After that, audit reports: ICAEW has created the Auditor Reporting Lab, alongside audit firms, to encourage modernisation in the market. KPMG Partner in Professional Practice, Accounting & Reporting, Pamela Taylor, has been thinking hard about how to make them more useful and more user-friendly.
This podcast counts towards your annual CPD – click the link below to log your time.
Host
Philippa Lamb
Guests
- Polly Tsang, Senior Financial Services Regulatory Manager
- Pamela Taylor, Partner in Professional Practice, Accounting & Reporting, KPMG
Producer
Natalie Chisholm
Series Lead
Mark Rowland
Transcript
Philippa Lamb: Welcome back. Two stories for you today. First, Polly Tsang, ICAEW Senior Financial Services Regulatory Manager, is here to talk about the government's plans for tokenisation. What exactly is it? What might it look like in practice, and what are the big questions about it that still need answering? After that, audit reports. Vitally important, of course, but not uncommonly a very dense read and hard to navigate. KPMG Partner in Professional Practice Accounting and Reporting, Pamela Taylor, has been thinking hard about how to make them more useful and more user-friendly. A quick reminder for all the accountants listening, this podcast counts towards your annual CPD. Log your listen on the ICAEW site. Just click through from the link you'll find in the show notes for this episode— it is very quick to do. So first up, tokenisation. The government wants the UK to become a world pioneer in tokenisation, and it's setting out plans to encourage more digital transactions. That aspiration comes with a lot of questions for business and finance, and especially for accountants. Polly Tsang is here with me. Hi, Polly.
Polly Tsang: Hi, Philippa.
PL: Welcome back.
PT: Thank you very much. Great to be back.
PL: Now, for newcomers, remind us, what is tokenisation?
PT: Tokenisation is the digital representation of a real-world asset. Let me give you an example. So The Shard, okay? Few buyers, few sellers, not unless you're the Qatari royal family, you're not really gonna be buying it. The idea of tokenisation is you can put The Shard on a distributed ledger technology, often a blockchain, and then you can splice it into, say, 1,000 pieces, in which case you can own a little bit of The Shard. So what does it do? It increases liquidity, because suddenly you have a lot more buyers and sellers, and potentially more collateral for additional funding. The second thing is, technically, that should be a lot cheaper, because currently you can do that through securitisation. However, that's a really complicated and expensive process, usually reserved for institutional investors. So there is a financial inclusion element to it.
PL: So faster, frictionless, yet cheaper potentially. And the downsides?
PT: Well, there are downsides, but I think before I go into the downsides, I have to explain it's not just the asset rails, it's also the money rails. It's because when you have both the money and the asset on DLT, then you get-
PL: DLT?
PT: Distributed ledger technology.
PL: Thank you.
PT: Most people refer to it as blockchains, but it's not just limited to blockchain. But that is a way. But when you have both, you have atomic settlement, instantaneous settlement, and that's where the magic really happens because suddenly if you add on a layer of smart contracts, you've got programmability. I'll give you an example. If you've ever bought a house or is in the process of buying a house, it is a pain. You have to deal with mortgage brokers, lawyers, things are held in escrow. There's 1,000 intermediaries. Lloyds are currently working on tokenising mortgages. What does that mean for you? Potentially, you could have your bank deposit tokenised. You've got your house tokenised. And when the interest rate reaches the rate that you want, it just happens instantaneously. You cut out all the middlemen. That's the idea behind it.
PL: Okay, so that's the sales pitch.
PT: That's the sales pitch, indeed. What are some of the drawbacks behind it? It's expensive. Now, the easiest things to tokenise are probably the ones that are frictionless at the moment already, so equities, say, for example. But where you really are probably gonna get value is your private market, so say, for example tokenising the land registry for housing, but that's expensive, and that's something financial institutions are looking at at the moment. But it's more where can we get the most value? The second thing about it is potentially it'll operate 24/7, right? And the instantaneous aspect means you will have to now do all your compliance upfront because in the past you've got a settlement period of, say, a few days where you could do, like, all your compliance. Now you have to front load it. And then the other thing is interoperability or the lack thereof because currently there's no set protocol where they all talk to each other.
