The financial and Eurozone crises have changed the face of politics forever

Sara Benwell 6.45am

Economic policy has always been important in politics, and people have always cared about fiscal policies that affect them directly, but not such a long time ago broader economic strategy only made up a small percentage of the issues that mattered when people decided who to vote for.

Essentially, voters cared if their taxes were going up, but when it came to broader economic strategy the issues were sidelined compared to other policies that had more obvious effects on people’s lives. Moreover, much of the banking world and financial terminology remained a complete mystery to the majority of the electorate, so as long as things were going well, economic policy was seen to be less important. Everyone presumed that the government and the bankers knew what they were doing.

Then came recession and the onset of the Eurozone crisis - and everything changed.

Now more people have a better working understanding of finance. Almost everybody I meet has an opinion about Greece, about Spain, about whether the Eurozone will break up and most importantly about whether or not the Government is doing the right thing to deal with the financial crisis or whether now is the right time for a credible plan B, or even C.

People don’t merely care about the areas of policy that effect them; they now care about the broader economic strategy. The space allocated to business and financial news - not just in the broadsheets but also in the tabloids - is increasing and is reflective of a growing public interest. These days it’s rare you’ll see any business stories in the national press that don’t have a direct link to finance and the economic situation; more often the stories will reflect job creation or losses, financial results, or economic indicators.

While the economic crisis is clearly not a good thing, it’s arguable that the increase in public knowledge and awareness has to be the silver lining to the debt crisis cloud. How many people fifteen years ago knew about monetary policy decisions, about inflation and about quantitative easing, let alone had a good working understanding of these terms as well as an opinion on them? Wider comprehension has to be a good thing.

There has also been a shift towards people wanting their financial institutions and their government to be held accountable. Now that everybody has seen the impact of the poor financial policies of the last labour governments and the problems that can arise when the bankers are given a free rein with little or no fear of retribution, there is an increasing focus on making sure that somewhere somebody is held responsible.

This has been reflected by the recent ‘shareholder spring’. While I think this is an exaggeration, and the term is used too widely and too often, there is no denying that the recent spate of chief executives like Sir Martin Sorrell being denied their bonuses would have been unthinkable a few years ago and reflects growing popular demand for more accountability in the business world.

Furthermore, policies like the ring-fencing of the banks, which I have written about here before, illustrate a move by the Government to introduce financial legislation designed to protect the electorate. This policy has recently been watered down, but that doesn’t change the fact that political parties have recognised the importance of bringing in policies to ensure that an increasingly aware voting public are sheltered from having to bail out the banks once more.

One can quite easily argue that the Coalition will stand or fall on the success of its economic policies. And it is increasingly clear that you cannot spend your way out of a recession, despite what the Labour party might claim.

So the question confronting us now is whether the Coalition Government has enough time left for its economic policy to come good, or whether ministers need to be considering a new plan.

Rest assured that whatever the answers to those questions, the British public is no longer ignorant about economics. And if the Coalition partners, particularly the Conservative party, wants to win the next election, they shall need to prove the credibility of their economic strategy.

Follow Sara on Twitter @sarabenwell

PMQs review: A muttering idiot of a draw

Jack Blackburn 3.45pm

The last Prime Minister’s Questions for three weeks before a joint Jubilee and Whitsun recess was a distinctly bizarre scoreless draw.

It didn’t so much resemble the two most senior politicians in the land debating matters of policy, as it did two angry siblings who simply weren’t listening to each other. Oh, and there was an irritating cousin thrown into the mix.

Edward Miliband’s tactic today was divide and rule. It is one we can expect to see more of over the coming months. Seeking to exploit the evident antagonism between the Business Secretary and Adrian Beecroft, author of this week’s controversial report on employment reform, the Leader of the Opposition set about asking where the Prime Minister stood.

This strategy is brazen but flawed, not least because all the front bench Lib Dems were strangely absent, thereby not allowing for television shots of awkward Lib Dems.

However, Mr Cameron avoided fulsomely embracing the report, suggesting that some recommendations would be taken and others would not, before the major exchange descended into an unstructured melee.

Edward tried to score points on, well, just about anything: Hunt, Coulson, growth, tax cuts for millionaires -  they were all there, culminating in his claim that “the nasty party is back”. Dave started banging on about the trade unions influence on Labour policy. All of the questions and the answers seem to have been decided quite some time before the session. It was a total damp squib.

