Brydon Review into UK Audit

"Language matters." so begins the Sir Donald Brydon Review into UK Audit.

In parts touching on the philosophical, Brydon suggests:

"Audit is not broken but it has lost its way and all the actors in the audit process bear some measure of responsibility."

Recommendations:

• A redefinition of audit and its purpose

• The creation of a corporate auditing profession governed by principles

• The introduction of suspicion into the qualities of auditing

•The extension of the concept of auditing to areas beyond financial statements

• Mechanisms to encourage greater engagement of shareholders with audit and auditors

• A change to the language of the opinion given by auditors

• The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement

• Suggestions to BEIS' work on internal controls and clarity on capital maintenance • Greater clarity around the role of the audit committee;

• A package of measures around fraud detection and prevention • Improved auditor communication and transparency

• Obligations to acknowledge external signals of concern • Extension of audit to new areas including Alternative Performance Measures

• The increased use of technology

Brydon quoting Karthik Ramanna  “I know of no better system than market capitalism to sustain liberty and create prosperity – and market capitalism cannot function without a robust audit function. If we do not save auditing, we cannot save capitalism.” 

And on fund managers.... " I was also rather underwhelmed during the Review by the interest in audit shown by some of the portfolio managers with whom I spoke. Few appeared to read the audit report thoroughly and several took the view that it was enough to know whether or not the auditor had given an unmodified opinion."

I do note, I did not speak to Brydon but have tangential advisory interests through being on an advisory group for IASB and for FRC.

Review can be found here.

The Private and External Costs of Germany's Nuclear Phase-Out

NBER Dec 2019. The Private and External Costs of Germany's Nuclear Phase-Out by Stephen Jarvis, Olivier Deschenes, Akshaya Jha.

“Many countries have phased out nuclear electricity production in response to concerns about nuclear waste and the risk of nuclear accidents. This paper examines the impact of the shutdown of roughly half of the nuclear production capacity in Germany after the Fukushima accident in 2011. We use hourly data on power plant operations and a novel machine learning framework to estimate how plants would have operated differently if the phase-out had not occurred. We find that the lost nuclear electricity production due to the phase-out was replaced primarily by coal-fired production and net electricity imports. The social cost of this shift from nuclear to coal is approximately 12 billion dollars per year. Over 70% of this cost comes from the increased mortality risk associated with exposure to the local air pollution emitted when burning fossil fuels. Even the largest estimates of the reduction in the costs associated with nuclear accident risk and waste disposal due to the phase-out are far smaller than 12 billion dollars.”

Paper Here.

Remote Working Apps and start-ups

I’m interested in remote working, comms software, and the rise of enabling software - I’ve kept up with what would be considered incumbents now like Slack, Zapier and I was an early user of Loom. H/T reading Pioneer’s DC Gross - I discovered many more:

“… remote is in vogue and founders are rushing to build all parts of the distributed startup supply chain: Terminal helps generate remote teams, Tandem and There attempt to create a remote “office”, and Loom helps teams share their work over video.

Fueled by this trend, collaboration products continue to be popular. Notion is increasingly the wiki of choice for teams [me: Notion also tries to replace AirTable, which is itself a relative newcomer; as well as Trello and other flow apps] . Coda and Threads are building new hybrid variants of Google Docs, bringing the best of Slack and documents together. Figma remains an ever-popular multiplayer Photoshop [Me: it’s more a of a collaborative design UI than Photoshop to mny mind, but still pretty amazing]

Parts of the stack are owned by incumbents (Slack, Hangouts, Zoom). I’m not certain their position is infinitely stable. Zoom, for example, has a fantastic “molecule moat”: the IP is hard to create. But there’s no tax on switching. It’s just a link you share over Slack. You could imagine a new Zoom getting adopted very quickly if it was better…”

Pioneer run a grants programme/competition much bigger than my own.

Japanese Wealth Fund on banning short selling

CIO of GPIF, large Japanese sovereign wealth fund, Hiro Mizuno gives insight into why GPIF no longer supports equity short selling (although still ok for bonds), stewardship in passive investing and the short term vs long term. He argues no such thing as a free lunch and that short term lending revenue needs to be weighed up against longer term stewardship value.

Interesting challenge to investors. From FT interview with the CIO:

How, as a fiduciary, can you make that call? You’re forgoing [a lot of] revenue because of this decision. Are you going to make that back long-term in performance gains?