PL: So essentially blockchains don't talk to each other?
PT: Indeed.
PL: And presumably there, there's gotta be questions around international oversight regulation— this is cross-border technology?
PT: Yeah. That will come later as well, but I mean, the benefits are there, particularly for cross-border movement of money and assets. That is a real benefit.
PL: And of course thinking about accountants, how do you account for it?
PT: How do you account for it?
PL: That's a whole other conversation. But it'd be fair to say that's an issue that isn't resolved?
PT: Yet. It is, because if you think about it, let's take the example of The Shard again. You own 0.001% of The Shard. What happens when you try to sell it? What happens when it gets destroyed, right?
PL: If it burns down.
PT: Yeah, if it burns down. What happens to your 0.001%? So there's a lot of legal questions that need to be answered before we can visit the accounting aspects of it.
PL: When the government talks about wanting to tokenise the economy, what are the specific wins that they're looking for there beyond that, beyond the things you talked about, as a nation?
PT: So I think the reason the UK wants to lead on tokenisation is threefold. One is competitiveness, the other is efficiency, and then the third is just unlocking liquidity. So let's take competitiveness first, right? UK financial services is our biggest export. It's 8% of our GDP. We employ over a million people. However, real growth since the financial crisis hasn't really been there. It hasn't really increased in terms of size, whereas other financial centers like Singapore, Dubai, America— they've really gone ahead, and particularly in digital assets. So what the UK government is seeing is, this is kind of like the digital big bang. It's got nothing to do with crypto, right? It's basically replumbing the financial systems. It's a bit like when we, the UK, was vying to be the center of stock markets back in the day. It's like that, but with digital infrastructure and programmability. So that's the idea behind tokenisation, right? The second thing is efficiency, which I have mentioned already. You get rid of reconciliation delays because let's face it, even though so much money moves in our systems, there's still a lot of friction. So getting rid of that, like multiple intermediaries and manual processes, that's all the benefit. And finally, liquidity, and that's the bit that most institutions are most interested in. It's just unlocking dormant capital and making it work for you, sweating those assets. That's the potential for tokenisation.
PL: You can see the appeal. I mean, what has been announced so far?
PT: So it's been quite exciting because just yesterday the Bank of England and the FCA have put their call for input on the future of tokenisation for wholesale digital markets. Okay. Which is quite exciting because it's definitely happening. So what has the government done? So they announced their wholesale financial markets digital strategy last year. They've appointed a wholesale digital assets champion, Chris Woolard, who's a partner at EY, to be the key liaison between industry and government in terms of working together to bring tokenisation to the fore. Digits, which is the digital guilt instrument, is basically the tokenised sovereign bond. That's gonna be quite interesting. That really shows that the government is serious about these things. And the other thing that they've mentioned is, which I think is quite good, is they want to regulate as in Bank of England and FCA, they want to regulate tokenised assets the same way as non-tokenised assets if it's on par in terms of risk, and I think that's quite a good way of approaching it.
PL: On the other side of this, what's the level of interest in financial services right now?
PT: Financial institutions definitely are for tokenisation. It's not a question of should we tokenise or should we not?
PL: They know they have to.
PT: They know they have to. However, it's: where is it most valuable to do so? Again, going back to unlocking collateral, right? Because if you think about it, if you combine it with agentic AI, suddenly, if you have programmable assets and agentic AI, potentially you can have AI do your collateral management in a bank, right? Live 24/7, which would be incredibly useful. I have to counter that with- sometimes there is a sense that it's a technology looking for a problem to solve, and I'll give you an example why. So Apple shares, right? They trade daily on the NASDAQ. There are also tokenised Apple shares.
PL: Okay.
PT: Yes, which is interesting. But if you look at the figures, on NASDAQ, I think Apple trades daily £10 billion roughly.