The meat of the session actually took place after the Leader of the Opposition had sat down. The Prime Minister was asked about the ECHR’s ruling on voting rights for prisoners. The Prime Minister said he would stand for the sovereignty of Parliament and his belief that going to prison meant you lost certain rights, including the right to vote. This is a story that shall keep on rolling.

However, the headlines were stolen by that irritating cousin, namely Ed Balls. He repeatedly asked the Prime Minister how many glasses of wine he’d had, and needled the Flashman in Dave, as is his desire. Finally, by now having “we’re in recession” chanted at him by Mr Balls, Dave could take no more and Flashman flipped. He described the Shadow Chancellor as a “muttering idiot”, causing uproar in the chamber.

Succumbing to goading as such an easy thing to do. It is also easy to wind someone up. However, both these important public figures should not be doing it. Mr Cameron was forced to withdraw his “unparliamenatry” comment. Mr Balls is not subject to sanction. Speaker Bercow, of the pseudo-Headmasterly air, should perhaps get in touch with that instinct now, because these two schoolboys could use some discipline.

Follow Jack on Twitter @BlackburnJA

We have misunderstood the role of auditors in the financial crash

Matthew Robertson 9.47am

“It is not the answer that enlightens, but the question.” Eugene Ionesco.

I regularly receive updates from LinkedIn, telling me how more of my friends and colleagues have connected to an ever-increasing network of workers. My typical reaction is to head for the delete button but lately a headline grabbed my attention: ‘The nation’s auditors find themselves more than ever under public scrutiny.’

Well. It is certainly the case that auditors were at least partly culpable in not spotting systemic problems in banks prior to the financial crisis hit in 2008. In particular, the off-balance sheet items that concealed banks’ toxic assets went unidentified.

Couple this with the Enron scandal, which toppled top-5 firm Arthur Andersen, and it is not difficult to see why auditors have acquired a bad reputation.

Political cynics might also point out that the following ICAEW (Institute of Chartered Accountants in England & Wales) members were MPs during the expenses scandal: Peter Bone (husband to the famous Mrs Bone and rebellious Tory MP for Wellingborough), Nick Gibb (now a schools minister), Justine Greening (Transport Secretary), Mark Harper (a Cabinet Office minister), Mark Hoban (Financial Secretary to the Treasury) and Iain Wright (Labour MP for Hartlepool and a former schools minister). Nothing like an expenses scandal to confirm the notion that all accountants ‘fiddle the books’…

But the perception held in some quarters that accountants are unethical and too close to their clients is an unfair one. It was true in the case of Enron, where Arthur Andersen was relying on large consulting fees generated by their client - comprising roughly 27 per cent of the audit fees for Arthur Andersen’s Houston office. That was a classic conflict of interest case, which prevented auditors from applying proper professional scepticism.

Professional scepticism is the bedrock of the entire accountancy and auditing world. It is an attitude that comprises a questioning mindset, being alert to conditions that might indicate misstatement due to error or fraud, and a critical assessment of audit evidence.

Truly to understand the importance of professional scepticism needs some understanding of the purpose of audit itself, namely to enable an auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. Its benefit is in instilling confidence in the financial statements of companies for those who use them, such as the Government, banks, shareholders, investors and so forth.

The common misunderstanding of the auditor’s role is around the level of assurance that is provided. Due to the nature of evidence available and time or financial constraints, it is impossible to provide absolute assurance that a financial statement is a true and fair reflection of the company. Instead an audit offers reasonable assurance.

‘Reasonable assurance’ is the measure of confidence that a financial statement has not been materially misstated by an auditor exercising professional skill and due care. This is not the same as saying a financial statement is correct, nor an opinion on the financial health of a company. It is merely stating that auditors are able provide an opinion to what extent the financial statements give a true and fair view of the company.

A further problem is that an auditor’s confidence is subjective. Users of financial statements derive their own confidence from many sources, including the knowledge that auditors work to professional standards (including a code of ethics) and within a regulatory framework. The company is also presumed to be subjected to strict reporting standards.

Auditors will not find every problem or irregularity in a company but they will use professional scepticism to ask the difficult questions that push management to exercise adequate controls. My favourite analogy is that auditors are the little voice inside your head that constantly asks ‘Why?’

