FINANCIAL SECTOR REFORM: AUDITING ISSUES

UNCLAS CAIRO 001932 SIPDIS SENSITIVE SIPDIS STATE FOR NEA/ELA, NEA/RA AND EB/IFD USAID FOR ANE/MEA MCCLOUD AND DUNN TREASURY FOR NUGENT AND HIRSON COMMERCE FOR 4520/ITA/ANESA/OBERG E.O. 12958: N/A TAGS: ECON EAID EFIN EG SUBJECT: FINANCIAL SECTOR REFORM: AUDITING ISSUES -------------- Summary -------------- ¶1. (SBU) The GOE's progress on meeting the remaining benchmarks in the Financial Sector MOU, signed in 2005, has been slow. Four hundred and twenty-five million dollars is tied to completion of benchmarks to improve the transparency and soundness of the banking system. To determine if these benchmarks have been met, the MOU requires accurate financial information on the state-owned banks. The required external audit process is dragging on, however, and USAID estimates that there will not be another disbursement under the MOU this year. The CBE has not issued the Terms of Reference for the external audits yet, and is vacillating on whether or not to include a requirement for a letter of certification from the international auditing firms. The Embassy would like to review with Washington agencies the USG position regarding what the reports from the international auditing firms should contain, and proposes a DVC or conference call in the near future. End summary. -------------- Background -------------- ¶2. (U) The Financial Sector MOU signed between the GOE and the U.S. in March 2005 includes important banking sector transparency and soundness benchmarks. In an effort to achieve greater transparency, the GOE agreed to allow internationally-recognized, impartial auditing firms to conduct an initial baseline audit and subsequent annual audits of the state-owned banks, using internationally recognized accounting standards. To support the GOE's efforts to achieve greater banking sector soundness, disbursements under the MOU would be made based on comparisons between the baseline audit and the subsequent annual audits. The comparison must demonstrate that: (i) the private sector share of new loans in the banking system is increasing, (ii) the share of non-performing loans (NPLs) as a proportion of all loans in the banking system is reduced by 50%, and (iii) cash recoveries of non-performing loans equal at least 20% of the book value of NPLs. Disbursements would be made on a pro-rata basis for progress toward achieving these goals. ¶3. (SBU) After the baseline audits by the international firms began in 2005, it became clear to the CBE leadership that these audits would produce results which differed from the results of the legally-required annual audit conducted by the GOE's Central Accounting Agency (CAA),considered by many to be a political instrument, rather than an impartial auditing body. The CBE balked at allowing the reports from the international firms to be called "audits," as the CBE leadership did not want two separate audits with different results. The USG ultimately agreed that the international firms would conduct "Full Financial Due Diligence" (FFDD) in place of a baseline audit, and hence no opinion letter would be submitted. Instead, the firms signed a cover letter confirming that the FFDD was done according to international standards. In the case of Banque Misr, KPMG, one of the international firms, confirmed to emboffs that if they had been allowed to render an opinion it would have been a qualified opinion and would have found a loss of LE 16, as opposed to CAA's LE 300 million profit and clean audit opinion. -------------- Subsequent FFDD Falls Behind Schedule -------------- ¶4. (U) The FFDD on the three state-owned banks which serves as the baseline was completed in November 2006 for the fiscal years ending June 30, 2004 and 2005. The baseline FFDD is intended to be as rigorous as an audit and produce the necessary information to make the annual comparisons required by the MOU. In late 2006, the CBE told USAID that the international firms would be able to conduct the next round of FFDD on the state-owned banks at the same time as the CAA conducted its audit of the banks, in early 2007. Post anticipated that the FFDD for the fiscal year ending June 30, 2006 could be done by July 2007, so a pro rata disbursement (assuming progress had been made) could be made several months later, after the necessary comparisons had been done. However, CBE has not contacted the international firms to conduct the FFDD, although the CAA has nearly completed its work. ¶5. (U) Moreover, the CBE not contacted the international firms to conduct the FFDD, but the CBE has also not yet shared with USAID the Terms of Reference (TOR) for the FFDD. We understand that the Ministry of Finance has urged the CBE to provide USAID a copy of the TOR so the FFDD can proceed. Until the FFDD is completed and the comparisons against the baseline made, $425 million (almost half of the total MOU amount) in disbursements hangs in the balance. -------------- Certification Letter -------------- ¶6. (U) The CBE has vacillated on whether or not to include in the TOR a requirement for a letter certifying the results of the FFDD. As noted above, the baseline FFDD of the three state-owned banks was accompanied by a cover letter from the international firms stating that the FFDD was done according to international standards, but it was not a certification or opinion letter, given CBE objections. The letter was a simple one-sentence summary that contained no information about methodology. -------------- Action Request -------------- ¶7. (SBU) The TOR process for the upcoming round of FFDD is a good opportunity for the USG to define exactly what the cover letter from the auditing firms should say. The USG has, in the past, considered funding the FFDD; doing so could provide some leverage to insist on a satisfactory certification letter. USAID, however, is currently not advocating paying for the FFDD. The international firms seem prepared to provide a certification letter and some officials at the CBE seem willing to include a requirement for such a letter in the TOR, as long as they do not have to agree to two separate sets of financial statements. Post would like to review the requirement for a certification letter with Washington agencies and we propose a conference call or DVC in the near future. JONES