PL: Okay.
PT: The tokenised version, £10 million.
PL: Okay.
PT: And you can kind of see why because it's already so frictionless, equities, right? So like- why would you need to? Why would you?
PL: But is that a branding exercise by Apple? I mean, they're a tech stock, so obviously they wanna trade in the latest way possible, and this is it, right?
PT: That is a very good point, and a lot of the tokenisation you see currently in the news stories where banks say they've tokenised gold or whatnot- is in a way, from my personal opinion, a marketing ploy. It's not true tokenisation. That's not to say it's not useful, but it's just finding that use case. And I have to say, private markets are ripe for the picking because that's where you can unlock a lot of the liquidity. However, it's also the most difficult to do.
PL: Am I right in thinking there's a banking trial underway?
PT: There is. So UK Finance and six banks are currently trialing tokenised bank deposits. We're talking about your bank deposit, but just tokenising it, putting it on DLT, backstroke blockchain, right? And that's really useful because potentially you can program it, and it can just execute itself and make things a lot cheaper. So that's currently at play at the moment.
PL: So bringing this back to accountants, the key questions for them, I mean, we've talked a bit about how do you account for these assets, but what else is there? I think there's a working party, isn't there?
PT: Indeed. So the ICAEW Digital Asset Working Party has been looking at aspects of tokenisation since the back end of 2023. So currently we're looking at the money rails—so stable coins, exchange-based tokens, but no doubt we will be looking at the tokenised aspects of assets when the legal certainty comes more into play because the legal and the accounting, they go hand in hand. And some of the interesting questions we're gonna have to look at: is it an asset in itself, the token? Is it a wrapper around the asset, or is it entirely something new? And another thing that we will have to grapple with is the tax aspects. So for example, if you buy a house, but you buy a tokenised version of the house do you still have to pay stamp duty? Like these are some very interesting questions that we look forward to exploring.
PL: Really interesting questions. There is a lot. There is a lot going on here. What's the timeline?
PT: So the timeline, so I would say it's gonna be an evolution, right, of the financial services infrastructure. It's not a revolution, so it's going to take time. Like rechanging the plumbing of the financial service system is gonna take time. I think in the close one to three years, next year, the crypto asset regime under the FCA is gonna kick in on the 27th of October next year. But in addition to that, I expect to see a lot more pilot initiatives from banks of different versions of tokenisations. In the medium term, I'm hoping that we can get a lot more legal and accounting clarity on how to deal with some of these aspects. But I think the long-term vision is it just operates and people don't even know that it's tokenisation. It's a bit like when you pay with your phone nowadays, you don't care what it operates on, right? It just works. That is the long-term aspiration.
PL: Accountants, they need to be preparing for this, don't they, now?
PT: Absolutely. And you know what? We've got a wealth of resources. We have a digital assets hub at the ICAEW where you can get the latest on what the working party is looking at. But we also have a digital asset conference 14th of November this year where we're gonna bring in a lot of great speakers, and it'll be very practitioner focused. Basically, if you're working or dabbling in this space, what do you need to know?
PL: Thank you very much, Polly. That's great.
PT: Thank you, Philippa.
PL: Moving on to the audit report, Pamela Taylor is here. Hello, Pamela.
Pamela Taylor: Hello.
PL: Before we talk about how audit reports can be improved, should we just remind ourselves exactly what they're for?
PT: The first and most fundamental thing that an audit report does goes back to the absolute heart of what does an audit do, which is it gives an opinion on whether or not the financial statements are materially misstated, i.e., whether or not a user can rely on those to make decisions that they need to make. That's the fundamental first piece. Secondly, there are some other things that will come through in audit reports if there are particular issues. So my example there would be if there's a material uncertainty about whether or not an entity could continue as a going concern, that's gonna come through in the audit report. So those first two things apply across all audit reports. Then we've got a third category, which is for listed entities and public interest entities, which is long form audit reporting or extended auditor reporting. It gets called different things. And what that does is it brings out what are the key matters that the auditor thought about in the audit. What are the areas that took the most auditor attention, auditor judgment, and time, which really gives an additional insight into those audits and the things that were occupying the mind of the auditor at the time.