The challenge the accountancy profession faced prior to the financial crash, and one it still faces, is the ever-increasing complexity of the financial system. More companies are today trading in an international context, which requires auditors to understand multiple reporting frameworks, different economies and to an ever greater extent, to have a knowledge of different IT systems. This can hinder their ability to ask the correct questions and thus exercise professional scepticism.

What was striking about this financial crash is found in this complexity. Merely a small population of mathematicians truly understood how financial securities such as CDOs and CDSs functioned. The financial system relied on computers designed by physics, engineering and mathematics graduates drawn into the lucrative world of investment banking. When it all came crashing down, as we now know, few could confidently value the assets banks held.

Auditors did not have the skill set to ask the appropriate questions. This allowed banks to hide their assets off-balance. The fundamental principle of professional scepticism was compromised.

The question is where the auditing profession goes from here. Increased regulation means that auditors must document and test more findings than ever before. This is certainly a welcome development where the auditing of major companies is concerned. However, does a letting management company based in the UK need to document the risk from currency translation into euros? Or a church need to document risks associated with financial derivatives?

There comes an extent beyond which regulation undermines an auditor’s work. Auditing ought to be a thinking man’s profession, not a process of regulatory box-ticking for the sake of it.

Follow Matthew on Twitter @FlatFootTory

Another example of a politician not understanding how small businesses work

Craig Barrett 10.45am

I was fascinated as ever to read yet another article about rescuing businesses by a politician seeking to depict banks as villains and distressed entrepreneurs as martyrs. Though I agree with the sentiment - namely that we should encourage entrepreneurial spirit - the overall framing is flawed.

The article in question, by the Tory MP George Eustice, appeared yesterday on ConservativeHome. Mr Eustice seems to have a fundamental misunderstanding of the nature of business rescue in this country, commenting unfavourably on the provisions of the Enterprise Act 2002 and the administration regime. The legislation has its flaws but it has been been to operate effectively by participants in the insolvency sector.

Making the same mistake as Peter Mandelson did when concocting the regime, Mr Eustice has gazed dewy-eyed across the Atlantic towards Chapter 11 of the US’ Bankruptcy Code and decided therein lies the solution. The debtor retains the right to retain control of their assets once a business has begun to fail, and has the luxury of court protection against interference.

Yet the best comparison I can think of would be for us to have allowed Gordon Brown to remain as Prime Minister in perpetuity until he had turned around the economy, without fear of interim challenge.

In fact, UK businesses have always enjoyed a flexible rescue culture, irrespective of legislation.

Working on the correct basis that it is rarely in anyone’s interest - including that of the bank - to see a company fail, the London Approach (as it used to be called) pioneered debt restructuring so as to make it possible for a business to survive and often without entering an insolvency process.

Mr Eustice comments that the terms attached to debt often become more onerous as part of a restructuring but omits to mention that these new terms are often a trade-off for write-down of total debt and/or an extension of the term of the debt. A business is given some breathing space but in exchange for ensuring that a bank does not make too much of a loss. Banks are commercial organisations that need to turn a profit - and they will only do so if they are allowed to strike deals on commercial terms (particularly as so many people seem to howl with grief when state-owned banks lose money).

For a bank, appointing an administrator or a fixed charge (LPA) receiver is a last resort - either the business or asset is a basket case or, more rarely, management has adopted the ostrich approach and only an outsider could rescue the situation.

In either case, it is not as straightforward as Mr Eustice might believe. An administrator owes a duty to all creditors and a fixed charge receiver - while being under a contractual obligation to the mortgagee - also owes a wider duty in respect of value of the asset over which he as appointed.

To suggest that a fixed charge receiver is tantamount to an old style administrative receiver is to stretch a point somewhat - fixed charge receivers have no ability to trade, which was the keystone of administrative receivership.

Yes, the costs of receivership are borne by the borrower but only in the sense that they become part of the overall debt. Why should a bank bear the cost of enforcement in order to recover what is owed to it? Mr Eustice appears to be suggesting that borrowers who default should somehow escape paying for the recovery costs relating to their own breach of contract.

