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Strategy and innovation

What does the audit committee expect from chief financial officers?

His/her interactions with the Committee are key but, according to the experts, a more proactive leadership is required from this body of the Board.
¿Qué espera el Comité de Auditoría de los directores financieros?
Category
Strategy and innovation
Content type
News
Written by
Editorial Dept
Reading time
18 minutes
Published
16 Feb 2022
The Financial Director and the Audit Committee are called upon to forge an alliance based on transparency, loyalty and trust. The CFO is the senior manager with the most internal information about the company and a 360º vision. His/her interactions with the Committee are key but, according to the experts, a more proactive leadership is required from this body of the Board. As was said in a recent workshop on this subject, this is about going from being financial managers to authentic Directors of Value.

The Audit Committee as guarantor of financial transparency

The first Audit Committees date back to 1939 as an expression of the need for companies listed on the New York Stock Exchange to overcome the mistakes of the crisis unleashed a decade earlier. More than 80 years have passed and their responsibility is increasing as crises occur, as has happened now with the pandemic, when this body has been more demanded given the seriousness of the risks and the delicate financial situation of many companies.

According to the Deloitte Audit Committee Guide, if we were to summarise their Committee functions in 4 strokes, these would be their main responsibilities. Their relationship with the CFO always comes into play:

  • Risk monitoring

    So important in these two years of Covid. Those related to cybersecurity, climate change and reputation are increasingly relevant. For this reason, there are companies where it is called the Audit and Risk Supervision Committee, which have the added functions of integrating ESG criteria.

  • The safeguarding of internal controls

    When drawing conclusions from the external audit, internal control problems that may exist in the company are detected, so the Committee will make recommendations to the Board on improvements and changes. And it also intervenes in the selection of internal auditors. It must be very attentive to the Ethics Mailbox. According to Deloitte, 86% of Audit Committees receive annual reports on inappropriate practices in the company.

  • Monitoring of financial information

    It ensures the integrity of the results and presents the management report and the annual, quarterly and semi-annual accounts to the Board. As well as the reports issued by the company for investors and analysts and those that are transferred to the regulatory bodies.

  • Interaction with external auditors

    And choose the auditor, hire them and supervise the entire process, guaranteeing the full independence of the external auditor.

What does the audit committee expect from chief financial officers?

A more independent and professionalised Audit Committee

There is a global trend to strengthen this important body, which has increasingly more monitoring and control responsibilities, by choosing directors with extensive training in finance, but also in risk, cybersecurity and non-financial information in general. It is about converting the Audit Committee into the cornerstone of transparency, prospective and good governance of organisations.

Boards of Directors are normally formed by people with a broad vision of the business and the interests of the shareholders, with specific financial training not being essential for this. This deficiency is made up for by the Audit Committee, which is given all the trust of the shareholder and is delegated financially crucial functions, but also internal and external control, some of which are critical for the relationship with investors and regulatory authorities, as well as for the company's reputation, as we have seen.

The workload of the Audit Committee, according to a trend observed both in America and in Europe, is increasing and has intensified in these two years of pandemic, when financial stability and risk have put the leadership of the Committee to the test and have required strong and rapid responses.

This decade, the evaluation of climate risk and cybersecurity have also been added to its traditional duties.. This multiplicity of fronts explains the concern for the financial and technical training of this Committee. In the United States, for example, 1 in 4 Audit Committee Chairs are retired CFOs. However, there is also the need for them to constantly update their knowledge. Ongoing training that will help facilitate the Committee's work with the CFO.

Deloitte, in the aforementioned Guide to Good Practices, recommends that the members of the Committee be up to date on trends and technological innovations. As a Committee chairman consulted by the consultancy pointed out, it is useful to organise these training sessions at least once or twice a year. Although it is the financial part that concerns us in this article, all sources agree on the imbalance between the growing importance of computer security and data protection and the lack of directors' specific and technical knowledge on these matters.

