INSITITUTE OF INTERNAL AUDITORS Launch of State of Governance Report

21 Nov 2019

Launch of State of Governance Report
Keynote Address by
Bernard Peter Agulhas
21 November 2019


Good afternoon ladies and gentlemen,

I am singularly honoured to have been invited to be your keynote speaker at the launch of the 7th annual State of Governance Report. I wish to congratulate all the contributors who participated in collating this report as it delivers insight to the state of internal audit and governance in the country. It is a privilege to be able to address you today on governance and its role in leadership and success at a time when the country is on the verge of what could become an economic crisis exacerbated by a failure of leadership and governance, both the private and public sector.

A Time for Action

At his inauguration President Cyril Ramaphosa said: “It is a time for us to make the future we yearn for. It is through our actions now that we will determine our destiny. South Africans want action and not just words and promises – and there will be action. It is through our actions now that we will give form to the society for which so many have fought and sacrificed, and for which all of us yearn.”

A Promise of Clean Government

His promises of a clean government, an end to the culture of impunity and the establishment of strong anti-corruption machinery are needed to enable the country to arrest the misappropriation of public funds in the private and public sectors and attempt to recoup the losses. The public, however, is all too aware that promises are empty if there is no action or delivery that follows them. Consequently, without action, confidence in our ability to change gets weakened.

Springboks – from disillusionment to triumph

There is no better antidote to the gloom of an economic crisis laid bare in a Medium-Term Budget Speech, than the national rugby team carrying the nation’s hopes to a thrilling victory in the Rugby World Cup.

Still recent in our memories, the final showdown in Yokohama between the Springboks and England ended in a dominant 32-12 victory for South Africa. This pushed the Springboks back into poll position as the world's # 1 team.

But it wasn’t always so. At the end of 2017, Springbok supporters were disillusioned, following long runs of bad performance under previous coaches. So, for Rassie Erasmus, the coach tasked with turning around the team’s performance, and for the team itself, to come back from the doldrums to scoop the Webb Ellis Cup was no mean feat. This triumphant win follows previous successes in 1995 (at home) and 12 years later in France (2007). That it took another 12 years to win it may be no coincidence.

Cyclical Performance

As in rugby where performance can be cyclical, the financial sector has been besieged since 2017, with high profile corporate collapses and state capture revelations exposed through the Zondo Commission that have implicated the auditors, accountants, boards and directors. These include the Gupta-linked Linkway Trading (Pty) Ltd, which first shone the light on the misappropriation of funds from state projects; the mighty Steinhoff collapse under the weight of a lengthy and complex management fraud; the VBS Bank collapse, as a result of executive looting; and now Tongaat Hulett, the 127-year-old company that has suspended trade in its shares due to accounting irregularities.

Cost to the Nation

This string of high-profile corruption, fraud and corporate collapse cases have cost the country, citizens and pensioners dearly.

In each case the public response has been to look first to the auditors for answers.

While recent business failures in South Africa have focused attention on auditors, should we not also recognise that the financial reporting system and corporate governance may not be working as they ought to?

Loss of Confidence – many root causes

Recently, a journalist asked me whether the auditing profession has a future; adding that as the loss of confidence in the opinions of external auditors is significant, I would have to do something about it. The journalist also noted that with audit and business failures happening almost daily, it can’t be easy.

The situation that many of these beleaguered companies find themselves in could just as easily be linked to:

  • a struggling economy,
  • questionable actions by management in preparing the financial statements,
  • weak corporate governance,
  • a lack of independence of audit committees and boards,
  • a lack of diversity of skills and gender in governance structures
  • tone at the top, or
  • fragmented regulation.

Anti-corruption efforts depend on the system working together

However, it does seem to be a prevailing view that if the auditors were doing their job, this fraud and corruption would not be perpetuated. While I stress that not every business failure is an audit failure, it is becoming clear that auditors and the audit product must evolve to meet the expectation gap of the market. However, it is obvious that we also need to recognise that the financial reporting system and corporate governance are not working as they ought to.

Tick-box versus real action

Corporate governance seems to be a tick box exercise for many corporate governance structures. While companies set out their commitments to good governance in great detail and say that they comply, this appears to be merely lip service. In the words of President Ramaphosa: “South Africans want action and not just words and promises.”

