Will Contagion in the Private Finance Initiative Marketplace Claim a Massive Casualty?

Here in Financial Regulation Matters we have focused on the Private Finance Initiative (PFI) marketplace on a number of occasions, and we have looked at the conduct of the leading auditors on many occasions too; in today’s post, the focus will be on the relationship between the two, which will provide with an overview of recent turbulent events within the marketplace and the potential, albeit a very slight one, of the contagion within the industry causing either a massive organisation to fail, or more probably their regulator to collapse.

We looked at the concept of the PFI late last year and discussed how the injection of private interest into the public sphere is perhaps the most obvious of examples of how one can, purposefully or otherwise, examine the theory and neglect the reality. Whilst we looked at how the ideology was creeping (although that word perhaps downplays the actual situation) into publically vital sectors like the NHS – Virgin’s recent consolidation in this particular sector, despite recently suing the NHS for a loss of contract is a key case in point – the obvious place to start is with the collapsed PFI powerhouse Carillion. We examined the crisis as it unfolded here in Financial Regulation Matters by looking at the unfolding crisis, the systemic effect of its collapse, and also the impact upon pension holders and the Pension Protection Fund although, as we now know, this was apparently just the start i.e. contagion is spreading within the marketplace. This was confirmed earlier this week with the news that Capita, an incredibly interwoven PFI company, saw its share price collapse by almost 50% after a profit warning from its Chairman who declared that the company had become ‘too complex [and] driven by a short-term focus’. The contagion continued to spread today with the news that Interserve, another interconnected outsourcing company, saw its share price collapse wiping almost £1 billion from its value; a number of other connected firms witnessed significant drops too. So, firstly, what does this mean for the future of PFIs? Initially it is difficult to see past the fact that the Government is, because of its past actions (across parties), fundamentally bound to the success of the companies and whilst Carillion was allowed to collapse, it is likely that the collapse of Capita and/or Interserve may force the Government to reconsider their pledge that these companies are not ‘too big to fail’; Carillion has the potential to become this scenario’s Lehman Brothers. For example, whilst Carillion’s collapse has initiated the stalling of key projects across the country, Capita has a hugely significant role in the organisational capacity of Councils, the operation of the London Congestion system, and the hugely controversial delivery of DWP Disability Tests amongst many other roles; the question then is will this firm, with its interconnection, be allowed to collapse so soon after Carillion? It would be a brave Government, particularly within the current climate, to allow contagion to continue to spread at its current rate. However, there is, regulatory speaking, a much bigger casualty on the horizon.

There exists the potential for one of two major auditing actors to suffer terminal damage because of the PFI contagion, and those two actors are KPMG and the Financial Reporting Council (the industry’s regulator). It should be stated immediately that this author does not believe that KPMG will fall because of these events; it is simply far too large not to be able to withstand the incoming pressure heading its way, but that pressure is considerable. We looked in the middle of last year at KPMG and how they had been fined by U.S. authorities for ‘misinforming investors’ and more recently at the auditor’s connection (and subsequent disconnection) from the Grenfell Tower Inquiry; more recently still, three former KPMG partners were charged with Fraud by US authorities in what is a particularly damaging case for KPMG’s perceived integrity. Yet, in relation to the PFIs, KPMG has had its name plastered across the business headlines because of suggestions that it may have breached rules in connection to its auditing of Carillion, more specifically in relation to recognition of revenue on significant contracts (the raison d’être for a PFI) and also accounting for pensions. The obvious issue here is that a massive firm has just spectacularly collapsed with almost no warning from those who are tasked with providing this information to the marketplace; in March 2017 KPMG gave Carillion a clean bill of health for which it was paid £1.4 million (KPMG was Carillion’s auditor every year since its founding in 1999) – just ten months later the company would go on to collapse. Part of that collapse, or indeed the spark which ignited the collapse, was the declaration that the company assets were overvalued by almost £1 billion, which is something that places KPMG at the centre of the ongoing investigation (along with other auditors like Deloitte); the question then is what does this mean for the regulator who is supposed to be maintaining standards in this most crucial of financial sectors? It was suggested recently in The Telegraph that this particular investigation will ‘make or break the FRC’, and it appears that this particular insight is absolutely correct, for a number of reasons. If the investigation is conducted with enthusiasm – which initial actions suggest is not the case – and results in a particularly impactful resolution for what is, quite clearly, errors at best and transgressions at worst on KPMG’s part, then the FRC may go some way to building a solid foundation upon which it can regulate effectively against the massive regulated bodies under its supervision. However, a forthcoming article by this author in The European Business Law Review assess the FRC within the context of potential CRA regulation and finds, fundamentally, that it is not a particularly well-founded or meaningful regulator (in fact, it is essentially a representative for the regulated bodies, not their regulator). The reality is, then, that the regulator will be revealed to be unable to regulate the large auditors, and therefore unable to both correct the behaviour and enforce increased standards within the sector; so, will this encourage the regulatory framework to be realigned and a new regulatory body placed in charge of ensuring standards in this socially vital sector?

Ultimately, there is a real chance that the FRC will be widely castigated for its regulation of the auditors, but whether or not it is replaced is another question entirely. This is simply because the lobbying influence of these massive multi-billion pound oligopolistic organisations is not only considerable, it is unmistakeable; the question then is what regulator would take on such a role? Does the FCA have the capacity/ability/willingness to do so? Almost certainly not, and the PRA and the Bank of England will not be pushing forward in the queue to add the ‘Big Four’ to its list of regulated entities, so even if the FRC is replaced, it will only be replaced with a similarly lenient and receptive regulator, which means that corporate collapses are never far away; unfortunately, we are told that someone is manning the ‘crow’s nest’, but that is often not the case.

Keywords – Carillion, Capita, PFI, Government, Business, Politics, UK, Regulation, Financial Reporting Council, Accountants, Audit, @finregmatters