A more independent and professionalised Audit Committee

“I have had very good experiences with a diverse Audit Committee, where not everyone has a financial background, but life would be even better if each Committee had at least one IT and technology expert who could better assess cybersecurity risks and IT transformation projects and know the relevant questions to ask”, points out Carla Smits-Nusteling, Chair of the Nokia Audit Committee, in a recent EY report.

The Audit Committee as a source of support for the CFO

As a KPMG study on Audit Committees underlines, one of the roles of the Chair of this body is to support the CFO. We must not forget that the Audit Committee is in charge of hiring, selecting and replacing external auditors, internal auditors and also the head of the company's financial management.

Relationships between the CFO and the Audit Committee, as advised by the codes and regulations on the matter, should be based on mutual respect, trust and transparency. The CFO has a direct impact on the company's risk profile, value creation and return on investment for shareholders. The Audit Committee and the CFO share objectives and values. As such, both parties are interested in building an open and effective relationship, as Deloitte maintains.

Deloitte's Guide to Audit Committees provides a catalogue of Audit Committee interactions in relation to the CFO . These include:

  • Promoting open communication with the Finance Division through specific executive sessions.
  • Evaluating the performance of the main financial managers, in particular the CFO and the Chief Accounting Officer (CAO).
  • Looking after the quality of work of all the financial personnel and for the hiring of suitable profiles for the correct allocation of resources in this area.
  • Selecting CFO candidates in case of replacement and inviting them to discuss their project before the Audit Committee.
  • Understanding the internal processes of the Finance Area for the early identification and resolving of accounting problems.
  • Having an updated view of the new accounting and financial information rules and the related risks.
  • Visiting the company HQ and regularly meeting with the executives of the Finance area.

This relationship sustained over time should lead the Audit Committee to consider a series of questions to ensure the proper functioning of the area under the responsibility of the Financial Director:

  • Whether the CFO has adequate staff, both quantitatively and qualitatively, to fulfil their financial statement responsibilities.
  • The Committee's ability to seek and support substitutions in that area, including that of the CFO, as well as the contingencies that occur so that no relevant position is left without a possible permanent or temporary replacement.
  • The training plans for all staff in the area and, in particular, in the digitisation of financial processes.
  • The way in which the Audit Committee participates in the evaluation of the CFO.

CFO-Audit Committee meetings

The official calendar of an Audit Committee usually includes 6 formal meetings per year on average. But their tasks do not end there. Directors and their Chairman maintain a fluid relationship with all levels of the company. It's what Deloitte calls“executive sessions”, where the Committee meets privately with the CEO, the CFO, the external and internal auditors or the head of legal services.

CFO-Audit Committee meetings

It is in these sessions where sensitive issues are discussed. It is recommended to pose these types of confidential meetings not only to address those critical cases but as a regular practice. They can take place prior to a formal meeting to discuss the agenda and priorities, or after the Committee meeting to discuss what was approved or debated.

According to a report prepared by Deloitte in the United States, 61% of Audit Committees hold regular meetings with the CFO. Although it is a high percentage, it does not reach the level of the relationship between the Committee and the external and internal auditors, with whom 80% of the Committees questioned by the consultant meet regularly.

This is how Audit Committees see the CFO

As we have seen, the Audit Committee considers the sessions with the CFO as transcendental for its work. You don't just expect results to be presented to you on a screen. You want to discuss ideas, not see a whiteboard. As a KPMG report graphically puts it, they demand less PowerPoint and more quality discussion and brainstorming.

The key for the CFO is in preparing these meetings well. Not only the base, which is presupposed to every Financial Director, but the form. Consultants' reports advise against treating the Audit Committee as a counterweight or as less-trained people who need to be presented with numbers and graphs. Rather, they are inclined to treat it as a partner with whom they can discuss among equals about the current fixed picture of the company and, increasingly, about the future and direction of the business.