I also fail to understand why Mr Eustice suggests that an insolvency practitioner would be required to seek permission from a court before selling a business or an asset. Mr Eustice is clearly unaware of the pressures the courts are currently under. It takes several months merely to get a date for an initial hearing. How would a business trade during this time? Who would fund it? The only way to keep a business going while an administrator waits months for a court hearing would be to ask the bank to fund it - the same bank that Mr Eustice seems hell-bent on attacking.

These proposals also pay no regard to one of the prime considerations of Britain’s business rescue culture - that of rescue. The flexibility inherent in the system means that businesses are often sold on without interruption to service - the uncertainty of awaiting a court verdict on a sale proposal would cause most customers of a distressed business to trade elsewhere, thus eroding whatever value remained. By being able to act quickly, an insolvency practitioner can maintain value to the benefit of all creditors.

Finally, to suggest that administration protection should be extended to sole traders or partnerships misses the key point that as these businesses have no requirements to make public filings, counterparties would have no visibility of their financial position. If a businessman wants the protections available, incorporation is the only way to ensure that protection. Widening the administration protections for sole traders and partnerships would actually result in more abuse of the system than any measurable overall benefit.

In fact, had Mr Eustice done a bit more digging, he would probably have concluded that the retail banks are currently being very supportive of businesses. It is possible to argue that a recession is good for the overall economy as it assists with trimming dead wood and streamlining and strengthening sectors.

Currently, the most pressure on SMEs comes from HMRC’s seeking to ensure prompt collection of taxes. If Mr Eustice is concerned about business survival, might I suggest that he has a quiet word with officials at HMRC?

Britain’s small and medium-sized businesses are what will return the country to prosperity. Therefore we must do all we can to encourage them. However, banks who lend to such businesses share a similar entrepreneurial spirit and we must ensure that an appropriate balance is maintained between the interests of creditors and the interests of debtors. Sadly, Mr Eustice has, like so many others, chosen simply to attack the creditors.

Follow Craig on Twitter @mrsteeduk

How to thaw the frosty relationship between the political class and the public

Iain Martin 11.07am

Deregulation of small businesses is proceeding quietly but promisingly

Matthew Robertson 6.01am

If you weren’t already up-to-speed with age related allowances, income tax thresholds and VAT on hot baked foodstuffs, the past couple of weeks have put paid to that.

The Chancellor’s recent Budget hit the headlines for many of the wrong reasons. One man, however, has been surprisingly off the radar. Can anyone remember the Business Secretary?

Proposals emanating from the Department for Business, Innovation and Skills (BIS) caught my eye more than anything else in the Budget - and no, that isn’t because BIS is better than the Treasury at stopping leakages.

The Government has repeatedly stated that small businesses are key to the economy recovery. For instance, David Cameron in November 2010:

“I feel very strongly about the need to do everything we can to help and promote small and medium-sized businesses. They provide nearly 60 per cent of our jobs and half of our GDP.”

The thinking is this: deregulate on behalf of these companies and they will invest, grow and hire new employees.

There have been no headline grabbing proposals so far but there has been some quiet progress. In October 2011, BIS released a discussion paper entitled ‘Simpler reporting for the smallest businesses’. It was not a statement of government policy but it did offer ideas and evidence that the Government seems to have taken on board.

The main idea was to reduce reporting requirements for micro entities. These micro entities do not actually exist in this country yet but they were defined by the EU competitive council in February 2012 as any company that matches two of the following three thresholds:

1. Turnover less than €700,000
2. Gross assets less than €350,000 
3. Fewer than 10 employees

This would cover approximately 60 per cent of UK companies registered at Companies House.

The reporting requirements for these companies would be significantly reduced. A profit and loss statement would not need to be filed at Companies House and only an abridged balance sheet would need to be prepared.

In plain English, if these proposals are adopted, a significant amount of work and expense undertaken by small companies to prepare accounts would no longer be necessary.

Meanwhile, the Office of Tax Simplification (OTS) has conducted a review of small businesses, in which it was found:

“Despite devoting time, expense and care to calculating tax and filling in tax  returns, half of small businesses worry about making mistakes in applying the rules. They also found that 20 per cent of small businesses (potentially 700,000 businesses) have difficulty working out how much tax they need to pay, and that half of all small businesses had experienced difficulties identifying what is a deductible expense.”