HM: This is a decision between making cash immediately or being better stewards for our constituency. Being good stewards, we create an environment in which corporate executives can focus on long-term value creation, rather than paying attention to how to make their short-term quarterly performance targets. So, the judgment is between cash now on one side, and a more qualitative, holistic, long-term benefit on the other, which not many people can actually see. That’s exactly why we spent such a long time debating internally as well as with our governance board. A lot of asset owners think lending is a free lunch and I think there is no free lunch in the real world. We are making this profit at the expense of some other risk. But, the thing is, we are not aware of what it is.

More here: https://www.ft.com/content/e71a387a-1c5c-11ea-97df-cc63de1d73f4

Critique of GDP and carbon Tax, Vaclav Smil

This is a good short critique of the carbon tax (I still think pricing might help but maybe I’m wrong). Followed by a good critique on GDP. 


From Vaclav Smil (Growth) and he knows way more than me on energy. 


“...The largest externality that remains unaccounted for is the undoubtedly very large cost of relatively rapid global warming (that would increase average tropospheric temperature by more than 2 ° C) attributable to anthropogenic combustion of fossil fuels and land-use changes (IPCC 2014). But in this case there is, at least, a reasonable excuse, as the complexities, interactions, and feedbacks of change attributable to rising concentrations of greenhouse gases are extremely difficult to monetize, especially as some regions, some countries, and some economic sectors will also derive various benefits from rising temperatures and from an accelerated water cycle, and as many of these impacts will not be seen in force for decades to come (and hence will be steeply discounted by today’s valuations). As a result, the carbon tax favored by many environmentalists and by some economists would be nothing but a largely arbitrary (and also a very crude) form of internalizing an unknown fraction of the unfolding and future effects of global warming. …”

And Smil on GDP (including the carbon tax critique). 


“... Given the complexity of modern economies, only a broad aggregate measure can capture their growth. This measure, now universally deployed, is gross domestic product. Its oft-repeated definition seems straightforward: GDP expresses the monetary value of all final goods and services that are produced or provided within the borders of a country during a specified period of time (monthly or quarterly in national reports, per year for international comparisons). But measuring GDP growth, and hence ascertaining its disappointing or satisfactory rates, is an inherently difficult matter and one whose systematic practice is quite recent. Its origins go back to the 1930s when Simon Kuznets was asked by the US Congress to estimate the country’s national income (Kuznets 1934). Its scope was defined by John Maynard Keynes, the measure became a key tool for the international financial institutions set up by the Bretton Woods agreement in 1944, and it was widely applied for the first time to the growing post-WWII economies (Coyle 2014).

Before too long it became obvious that, like every aggregate measure, GDP has many drawbacks—but despite suggested adjustments and proposals for alternative accounts, it has become only more entrenched as the dominant yardstick for appraising the achievements and assessing the growth of national economies.

Problems begin with the choice of currency. In order to derive comparable values required for calculating long-term growth rates it is necessary to express GDP in constant monies, that is in inflation-adjusted terms, but that requires continuous, reliable, and broadly based monitoring of price changes. Not doing so may make only a small difference when inflation remains low (as it has been, generally, in the West since the beginning of the 21st century) but comparing costs in current monies during periods of higher inflation rates (in the West they reached double digits during the 1980s) could lead to major distortions. Even in countries with capable statistical services, this results in often considerable uncertainties, as is best illustrated by the frequency and extent of GDP revisions. Zwijnenburg (2015) found that between 1994 and 2013 the mean absolute revision of year-on-year quarterly growth (the growth rate of a quarter compared to the same quarter of the previous year) for 18 countries in the Organisation for Economic Co-operation and Development (OECD) was 0.36% after one year, 0.5% after two years, and 0.61% after three years, with the average three-year value as high as 0.93% for Japan. As the originally assessed growth rates during that period were on the order of 1–3%, such revisions clearly matter.

