The growing interest in economic issues and scrutiny in matters of governance are by far the only positives drawn from the ruckus sparked by recent government actions. With the ruling alliance increasingly inclined to navigate through its mandate by twisting regulations, juggling dangerously with key institutions and establishing despotism as the new normal, there are clear indications of serious repercussions swaying our way.
The Bank of Mauritius (BOM) is one of the front runners dashing straight into the storm. Its decision to turn into policy, the fantasy classroom exercise of Milton Friedman is a clear hint of a government running out of ideas on how to jump start the economy towing it out of the deep slump. Let’s cast aside the futile terminological debate on what’s helicopter money or how does it differ from quantitative easing. Let’s rather remain on the unchallengeable statement by the very same Milton Friedman – There is no such thing as a free lunch.
The malicious amendments slipped into Covid 19 Act allowing the BOM to depart from traditional policy, not only undermines the independence of the central bank but also entail both governance as well as compliance issues. With whistle blowers drawing attention to financial concerns and incestuous political relationship between the government & BOM, a diligent focus should be laid on consequences of these decisions on other key aspects within the BOM. The distribution of unrealized gains and its impact on accounting practices, audit standards and fiduciary duties of BOM directors are issues of extreme concern.
Accounting – Will the devil hide the details ?
Risks posed by distribution of unrealized gains have featured high on the agenda of reputed International Institutions such as the International Monetary Fund (IMF), European Central Bank ( ECB) and the Bank for International Settlements (BIS). They all concur on the sacrosanct importance of avoiding payout from unrealized gains. The ECB emphasizes on the need to preserve trust by transparently ringfencing unrealized gains from distribution rather than use shrewd accounting policies to disguise payouts. The European institution also warns on arrangements through subsidiaries and special purpose vehicles which would result in darkening transparency and erode trust.
The prudence principle advocated by the BIS, in the context of income recognition consists of an asymmetric treatment of valuation gains and losses. Which implies, unrealised gains arising from foreign currencies are not recognised as income in the profit and loss account, but are recorded in revaluation accounts (on the liability side of the balance sheet) and thus do not form part of distributable profit. Moreover these unrealized gains could be reversed in the future, thereby weaken the financial situation of the central bank.
Companies Acts adopted across various developed countries clearly state while computing profits for declaration and payment of dividend, any amount representing unrealised gains, notional gains or revaluation of assets and any changes in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair values should be excluded. In Mauritius one of the amendments brought to the Companies Act, through the Business Facilitation (Miscellaneous Provisions) Act 2019 -Act No 14 of 2019, relates precisely to distribution of dividend – “The Board shall not declare a dividend unless it is satisfied that, on payment of that dividend, the company shall continue to satisfy the solvency test”
In its “Revised guidance on realized & distributable profits – 2017” both the Institute of Chartered Accountants in England and Wales (ICAEW) and Institute of Chartered Accountants of Scotland (ICAS) emphasize on the importance of identifying distributable profits. Though the body recognizes the absence under law to distinguish in its accounts between distributable and non-distributable profits as such sufficient records should be made available as to distinguish between those profits which are available for distribution and those which are not. Both ICAEW and ICAS consider the above as a critical point because a dividend which has been paid unlawfully could become personally repayable by the directors. This should serve as a reminder to accountants who might be tempted into spin doctoring.
There are handful of precedence around the world, whereby to avoid undercapitalized commercial banks being stripped of capital, central banks have issued resolutions recommending the stopping of dividend payouts from unrealized gains by banks that do not meet prudential regulations. The current situation prompts a pertinent question. How can the central bank not comply with regulations it imposes on commercial banks?
Auditing – When the ham gets sandwiched
What could be a better testimony than one from an inside man. Though an unlikely source, yet this might be probably his greatest contribution of his long career at the central bank. Addressing members of the Mauritius Institute of Professional Accountants (MIPA) at a forum held on 11th August 2016, former governor of BOM Mr Yandraduth Googoolye intervened on the theme – “Growing Prominence of the role of auditors: A Central Banker’s perspective “. The following is an enlightening extract from his speech .
“One of the tenets of the Core Principles for Effective Banking Supervision, developed by the Basel Committee on Banking Supervision in 2006 and revised in 2012, is that banks should have in place internal control frameworks to establish and maintain a properly controlled operating environment for the conduct of their business taking into account their risk profile, which should include, inter alia, appropriate independent internal audit and compliance functions to test adherence to these controls as well as applicable laws and regulations. In addition, the bank’s Board and management have the responsibility for ensuring that the financial statements issued annually to the public bear an independent external auditor’s opinion as a result of an audit conducted in accordance with internationally accepted auditing practices and standards.
Therefore, both external and internal auditors have a key role to play in strengthening corporate governance as they are the third line of defence within the combined assurance frameworks after the risk management control and compliance functions.
The internal audit function is one of the fundamental “checks and balances” for sound corporate governance, designed to provide an independent assurance to the board of directors and senior management on the quality and effectiveness of a bank’s internal control, risk management and governance systems and processes, to help the board and senior management protect their organisation and its reputation. While external auditors, on the other hand, are responsible for providing reasonable assurance that the financial statements are free from material misstatements and prepared according to international financial reporting standards.
The importance of Auditors in this time and age cannot be over emphasised. Being myself a fellow of the Chartered Association of Certified Accountants, UK and a Fellow of the Association of International Accountants, I am very much alive of the expectations which regulators, stakeholders and members of the public generally have from auditors. They expect auditors – internal and external auditors alike – to be the watchdog of their respective institutions. “
Let’s now browse through Annual Report of the BOM ( Year ended June 2019) and pay attention to some quite interesting observations and notes by of Deloitte.
“We have audited the financial statements of Bank of Mauritius (the “Bank”) set out on pages 135 to 185, which comprise the statement of financial position as at 30 June 2019, and the statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, the accompanying financial statements give a true and fair view of the financial position of the Bank as at 30 June 2019, and of its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs) and comply with the provisions of the Bank of Mauritius Act 2004.”
With the BOM distributing MUR 98 billion from unrealized gains to the benefit of the government, the auditor of BOM is stuck in an unprecedented dilemma. In accordance with IFRS they are bound to “Qualify” their report. ( An auditor’s report is qualified when there disagreement with management regarding application, acceptability or adequacy of accounting policies). Furthermore they are bound to adhere to various regulations of the FRC act, namely : reporting of material irregularity and obligation to give a true and fair view. Any departure from these principles would be considered as a major failure resulting in revocation of license, setback for the franchise / brand and even be liable to criminal prosecution. As for the BOM, it would surely enter the dark hallmark as the first central bank unable to obtain a clean audit report.
Fiduciary – Beneath the gloss
Over the recent years, the fiduciary duties of Directors of the Central Bank have been repeatedly highlighted. Directors must form their independent judgment as to whether acceding to the request of government is in the best interests of the institution. Any Director having knowledge of any wrongdoing, yet takes no steps to prevent it, can only be treated as a party to the breach. Directors are bound to supervise acts and omissions. Given some of the directors hold other functions within their private companies, it would be wise to question their consistency and find out if similar rationales would apply when handling their private interest. Some could even argue the condonement might have resulted in private yields.
The shady moves of creating Special Purpose vehicle or distributing unrealized gains can as per any sound mind be interpreted as a violation of the BOM act, given the role of directors is to “ensure the security, liquidity and return of the foreign reserves”. Though the BOM Act does cater for the protection from liability of Directors, the blatant offences and consequences thereof giving rise to popular unrest, should reasonably trigger reaction from the directors. In any case they will be remembered for decades to come.