The OTS goes on to recommend:

“Small, unincorporated businesses should have the option to calculate their taxable income on simpler cash receipts and payments basis.”

It is not certain what impact these proposals would have on small businesses if implemented, but the Government hopes they will provide businesses with more assurance on tax issues, which could lead to more business confidence and a boost to the economy.

These proposals have undoubted benefits. Whether banks would be more or less willing to lend, however, is unknown, but the thinking from BIS is that complex regulation currently impedes small businesses from accessing credit. This lack of access is in turn preventing investment and hiring.

There are many difficulties, such as the concern that these basic accounts would be inferior to those published for other, bigger entities. This could counteract any help small businesses get from reduced complexity in terms of accessing credit.

Above all, these proposals do not seem to consider how useful accounts can be. For instance, a receipts and payment account does not indicated a company’s profitability and would be subject to manipulation (e.g. a company with a cash surplus of £2 million could spend all of that on a new building or a machine just before the end of the tax year, thus giving it a net figure of zero). Users of these accounts would be handicapped by the lack of recorded trading activity, not to mention the effect it would have on the tax chargeable to these companies.

A better approach would be to simplify the tax system itself, in particular by merging PAYE and NIC operations. The contributory idea of NIC has long since disappeared. Furthermore, the result would be more upfront about true total tax rates, which would help to clarify the taxation debate and possibly put pressure on the Government to reduce taxes. The Budget states that the Government is consulting on this change so we will have to wait and see.

Whatever direction we are heading, these proposals could have a great impact on small businesses across the country. What cannot be denied is that the Government is trying to make Britain appear ‘open for business’ by assisting small businesses, the bedrock of the economy.

It might not be the most fashionable or tabloid-friendly sentiment but small businesses are going to determine how quickly Britain grows out of these difficult times - not the 50p top rate, not age related allowances, nor VAT on food.

Matthew Robertson is a trainee accountant. Follow Matthew on Twitter @FlatFootTory

Though an American will win, an African should be the next President of the World Bank

Alexander Pannett 7.15am

The World Bank is about to elect a new President.

There are three very well qualified candidates, who all promise to change an institution that has suffered severe criticism in recent years about its approach to global development.

The World Bank has a real opportunity to select a President from a developing nation and break out of its image as being run at the behest of the World’s richest nations (i.e. the West~).

In this regard, there is a clear favourite in Nigeria’s finance minister, Ngozi Okonjo-Iweala (pictured above). As well as being an economics graduate from an Ivy League university and a former managing director of the World Bank itself, she has a proven track record as a finance minister of a major developing nation.  She also has the backing of the African Union. Who better to reform the World Bank and revolutionise its approach to the developing world?

Unfortunately, every president since the bank’s creation in 1946 has been an American. This is the consequence of a gentleman’s agreement with European nations. They support an American candidate for the World Bank and, in return, the Americans support a European for the head of the International Monetary Fund (IMF), its sister organisation.

Voting at the IMF and the World Bank has also been weighted in favour of richer, Western nations. Thus the global financial institutions of the Bretton Woods system have been dominated by westerners since their inception.

Such a bias towards the developed world has attracted criticism that the conditions of economic funding to developing nations are often unsuited to those nation’s particular needs, concentrating on short-term GDP growth rather than long term stability. The results have often led to painful restructuring of traditional societies, local industries and employment practices as economies are forced to open up to global free markets in return for capital from the World Bank.

The experiences of Russia, Eastern Europe, Asia and Latin America in the 1990s, are all demonstrative of this economic “shock therapy”, which often achieves more harm than good by forcing countries to accept structural adjustment packages which are tied to strict conditions resulting in a developing country deepening its dependence on foreign financial flows.

The consequences have been spiralling debt, massive unemployment, rising economic inequality and widespread social depredation as social services crumbled.

Developing countries that accept credit from the World Bank to ease desperate liquidity concerns have ceded economic sovereignty to World Bank supervision, where World Bank consultants can intervene and recommend private investor infrastructure ‘partnerships’ in areas ranging from health and education to utilities.

This transfers economic authority to the IMF, World Bank and foreign investor interests, leaving the developing country with little option but to accept strict conditions in order to ensure continued access to credit in order to meet its debts. Structural adjustment packages have deepened and prolonged financial crisis and underdevelopment in many cases and undermined the sovereignty of developing countries.