On the most basic level, proper GDP accounting requires a definition of the economy, that is, putting the boundaries on what gets counted. Because GDP accounting was established at a time when manufacturing was a leading sector of the economy (with shares of 30–40% during the 1950s), its output continues to be monitored in a relatively more disaggregated manner than the contributions of the now-dominant service sector (in itself a highly heterogeneous group of activities) which make up 70–80% of GDP in affluent countries. Counting all final goods and services may seem to be a fairly comprehensive definition of economic activity—but it is not. Even if we knew with great certainty the size of a country’s economy defined by monetary transactions, it would be still difficult to make a proper adjustment for calculating real long-term growth unless we also knew the trend of nonmonetary exchanges or activities, whose share of the overall economy may remain fairly stable for decades but may rise or decline as economies advance or falter. As it is structured, the GDP concept cannot capture nonmonetary exchanges (the barter economy) and unpaid work (such as household chores or child care provided by members of a family or by relatives and friends) or those financial transactions that take place outside the monitored flows of modern economies, deliberately avoiding them or being hidden, a sector known as the informal, shadow, underground, or black economy.

The barter economy, common in all preindustrial societies, has been largely eliminated in modern economies, while unpaid services are as important as ever and unreported transactions are thriving. Housework has been always excluded from GDP, and although it can be argued that most household chores became easier over time, care of the elderly will be taking more unpaid time in all affluent societies with aging populations and rising life expectancies. Interestingly, Britain’s Office for National Statistics estimated that in 2014, when the country’s GDP reached £ 1.8 trillion, the value of unpaid labor was £ 1 trillion (Athow 2016). And counting only what is sold and bought leaves out many important activities, particularly in modern economies with their rising shares of electronic information and digital production: Internet providers charge a monthly fee that includes virtually unlimited access to almost any conceivable category of information, with the marginal cost of searching for news or participating in social media being very close to nothing, and hence excluded from the standard GDP accounts. The size of the black economy can be only estimated but its share of total production was growing during the last decades of the 20th century (Lippert and Walker 1997), and at the beginning of the 21st century its size was put at about 15% of official GDP in affluent nations and at one-third in low-income countries, with shares as high as 40% or more in Mexico, the Philippines, and Nigeria (Schneider 2003). The best available studies show it to be far from negligible even in some of the world’s most affluent countries with generally good governance and with low levels of corruption.

A comprehensive study of the shadow economy in the European Union put the average for all member states at 18.3% in 2015, with the range from 8.3% in Luxembourg to 30.6% in Bulgaria, and with Germany and France nearly identical at, respectively, 12.2% and 12.3% (Schneider 2015). In an older study of 162 countries, Schneider et al. (2010) put the mean at 31% in 2007, with the extremes ranging between 8.2% for Switzerland to 62.6% for Bolivia. How uncertain these estimates are can be illustrated by many comparisons. In a closer study of Germany’s black economy, Schneider and Buehn (2016) compared the outcomes of eight studies using different methods (including discrepancies between expenditure and income and between official and actual employment, a currency demand approach, and surveys) and found that between 2000 and 2005 estimates of the country’s shadow economy were as small as 1% and as large as 15–16% of official GDP. And while Schneider et al. put India’s shadow economy at 21% of official GDP in 2006, a confidential report commissioned by the Indian government (and leaked to the press) put the size of the country’s black economy at nearly 75% of the official GDP (Mehra 2014). And Statistics Canada (2016) claimed that in 2013 the country’s shadow economy was just 2.4% of official GDP and that this share had remained unchanged since 2002, a remarkable fact (if true)—while Schneider (2015) put Canada’s 2015 share at 10.3%, identical to the Australian rate. And then there is GDP’s almost utter inability to capture qualitative improvements.