PL: So there's an art and a science. They are vital tools. They are packed with essential information, as we know, but presumably they're not always read cover to cover. How do people tend to consume them?
PT: I think in very different ways, talking to different users as to how they get used. So there are some users who will have a look and check if it's a, what you might call a clean audit report. Does it give a clean bill of health on the accounts? That's an important first step. Other investors will go further than that and actually look at some of the key audit matters and look at what the auditor's been interested in. And the advantage of doing that is almost as a way of signposting. What types of things in the financial statements was the auditor getting really interested in? Where might that user might want to go and have a look at the financial statements or think about it in a different way? So it's got real value to look at those extra pieces of reporting, particularly 'cause they can act as a signpost to understand what interested the auditor and what the auditor has done about it as well. But not everybody goes on to read those extra pieces, and I think there's a real perception among many people that audit reports are long and that they can be difficult to read and difficult to digest for various different reasons. And I think that's a valid challenge and one that we've been grappling with at KPMG and across the accounting profession.
PL: Yeah. I mean, people are busy. They are time-poor, they cherry pick the bits they think they need and as you say, potentially miss out on content that actually would be valuable to them. Firms are trying to make them more engaging. Talk to us about how that might be possible, how it might really be achieved.
PT: There are a few different ways I think of trying to make audit reports more accessible and more relevant to users. So first of all, I might pick up on relevance. So of the information that we're giving in these extended auditor reports, what more relevant information for users can be given? So at KPMG, for a number of years, we've been championing the idea of graduated findings on audit reports, giving a bit more of a qualitative view on some of the judgments that management are making in the key audit matters. That's something that we've tried in the market, and there's been a lot of discussion about, and is one of the topics that the FRC have been picking up on with some recent proposals they had on audit reports. So the question there, I think, is, of all the discussions that are being held with audit committees and views that are being given, how much is it appropriate, right or relevant to be given in audit reports to give that additional insights to users who are the ultimate people we are communicating with as auditors? The second area that we've been engaging with to try to make audit reports more interesting is thinking about what transparent information can we give that might not be there already. So we've been thinking about and reporting in some cases on how controls were or weren't relevant to our audit because it's not necessarily an area that users understand, so maybe a little bit more transparency. But even without those additional reporting, there's a piece about just accessibility of the document itself. Audit reports are complicated, and they have a lot in them, and some of that's unavoidable without regulatory change. But it doesn't mean they have to be really hard to read. There are things that can be done, and what we've looked at is reorganising audit reports to bring in some executive summaries upfront, looking at the use of graphics, bringing in boxes and headings to, to pull out key pieces of information. And thinking about what additional information we can give maybe about talking to the conversations with the audit committee and the layout and how that looks in different boxes. So, lots of structural things that can be done, and we are doing. Now, it's an evolution. We'll continue to think about this. I've been thinking about this for years. Okay. And I will continue to think about these things for years. But just how do you make something more readable when it's necessarily quite long and complicated?
PL: Yeah, and as you say, there's the physicality of the report, and auditors have limited control over that because they don't actually produce the report at the end of the day. So presumably there's conversations to be had with clients there about how they want things to be.
PT: There's an ecosystem involved in this question, to be honest. So picking up on the physicality of the report, interconnectivity hyperlinks from the audit report to other sections of the annual report can work really well to just make it more accessible. That depends on the entity that is hosting that report.
PL: Yes, if they want to do that.
PT: If they want to do that and do they want to do that? That can go as well for graphics and colors, and how does that come through in a report when it's sitting in someone else's annual report. So that's part of the conversation, and I know that auditors have done some more adventurous things with colors and graphics where they can, but there can be limitations on the ability to do that.
PL: Yeah. Presumably clients have their own branding teams. They have their own ideas about how they wanna do it.