As Alan Haughie, CFO of several North American companies in recent years, explains: “I prepare religiously for most things. And I do it because I want to free my mind, so I prepare routine tasks such as giving a presentation in such a way that I know its content by heart. This means that I can look at the people. I can observe their body language, their physical reaction to things I say, without having to look at my notes... To see if my message is getting through”.

There is an old adage that life is 10% what happens to you and 90% how you react. And how do the Audit Committees react to the meetings with the CFO? A global survey conducted by KPMG among directors from around the world provides very interesting data on this CFO-Committee collaboration.

  • Committees are self-critical about how they evaluate the CFO's performance. 25% consider that they do it very effectively, but 58% only generally effectively and 17% not at all effectively.
  • When evaluating how they supervise the financial reports submitted by the Financial Department, the Audit Committees consider them very effective in 54% of cases, generally effective in 44% and not at all effective in only 2%.

That is to say, the evaluation is very high, but it is to a greater extent on the information sent than on the more qualitative part, which would support the Audit Committees's demand for greater debate and exchange in their meetings and relations with the CFO.

The CFO, the professional most highly valued by the Audit Committee

In the same KPMG survey, members of the Audit Committee had to rate the different professionals with whom they interacted from Excellent to Fair. These are the percentages of the Excellent rating:

  • Director of Investor Relations: 28%
  • Director of Technology: 29%
  • Director of Legal Affairs: 50%
  • External Auditors: 63%
  • Chief Financial Officer (CFO): 66%

A high overall assessment that, when broken down by country, yields significantly different results in the case of Spain. As such, according to the Audit Committees of Spanish companies, the information that reaches them from the CFO is“ Excellent” for 50%, compared to 66% globally, while for 36% it is“ Good, but problems arise periodically” and for 5% it needs to improve. For Spanish directors, the best valued professional would be the External Auditor.

ESG criteria in the Audit Committee

The Boards of Directors are called to lead the integration of environmental, social and good governance (ESG) criteria in their decisions and investments, in the daily management of the company, as investors already do in their company evaluations. It is about integrating financial and non-financial information. For example, reflecting the CO2 emission criteria in each investment and on a day-to-day basis and then reporting what has been achieved and what has not. Who has that responsibility?

As indicated in recommendation 42 of the Code of Good Governance of listed companies in Spain, it is the responsibility of the Audit Committee to supervise the process of preparing non-financial information, in addition to non-financial risk control and management systems. And recommendation 39 also mandates the Boards to designate Audit Committees by virtue of their non-financial knowledge.

This integration supposes a change of culture in the companies. As Karim Hajjas, CFO of Solvay points out, CFOs and Audit Committees are not comfortable seeing a report with a negative rating and it takes courage to undertake this integration.

ESG criteria in the Audit Committee
“There are gaps when you do things about sustainability: you are not perfect. You can say: 'I'll wait, refine everything and then publish', or you can say: "If we want to build trust, we can start now to reveal in our integrated reports that we're not particularly perfect at everything, but we're determined and committed to getting better."

At a workshop hosted in 2021 by EY, Accountancy Europe and ecoDa on“ Sustainable corporate governance: The future role of audit committees”, the participants agreed on several key points that affect the role of the Audit Committee and the CFO in this difficult and motivating task:

Risk monitoring

Audit Committees could oversee a single matrix that integrates medium- and long-term ESG risks with all other risks.

Communication and reporting

Non-financial information is more valuable if it is integrated with financial information. For investor-focused reporting and transparency of global capital markets, there is an urgent need for globally consistent standards. Until this is achieved, cooperation and alignment between the different initiatives is key.

The CFO could be repositioned as Chief Value Officer of the company

I would work with the Audit Committee to establish robust processes for moving non-financial as well as financial information and focus on the net value creation process.

Interest payment

Boards of directors should incorporate ESG-related KPIs into long-term incentive plans, setting targets that are ambitious yet realistic.