This is why a World Bank president who understands the harm that neo-liberal economic policies can impose on un-prepared markets is vital if developing nations are to secure lines of credit that promote sustainable development rather than trap nations in debt.

Regrettably, the chances of a non-American becoming president are nil. With the Europeans having secured the American vote for the election of their candidate, Christine Lagarde, to lead the IMF, they are certain to return the favour. Moreover, it is election year in the United States and President Obama will not want to be seen as weak by becoming the first US President to fail to have their World Bank candidate elected.

This is not to say that President Obama’s nomination, Jim Yong Kim, is not an excellent candidate, with an impressive reputation in international development.  He is also a doctor and former World Health Organisation official. The fact that President Obama has selected an individual with deep experience in development rather than a former politician or banker, as all former American nominations have been, suggests he is starting to address concerns that the World Bank be changed to meet the needs of developing countries rather than be a mere Jesuitical proponent of laissez-faire economics.

Yet until the World Bank and IMF appoint candidates according to merit rather than arcane arrangements, we will carry on wasting chances to help developing nations in a sustainable way and alleviate the grave poverty and environmental concerns that will continue to afflict both humanity and the biosphere we live in for the foreseeable future.

Follow Alexander on Twitter @alpannett

Governments can lead industrial strategy, and Lord Heseltine for one should know how

Nik Darlington 8.48am

“Eleven years is a long time in this industry,” said technology pioneer Steve McConnell.

It is. Eleven years ago, I was plugging a clunky laptop into a telephone line in order to download a web page in the same amount of time it took Roger Bannister to run a mile. Sometimes even as long as it would take Ed Balls to run a mile. Yet this morning I travelled to work flicking through a variety of newspapers on an iPad.

But if a week is a long time in the industry of politics, on another hand, then eleven years might be considered a lifetime.

Not for TRG patron Lord Heseltine, whose maiden speech in the House of Lords was delivered last week, eleven years after his being elevated to the peerage. Reassuringly steady, I’d say. Don’t pop your head above the parapet until you’ve get the measure of a place.

Flanked by former Cabinet colleagues Lord King and honorary TRG life member Lord Howe, the former Deputy Prime Minister spoke about his new and “expanded” role improving the competitiveness of British industry.

And this morning he has an op-ed in the Times (£), in which he demands brutal frankness about the country’s weaknesses if we have any hope of becoming world-class.

“There are exciting new markets but we rarely ask ourselves how we can compete in them against German, French and Italian business if we cannot compete in our our European home market. In Government in the 1990s, I was told that 40 per cent of our companies were world-class; the German equivalent was 60 per cent. When the Chinese Prime Minister left the UK a few months ago he placed orders for £1 billion. A few days later he placed orders for £14 billion in Germany.”

Acknowledging our relative decline is but one step. Lord Heseltine insists we must invest in long-term factors such as infrastructure, R&D and schooling for the young to ensure workers are ready-made with the right skills.

And significantly, Government must have a role in shaping long-term industrial strategy and investment, because the private sector - in search of a quick(er) buck - won’t.

“It is a common criticism that we are too short-termist in our approach to investment. So we need to ask who owns British industry, and whether they see themselves as having a responsibility for anything other than short-term valuations of their shares. Our largest institutional investors are owned and managed internationally, and are thus unlikely to see themselves as a driving force of UK plc. How do we deal with that?

Of course, governments can only set the foundations - individuals and companies must stand up and deliver too. We all have to take responsibility for making Britain more competitive.

“Trade associations can encourage their members to raise their game but are they strong enough to tell their less effective members - the slowest ships in our industrial convoy - that their failure may be their fault and not that of the Government or the economy…

“I intend to ensure that these hard questions are not just grappled with in the heart of Whitehall but that they also get a response from boardrooms and council chambers up and down the country. Otherwise we will not be able to craft an industrial strategy that will give us the growth and jobs we so painfully need.”

“From Liverpool to Canary Wharf, Michael knows how it’s done,” said the Chancellor, last week. The coalition is an ideal setting, and the economic downturn an apt scenario, for this more dirigeiste approach. And few at the top of politics believe in that approach as fervently as Lord Heseltine.

Why? Because few others have proven how well it can work.

Follow Nik on Twitter @NikDarlington