PT: Yeah, absolutely. So there's a conversation there. The other part of the ecosystem to bring into it is, of course, the regulator. Where that comes in particular is there is a lot of material that just has to be in an audit report. It's a communication tool, a vital communication between the auditor and the ultimate client, which is the user. But a lot of it also has to be compliant. What the regulator's been consulting on recently that I think will be welcome generally is actually removing some of the content from an auditor's report, and I think it could make them quite considerably shorter, which is one of the criticisms levied against audit reports.
PL: What sort of things might go?
PT: So there are chunks of the report that explain auditors' responsibilities in relation to certain reporting, additional reporting. So explaining that there's a responsibility for the auditor to report if this aspect doesn't agree to that aspect. What the proposal is is that there won't be any reporting there unless there's something to say. So instead of reporting, " This was everything we should have reported to you, we have nothing to report", we just don't report if we've got nothing to report, and say something if there's something to say. That's gonna make it a lot easier to identify, "Here's something I need to go and have a look at," rather than it being buried in some text. So quite, in a way, a small change, but it could have quite a considerable impact.
PL: Yes, because if it's there, it's obviously of interest.
PT: Yeah, absolutely.
PL: You mentioned bringing other elements that would be potentially useful to end users. Qualitative views on accounting or judgments. That's gonna be delicate ground with clients as well, isn't it?
PT: There are always interesting conversations with the directors of the companies that we audit because we're reporting to audit committees anyway on these things. They can be delicate conversations, different views, but the auditor's there as the directors are there to exercise some views and some judgment and to be part of that conversation. I think the key question, and one that was also covered in the FRC's consultation, so we will see where that goes, is to what extent do those qualitative views get reported publicly as well as to the audit committee. Obviously, in a context where the audit report is clean, as it were. So the outcome is generally happy. This is the additional insight that potentially goes along with that. To what extent can that be given?
PL: What's the timeframe on the FRC's work on this? Where are they at with it?
PT: The consultation closed in January, so any new standards that come off the back of it, I'd expect in the next couple of months. The expectation in the proposal was that it would be effective for essentially December 2027 year end, so periods beginning on or after the middle of December this year is how they phrase it. So potentially quite soon, some of these changes.
PL: But even without that, as you say you've laid out the advantages of doing this very clearly. You can see why obviously it's a smart thing to do. There is an ICAEW Audit Reporting Lab, isn't there? If people are interested in this, they don't have to do the work from the ground up?
PT: Absolutely. The Audit Reporting Lab, they've just launched their hub, which is really worth a visit. The lab brings together representatives from the firms, people who've been doing a lot of thinking on these topics, as well as stakeholders, including crucially users, investors, to think about how can audit reports be improved and what can firms do? So as part of that, for example, there are some good practice examples of some of the things that I talked about in terms of graphics, headings, boxes. There are some discussions of linguistics, language, and plain English. Plain English can go a really long way in audit reporting, so there's some discussion on that. There's also a bit of an explainer to what is an audit report and what are the different bits that make it up. So anyone who's interested in how to report as an auditor or interested in what audit reports are, I think it's a really good resource. And my encouragement to anyone who is thinking about how to improve their audit reports would be really to think about having got a compliant document, how are you addressing the user? What's the user's perspective? How well can they pick up on what you're trying to get across?
PL: The Audit Reporting Lab sounds like, or the hub, sounds like absolutely the first place to go.
PT: It's a really good starting point.
PL: We'll put a link in the show notes to that. Thank you very much, Pamela.
PT: No problem.
PL: That is it for this episode. Check out the links around both the subjects we've covered today when you go to the show notes to log your listen as CPD. The next episode of Behind the Numbers, we'll be looking at CEO pay. How much is too much? When does it turn into a governance issue? And how can it be kept in check? If you have feedback or ideas for the podcast team, please share them with us. Here's the email address: podcasts@icaew.com. Meanwhile, if you can find a moment to rate the series on your app, we would be very grateful as every rating helps us reach new listeners. Thanks for being with us.