BOARD OF AUDITORS
Annual Report to the Board of Governors
for the period from 8 October 2012 (date of inauguration)
to 31 December 2012

European Stability Mechanism

1.

Annual Report of the Board of Auditors

Introduction

The Board of Auditors of the European Stability Mechanism (ESM) was set up pursuant to
Article 30 of the Treaty establishing the ESM (ESM Treaty) and Article 24 of the ESM ByLaws. The Board of Auditors is independent from the Board of Directors and its members
are appointed directly by the Board of Governors.
The Board of Auditors carries out independent audits, inspects the ESM accounts1 and
monitors and reviews the ESM’s internal and external audit processes and results2.
This report, which is addressed to the Board of Governors in accordance with Article 24(6)
of the ESM By-Laws, provides information on the audit work of the Board of Auditors, its
audit findings in relation to the ESM financial statements and its conclusions and
recommendations for the period from 8 October 2012 (the date of inauguration) to
31 December 2012. The report will also be made available to the national parliaments and
supreme audit institutions of the ESM Members, as well as the European Court of Auditors
and the European Parliament3.
The members of the Board of Auditors were appointed by the Board of Governors on
8 October 2012 as follows:






Mr Harald Noack, nominated by the European Court of Auditors
Mr Marc Gengler, nominated by the Supreme Audit Institution of the Grand Duchy
of Luxembourg
Mr Ulrich Graf, nominated by the Supreme Audit Institution of the Federal
Republic of Germany
Ms Katarína Kaszasová, upon the proposal of the Chairman of the Board of
Governors
Mr Jules Muis, upon the proposal of the Chairman of the Board of Governors

The Board of Auditors elected Mr Harald Noack as its Chairman and Ms Katarína
Kaszasová as its Vice-Chair. The members of the Board of Auditors were appointed for a
non-renewable term of three years, except for Ms Kaszasová and Mr Graf, who were
appointed, their names having been drawn by lot, for a non-renewable term of four years to
ensure continuity of the work of the Board.
The members of the Board of Auditors have undertaken, at the time of their appointment
and during the performance of their duties, to avoid all conflicts of interest and refrain from
any action incompatible with those duties. The members of the Board of Auditors act
independently and have not sought or taken instructions from the ESM governing bodies,
the ESM Members or any other public or private body4.

1
2
3
4

Article 30(3) of the ESM Treaty.
Article 24(4) of the ESM By-Laws.
Article 24(6) of the ESM By-Laws.
In accordance with Article 30(2) of the ESM Treaty and Article 24(9) of the ESM By-Laws.

Page 2 of 8

European Stability Mechanism

Annual Report of the Board of Auditors

2.

Activities of the Board of Auditors

2.1.

Meetings

The Board of Auditors held three meetings in the period from 8 October 2012 to
31 December 2012. As a rule, the members of the Board of Auditors attend monthly
meetings at the ESM premises; however, the meeting in December was held as a conference
call.
During its meetings, the Board of Auditors received regular updates on the activities of the
ESM and the ESM governing bodies, attended presentations by management on specific
topics requested by the Board of Auditors (e.g. economics and policy strategy, asset and
liability management) and met with the external auditors and with representatives of the
European Investment Bank who were responsible for the provision of outsourced
accounting services to the ESM.
2.2

Scope

The Board of Auditors has:


performed limited review procedures in accordance with Article 30(3) of the ESM
Treaty. Among other things, it has reviewed the accounting and reporting system,
procurement policies, service-level agreements and risk-management policies, and
made a top-down preliminary assessment of the financial assistance for Spanish
banks;



reviewed the ESM financial statements for the period from 8 October 2012 (date of
inauguration) to 31 December 2012, which were drawn up and adopted by the Board
of Directors on 21 March 2013;



noted that, in accordance with the aforementioned financial statements, the balance
sheet totals as at 31 December 2012 were EUR 740 billion, consisting mainly of
loans and advances to euro area Member states (EUR 39 billion), subscribed capital
called but not paid (EUR 47 billion) and subscribed (“authorised” according to
Article 8 of the ESM Treaty) capital not yet called and unpaid (EUR 620 billion).
Own funds amounted to a total of EUR 700 billion and liabilities were mainly
composed of debts evidenced by certificates (EUR 39 billion). There was a net loss
for the financial year of EUR 0,5 million, this mainly being the balance of interest
receivable and similar income (EUR 16 million), interest payable and similar
charges (EUR 4 million), net profit on financial operations (EUR 1 million) and
general administrative costs (EUR 14 million);



monitored and reviewed the external audit processes performed by
PricewaterhouseCoopers, Société coopérative, Luxembourg (PwC). On 8 October
2012 PwC was appointed by the Board of Governors to carry out a statutory audit of
the financial statements of the ESM as of and for the year ending 31 December 2012
in accordance with the International Standards on Auditing as adopted for
Luxembourg by the Commission de Surveillance du Secteur Financier (CSSF), the
provisions of Luxembourgish legislation, the professional standards adopted by the
CSSF and the professional standards issued by Luxembourg’s Institut des Réviseurs
d’Entreprises;
Page 3 of 8

European Stability Mechanism

Annual Report of the Board of Auditors



noted that PwC issued an unqualified auditor’s report on 21 March 2013 stating that
“the financial statements give a true and fair view of the financial position of
European Stability Mechanism as of 31 December 2012, and of the results of its
operations and its cash flows for the period from 8 October 2012 (date of
inauguration) to 31 December 2012 in accordance with the general principles of
the Directives”;



met regularly with the ESM Managing Director and other members of the
Management Board, including the Secretary General, the Head of Corporate
Governance and Internal Policies, the Head of Finance and Control and the
Operational Risk Officer, and with other members of ESM management, to discuss
relevant issues and developments;



requested and received a number of written representations from members of the
ESM Management Board concerning issues of oversight interest (the role of the
ESM and its global partners, an explanation of the issue and repurchase process,
application of the EU public procurement directive, the appointment of the external
auditor and a presentation of the ESM financial statements).

