriate steps are taken to secure the data.

Who needs to know, and who does not?

If the circle of those informed about the incident is too wide, not only is the risk of a conflict of interest increased, but so too is the likelihood that communications may be made in unguarded terms. This may result merely in embarrassment, but it could also prove costly in subsequent litigation.

What are the rights of the employee(s) under suspicion?

If decisions are taken to suspend or dismiss staff without due process, the results can be disastrous. Unguarded and ill-considered behaviour towards employees may subsequently be shown to have been unfairly prejudicial or even defamatory.

How do we preserve confidentiality?

For example, whistleblowers need to be managed sensitively. If not they may take their concerns outside the business.

How do we get our money/assets back?

If management are unaware of the various routes open to them to recover assets and do not engage with their professional advisors soon after discovery, they may fail to recover assets that might have been available for seizure.

Plan to avoid disaster

Failure to tackle instances of financial fraud properly could result in losing the opportunity to secure assets, claims for unfair dismissal, and prejudicing criminal prosecutions.

No two fraud investigations are the same but management who are able to refer to agreed policies and protocols against which they can assess their options on day one, are more likely to retain control. It will also be helpful to have to hand a list of possible points of contact, including a shortlist of external advisers, so that decision-makers have access to appropriate advice, at short notice, when it is most needed. Not only will preparation and planning upfront and before disaster strikes help ensure an efficient and coordinated response, it may also go a long way to fulfilling the organisation's regulatory responsibilities.

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Have their objectives been achieved?

International Financial Reporting Standards have been in place for several years and many building societies have committed significant resources in adapting financial reporting systems that can produce financial statements and disclosures that comply with this new reporting regime.

Going back a few years, it is worth remembering that the reasons for implementing the global harmonisation of accounting standards were:

• to drive uniformity and comparability;
• to improve efficiency of capital markets; and
• to establish a consistent approach for assessing and reporting risk.

Has the introduction of IFRS improved efficiency of capital markets and consistency of approach for assessing and reporting risk?

Clearly very few if any can credibly claim to have forecast the extent of the financial crisis that we have seen unfold over the last 18 months, but it is a fact that financial markets across the globe were on the brink of collapse, but for the intervention of governments around the world.

Against this background, it does lead us to question the credibility of risk disclosures if they did not give an indication of the potential extent or scale of world wide losses that have been recently experienced? Though of course the quality of risk disclosures are significantly impacted by the assumptions on which they have been based and it is clear that the events were unprecedented.

But how about uniformity and comparability of accounts – how does the building society sector fare in assessing and reporting risk?

Twelve of the top twenty building societies⁷ have now fully adopted IFRS. Whether this has led to increased comparability in disclosure across the sector is what we have sought to determine based on an analysis of the relevant IFRS7 disclosures.

What is IFRS 7?

The objective of IFRS 7 is to provide disclosures to evaluate:

• the significance of financial instruments for the entity's financial position and performance; and

• the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity managed those risks.

Uniformity and comparability – how did our sample of societies compare?

IFRS 7 is one of the few standards that is reasonably easy to understand. The guidance is also quite helpful in suggesting formats for presenting data, though it is open to interpretation in terms of the nature, extent and fine tuning of the disclosure.

From our review, it is therefore somewhat surprising that the uniformity and comparability of such risk disclosures is quite varied. This includes:

• a wide variety in the extent and format of the disclosures made by societies which can make it difficult to cross compare society to society. The cross comparability goal is a fundamental reason for introducing international accounting standards, but for societies this has not yet been fully achieved from an IFRS 7 perspective;
• some societies like to put the readers of accounts to work with many requiring readers to work out things like maximum credit exposure for themselves by referring them to asset listings within tables that do not have sub totals;
• some societies have been very good at making it clear which assets and their associated income and expenses fall into the asset categories of "held at fair value" and "assets not held at fair value" whilst others are less helpful and it takes effort to work it out so that meaningful comparisons from society to society can be made; " disclosure of income and expenses on assets not held at fair value is only explicitly stated by 3 societies; and
• only 5 were found to disclose interest income arising on impaired financial assets.

However, we did note that in the current environment the most consistent disclosure was in respect of liquidity risk, where all societies provided a description of how they managed liquidity risk, and all provided maturity analysis for financial liabilities setting out the remaining contractual maturities albeit using different bandings.

In order for societies to compare where they stand amongst their peers we have selected a few key requirements of IFRS 7 and have set out the results our sample achieved. The results are detailed anonymously but they will give you a useful cross check guide to see where you stand when determining the extent of your IFRS 7 disclosure in future periods.

The charts largely speak for themselves, confirming that whilst the new disclosures are certainly informative and useful to readers of accounts we are some way off having the uniformity that IFRS set out to achieve.

However, as societies become more comfortable with the requirements of IFRS and increasingly compare their own disclosures to those of their peer group, we fully expect the extent of uniformity and cross comparison of disclosures to increase.

COMBINED ASSURANCE

Combined assurance is one of the current hot topics in assurance circles but few societies have set about developing a detailed framework in anger. It's a 'nice to have' often put in the too difficult box.