For decades Bell offered American consumers one model of its standard black rotary-dial phone, and then came push-button dialing, a variety of electronic phones, and eventually cellular phones and smartphones. Successive outlays spent on acquiring these items or paying rental fees tell us nothing about the fundamentally different qualities embodied by changing designs. The same is, of course, true about cars—a rising share of their value is now in electronic components and hence they are mechatronic devices, not simply mechanical machines—and, to different degrees, also about housing and long-distance travel, in terms of both speed and comfort: compare what the same price bought in 1955 with a seat in a propeller-driven Constellation and in 2015 in a Boeing 787. GDP is not a reliable measure of the total economic product, and it is an outright inferior measure as far as the quality of life and real prosperity are concerned. From a long-term perspective, the most fundamental failure of GDP accounts is to ignore diverse forms of environmental degradation caused by economic activities and treat the depletion of finite resources as current income that adds to wealth. These are, of course, utterly unsustainable premises as no society can exist without adequate support provided by natural capital stored in biodiversity and in photosynthesizing species and maintained by many indispensable environmental services ranging from soil renewal to water retention by forests and wetlands (Smil 1994, 2013a). Remarkably, economists call these critical omissions “environmental externalities”: the very choice of the noun is telling because historically they were not an integral part of the cost of doing business and their still far from adequate pricing has been making slow progress. Most major gains have come only since the 1950s, with most of the externalities far from getting internalized. Reducing air pollution is an excellent example of this internalization of former externalities, that is paying higher prices in exchange for a cleaner environment. One of the first large-scale instances of this effort was the elimination of visible particulate air pollution from the combustion of coal in large electricity-generating plants, due to the post-1950 installation of electrostatic precipitators that remove more than 99% of all particles (USEPA 2016a). The next step, starting during the 1970s, was a large-scale adoption of flue gas desulfurization that greatly reduced the risk of acid precipitation, first in Europe and North America, later also in China. Removal of particulates and sulfur raises the cost of electricity generation by about 10%. But most externalities remain entirely unaccounted for. Among the most widespread negative impacts whose costs are completely ignored in product pricing are the declining yields caused by the universally increased rates of soil erosion in intensive row-crop cultivation (of corn or soybeans, two leading grain and legume species); the formation of dead zones in coastal waters caused by excessive runoff of nitrogenous fertilizers causing eutrophication of aquatic environments; the health effects and material damage caused by the photochemical smog that is now common in all megacities; and the rapid loss of biodiversity caused by such diverse actions as mass-scale monocropping and tropical deforestation. The largest externality that remains unaccounted for is the undoubtedly very large cost of relatively rapid global warming (that would increase average tropospheric temperature by more than 2 ° C) attributable to anthropogenic combustion of fossil fuels and land-use changes (IPCC 2014). But in this case there is, at least, a reasonable excuse, as the complexities, interactions, and feedbacks of change attributable to rising concentrations of greenhouse gases are extremely difficult to monetize, especially as some regions, some countries, and some economic sectors will also derive various benefits from rising temperatures and from an accelerated water cycle, and as many of these impacts will not be seen in force for decades to come (and hence will be steeply discounted by today’s valuations). As a result, the carbon tax favored by many environmentalists and by some economists would be nothing but a largely arbitrary (and also a very crude) form of internalizing an unknown fraction of the unfolding and future effects of global warming.

These are not new concerns. Kuznets was fully aware of these deficiencies (obviously not of the effects of global warming but of environmental externalities in general and of other ignored inputs). He asked who could place a value on the country’s rivers or on the skills and capacities of housewives and his suggested subtraction of dis-services from national income estimates was far more radical than most of the recent calls for GDP redefinition. His preference is worth quoting at length.

This writer, for one, would like to see work begun on national income estimates that would not be based upon the acceptance, prevailing heretofore, of the market place as the basis of social productivity judgments. It would be of great value to have national income estimates that would remove from the total the elements which, from the standpoint of a more enlightened social philosophy than that of an acquisitive society, represent dis-service rather than service. Such estimates would subtract from the present national income totals all expenses on armament, most of the outlays on advertising, a great many of the expenses involved in financial and speculative activities, and what is perhaps most important, the outlays that have been made necessary in order to overcome difficulties that are, properly speaking, costs implicit in our economic civilization. All the gigantic outlays on our urban civilization, subways, expensive housing, etc., which in our usual estimates we include at the value of the net product they yield on the market, do not really represent net services to the individuals comprising the nation but are, from their viewpoint, an evil necessary in order to be able to make a living (i.e., they are largely business expenses rather than living expenses). Obviously the removal of such items from national income estimates, difficult as it would be, would make national income totals much better gauges of the volume of services produced, for comparison among years and among nations. (Kuznets 1937, 37)

Economists have suggested fixing many inadequacies of GDP with suggestions ranging from using comparable market rates to value household chores (or shadow pricing measured by time devoted to a task) to quantifying environmental deterioration, and many critics have called for more radical redesigns or for abandoning the measure and adopting an entirely new valuation (Nordhaus and Tobin 1972; Zolotas 1981; Daly and Cobb 1989; Costanza et al. 2009; World Economic Forum 2017). In all cases, the goal is to quantify the extent to which economic development meets society’s needs (for adequate nutrition, shelter, personal freedoms, environmental quality) rather than measuring the magnitude of market transactions….”

Read Smil on Growth, Amazon link here.