Importance of an effective combined assurance model

In a combined assurance model, in which the internal auditors play a key role in concert with external auditors, an organisation relies on its governance processes and structures to prevent fraud, ensure the accuracy of financial accounts and manage organisational risk. In theory, these checks and balances allow those charged with governance to hold management to account and ensure that massive fraud and corruption are not perpetrated.

There are many safeguards that are required and ought to be there and implemented by boards, audit committees and directors before the financial results get to the external audit stage. The external auditors come into the financial reporting process as the last line of defence to determine whether the financial statements fairly present and comply with relevant laws. So the effectiveness of the interplay between internal audit and external audit is paramount.

However, how many organisations use governance and oversight as a mere checklist so they can produce financial statements? How many give any thought to developing the spirit of good governance throughout the organisation?

It shouldn’t be an exercise, but a mind-set.

Governance structures must be driven by good governance thinking, as well as compliance to laws and regulations. Governance and compliance go hand in hand.

While internal compliance assures that there is adherence to the rules, regulations, and best practices as defined by internal policies; external compliance ensures that organisations are following the laws, guidelines, and regulations imposed by governments, industries, and regulators. There is significant danger in dealing with either compliance or governance as an exercise and not a mindset, as tick-box complacency can allow corruption to persist undetected.

If management and governance structures are not driven by good governance thinking, businesses will continue to fail. A case in point is Steinhoff which, after a 15-month wait for the forensic report into its collapse, revealed that its troubles were “precipitated by a widespread fraud perpetrated by a small group of senior executives”. It has since discovered that its options for recourse against directors, board members, internal auditors and others are limited.

Fragmented regulation

The reality is that there is no regulation, no professional regulatory oversight beyond that of auditors; therefore, there are few opportunities to take action against those who should be held accountable.

This gap in regulatory oversight over the broader financial reporting eco-system offers investors scant recourse for action against those charged with governance in the event of a failure and significant investor losses.

As a result, the Steinhoff case is a prime example for supporting the need for the comprehensive regulation of the financial reporting eco-system.

Comprehensive Regulation

This need was first recommended to the Minister of Finance by the World Bank in 2013. Comprehensive regulation would lead to the broader accounting profession and those involved in the financial reporting chain being brought under one regulatory framework to ensure adequate oversight and accountability throughout the financial reporting chain.

The recommendation is not unusual. The UK’s Financial Reporting Council (FRC) and its Mauritius counterpart have mandates extending to directors, audit committees, company directors, boards, financial statements and auditors.

While the FRC in Mauritius is backed by legislation, the UK has just concluded several reviews of its FRC, the profession, audit firms and the risks of lack of market competition. Subsequently, it has resolved that the FRC must be transformed into an independent regulator that is supported by legislation and has the powers and resources to take action. It will now have governance in its name as it will be called the Audit Reporting and Governance Authority.

Last year, National Treasury asked the IRBA to do research into other regulators and then outline a proposal for South Africa to move towards a comprehensive regulation model for the broader accounting and financial reporting environment. The IRBA Board recently approved the detailed research, which has been be submitted to Treasury.

Fight against corruption – increased accountability

The fight against corruption and President Ramaphosa’s intention to turn words into action can be spurred on by regulating accountants across the financial reporting and governance eco-system. By holding all those accountable through regulatory oversight and allowing for speedy consequences for failure to execute good governance, we will be able to move from lip service to embedding a spirit of good governance at our entities – an action that is vital for business to succeed and for our economy to grow.

Need for an economic turnaround

The economy as we have seen in Minister Mboweni’s budget speech is in a more dire condition than we thought. Despite all these other governance issues and failures by TCWG, the auditors, and at times the internal auditors, have remained in the spotlight, perhaps unfairly, as the public questions how audit can be relied upon to protect their investments.

Improving the financial reporting chain

The audit regulator, with the public interest at heart, we have a responsibility to address all these concerns while making efforts to improve audit quality, enhance standards in relation to areas of weakness, and help the profession to respond with changes that will restore confidence in audit quality and opinions.

Equally we see that we have a broader role to play in improving governance earlier in the financial reporting chain by assisting audit committees and addressing any corporate governance weaknesses. In the end, this will allow the combined assurance model to operate as it should.