Why is this the case?

There is little doubt that a one stop view of the assurance activities in operation across a society including summary dashboard reporting at the Board, Audit Committee or Executive level is a desirable piece of management information.

Increasingly Executives and Non-executives alike are quite rightly demanding simplified "joined up" reporting that allows them to ask pertinent questions of the assurance providers concerning quality, coverage and cost.

This contrasts to some MI which can be observed, which is a voluminous and complicated set of assurance function period reports. Only when the information is easily digestible can real direction be given from the top to the assurance providers below as to how the assurance framework should be structured and developed.

Therefore the challenge is to devise an operational and reporting framework that can provide a central view of the assurance gained across the society highlighting:

• linkages to significant risks within the society with the purpose of providing comfort that this activity is appropriate and in line with the Board's risk appetite;
• allocation of assurance resources across the society;
• potential duplication of assurance activities; and
• areas of the society with little or no assurance coverage.

The goal of such a framework is to enable Executive and Non-executives alike to:

• challenge the level of activity both across the society and within individual business line assurance functions and provide challenge as to how resources are allocated across the organisation with due regard to the society's risk profile and the Board's own risk appetite;
• understand and challenge the cost of assurance activities particularly in the light of an increased focus on cost control; and
• provide comfort to stakeholders, including the regulator, that the society has a robust and increasingly mature risk management framework.

The benefits to the Board are clear but what of the assurance providers themselves?

Arguably, creating such a framework supports "desirable behaviours" across all relevant assurance activities, engendering a more robust and risk sensitive framework at the operational level. Being part of a joined up, transparent, demonstrably value adding defence model should be of interest to all in the assurance professions. Specifically, benefits may include:

• breaking down traditional 'silo' mentalities across the assurance functions and encouraging a common understanding by all of the risks faced by the society;
• developing more efficient assurance plans may allow more detailed work in fewer areas for staff in certain functions, particularly internal audit, allowing staff to develop areas of specialism and the opportunity for 'deep dive', detailed reviews;
• developing a common view of the society in each of the assurance functions supports a more cohesive approach and a common understanding of the business irrespective of different emphasis on risk types, or the assurance activity undertaken;
• allowing collaborative working where appropriate, reducing the assurance burden on business operations and avoiding duplications of effort entirely; and
• increasing the respect the business has for these functions through provision of service to the business which demonstrably adds value in all its activities.

To implement such a framework is not without its challenges however. Differing working practices, skill sets, internal profiles and to some extent politics within the various assurance functions can all hamper the development of such a framework. In particular the ownership of the combined assurance model and reporting can be a stumbling block.

Solutions are specific to each society but some of the general considerations are:

• Ownership – It can be argued that as the third line of defence, the internal audit function is best positioned to own, challenge and drive the development of the framework forward as in the course of its work internal audit is likely to be providing challenge to the assertions of other assurance functions.
• Structure – combined assurance reporting can only truly succeed if each assurance function has a harmonised view of the society which facilitates speedy assessments of the organisation and allocation of resources. This is not necessarily always the case, therefore one of the key challenges in developing this model is ensuring that assurance functions agree not only on the strategic direction and risk appetite of the society but on how to break the society down in to elements to be subject to assurance activity.
• Assessment – once a view of the organisation has been agreed, how each individual function reports their assurance activity will vary. Decisions as to how best to represent the activity of each assurance function need to be approved by all stakeholders prior to populating the combined assurance report. Furthermore, the recipient of the data needs to be adequately informed as to the meaning and purpose of the report.

Whilst there are undoubted benefits to a combined assurance reporting framework, there are also significant hurdles to overcome in developing a framework that adds real value to the society.

Does that mean we should carry on as we are, completing our plans with little regard for the other assurance functions?

As the regulator and stakeholders alike continually push for more robust and mature systems of risk management and value adding, transparent approaches to assurance, maybe now is the time to start.

Footnotes

1 Taken from CP08/22 – note that "a retail deposit which would otherwise have a residual contractual maturity greater than 90 days must be included within a firm's calculation of its retail deposits where, subject to a loss of interest or payment of another form of early access charge, that deposit's maturity may be altered such that its residual contractual maturity ceases to be greater than 90 days" (BIPRU 12.6 13 R (proposed)). It is expected that the 5% requirement will therefore cover the vast majority of retail funding liabilities

2 Paul Sharma, director, wholesale and prudential policy at the FSA, revealed the FSA's decision to a City & Financial conference in February 2009. Sharma said that bringing the new requirements in would be "wholly inappropriate ... during a significant economic recession"

3 Where such data was reported we have assumed that all amounts reported as "Debt securities issued by public bodies" to be investments in central government bonds. This figure has been calculated as a percentage of retail funding liabilities outstanding at the balance sheet date

4 CP08/22, paragraph 9.9

5 Excluding Nationwide

6 Excluding Nationwide

7 Those societies that are in the process of merging with another organisation have been excluded from our analysis

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.