Restoring confidence in financial reporting

If we are to turnaround the economy, we must restore confidence in both financial reporting and auditing, so that investors can confidently rely on financial statements and make sound investment decisions. We have now completed two years of our restoring confidence strategy and while it is early days, we have seen that the World Economic Forum Global Competitiveness Index has recorded slight improvements in the perceptions around the strength of auditing and accounting standards and in the area of shareholder governance. Sadly, we are still a way off from the top of the rankings, a position we held for seven consecutive years.

What IRBA has done.

ISQM1 – Leadership and Governance focus

One of the areas where we have done a significant amount of work is in contributing to the revision of ISQM1.

The Proposed International Standard On Quality Management 1, Quality Management For Firms That Perform Audits Or Reviews Of Financial Statements, Or Other Assurance Or Related Services Engagements

The revised standard has a far greater focus on audit firm governance and leadership than before. It requires the firm to establish quality objectives that address the firm’s environment and system of quality management, including the firm’s culture, decision-making process, actions, organisational structure and leadership.

Transparency Reports as a tool for audit committees

We have also introduced a requirement for audit firms to produce annual Transparency Reports. At the moment, it is voluntary, but we envisage that this will evolve to become a mandatory requirement to allow audit committees to have an additional way of assessing audit firms’ quality management systems.

Audit Quality Indicators

Also in support of audit committees, we are about to launch Audit Quality Indicators which is a set of measures for audit committees to benchmark and compare audit firms. This will be accompanied by a thematic report.

Supporting Ramaphosa’s drive for investment

I recently met with one of the presidential envoys tasked to bring investment into South Africa and used the opportunity to explain the way in which the auditing profession can support this national effort by rebuilding confidence in financial reporting.

For it is clear that there is a role for auditors and accountants in the economic turnaround and specifically a key role in driving ethical and accurate financial reporting, focusing on the public and national interest. The turnaround will also rely on audit committees and boards who must strengthen their independence and commit to holding management accountable.

It remains to be seen as to whether our government will see comprehensive regulation as a solution to the current situation. We believe that regulation and oversight of the entire financial reporting chain is critical if we are to root out all corruption and malfeasance and improve corporate governance.

Leadership crisis

What has become clear is that the country also has a leadership crisis, across all spheres. With so many leadership positions at State Owned Entities vacant, and the number of disgraced CEOs in recent months, we are seeing a real gap in terms of ethical leaders. The tone-at-top for too long has been self-serving and self-interest focused. With insufficient accountability, corruption has continued unabated as there is a sense that perpetrators are not punished for doing wrong. To turn the country around, we need a new generation of leaders that are committed to ethics, professionalism, public interest and above all good governance.

The role of internal and external auditors

Our professions, both internal and external auditors, have a role to play in the turnaround of the economy by holding ourselves and our clients or employers to the highest standards. We have the power within our hands not to allow complacency or malfeasance to continue.

The IRBA as the audit regulator will continue to play its role in strengthening regulation and implementing measures to address the root causes, but we cannot do it alone. We also need to rely on the specific skills and role of internal auditors.

The skills of internal and external auditors are key

In the areas of governance, risk management and internal control, the International Accounting Education Standards Board (IAESB) has identified a number of Non-Authoritative Detailed Learning Outcomes (NDLOs). These competencies will help us to:

  • Use ICT to identify organisational process and control failures and determine the root cause of these failures
  • Evaluate the impact of process and control failures on an organisation
  • Develop appropriate responses to process and control failures
  • Assess the completeness and accuracy of data and information derived from digital sources
  • Identify opportunities to use ICT to enhance communication with those charged with governance, and
  • Describe clearly how to protect systems, data and information from internal and external security threats, including working with third parties.

Must change, must improve and do more

In conclusion, despite initial fierce resistance to increased or tighter regulation, we are seeing that there is a general recognition that the broader accounting profession must change, must improve, must do more.

As a result, we have seen greater collaboration between professional accounting bodies and an increased willingness to work together, to return our profession to its number one ranking.

To borrow words from the Rugby World Cup, as accountants, auditors and as citizens in our great nation… we are #StrongerTogether.

Thank you