3.

Findings

3.1

Financial statements

In accordance with Article 23(2)(d) of the By-Laws, the Board of Auditors has issued a
separate report on the financial statements, in which it concludes:
“Having examined the start-up phase of the ESM, the Board of Auditors observes, as
detailed in its annual report prepared in accordance with Article 24(6), that the
institution is still evolving and faces considerable challenges and work in progress as
regards establishing suitable internal, operational and managerial controls; and notes, to
the best of its judgement, that no other material matters have come to its attention that
would prevent it from recommending that the Board of Governors approve the ESM
financial statements for the period from 8 October 2012 (date of inauguration) to
31 December 2012.”
3.2

External audit

Article 29 of the ESM Treaty provides as follows: “The accounts of the ESM shall be audited
by independent external auditors approved by the Board of Governors and responsible for
certifying the annual financial statements”.
The ESM financial statements for the period from 8 October 2012 (date of inauguration) to
31 December 2012 were audited by PwC, which was appointed as “réviseur d´entreprises
agréé” (certified auditor) by the ESM Board of Governors on 8 October 2012. The
engagement letter was signed by the ESM representatives on 4 February 2013. Under the
terms of the engagement, PwC was to carry out a statutory audit of the financial statements
of the ESM as of and for the year ending 31 December 2012 in accordance with the
International Standards on Auditing as adopted for Luxembourg by the CSSF, the
provisions of Luxembourgish legislation, the professional standards adopted by the CSSF
Page 4 of 8

European Stability Mechanism

Annual Report of the Board of Auditors

and the professional standards issued by Luxembourg’s Institut des Réviseurs
d’Entreprises. PwC issued an unqualified auditor’s report on 21 March 2013 stating that
“the financial statements give a true and fair view of the financial position of European
Stability Mechanism as of 31 December 2012, and of the results of its operations and its
cash flows for the period from 8 October 2012 (date of inauguration) to 31 December 2012
in accordance with the general principles of the Directives”.
Article 24(4) of the By-Laws provides that the Board of Auditors “shall monitor and review
the ESM’s internal and external audit processes and their results”.
The Board of Auditors would like to bring the following matters to the Board of Governors’
attention.


During the planning phase, PwC determined that the areas of lending and funding,
the recognition of other revenue/expenditure and the calculation of interest
income/expenditure were audit risks, and adjusted its audit approach accordingly.



PwC noted that internal controls were not yet fully operational as at 31 December
2012 and therefore applied an audit approach based on full substantive testing. A












fully fledged internal control and governance model taking into account the “three
lines of defence” approach should be built up.
PwC confirmed that, as at 31 December 2012, there were no material issues
regarding the balance sheet, inherent risks and management controls of those risks
or the effect of estimates on the accounts.
PwC also confirmed that no significant uncorrected misstatements had come to
light.
PwC concluded that, as at 31 December 2012, no impairment of loans was required.
PwC informed us that it had good working relations with ESM management, with no
areas of disagreement.
PwC also concluded that the accounting system and organisational arrangements
were not yet appropriate having regard to the nature and scale of the ESM’s
business, and therefore the ESM management should continue to strive for full
implementation in these areas in order to ensure independent accounting proofing
and reconciliation as well as a stronger financial control function for monitoring the
statutory and management accounts.
PwC was appointed by the Board of Governors without a proper tendering
procedure. Although this decision seems to have been dictated by urgency and
practicality in view of PwC’s engagement as the auditors for the European Financial
Stability Facility (EFSF), the Board of Auditors recommends that the audit of the
financial statements as at 31 December 2013 and in all future years be put out to
tender in accordance with EU legislation.
Under the terms of the current engagement with PwC, the Board of Auditors has no
access to the external auditor’s documentation or to the organisations providing
outsourced services. The Board of Auditors recommends that access be guaranteed
to their documentation for the audit of the financial statements as at 31 December
2013 and in all future years.

Page 5 of 8

European Stability Mechanism

3.3

Annual Report of the Board of Auditors

Internal audit

Article 28 of the ESM Treaty provides as follows: “An internal audit function shall be
established according to international standards”.
The ESM decided to create a one-man internal audit department using an internal auditor
from the EFSF with several years’ experience.
Article 24(4) of the By-Laws provides that the Board of Auditors “shall monitor and review
the ESM’s internal and external audit processes and their results”.
The Board of Auditors met the designated internal auditor several times during the period
under review to discuss the Internal Audit Charter and the internal audit work plan for
2013.
During the period October to December 2012 the organisation was in a process of start-up
and no internal audit report was available.
3.4

Treasury audit

The Board of Auditors has requested a treasury audit, which will be carried out in 2013.
3.5

Board of Auditors’ limited review

The Board of Auditors has made a start on a first inventory of the ESM’s risk management
architecture, its operating system, risk management ownership, delegation risk and end
responsibility. It will pursue this topic in the year to come together with the ESM
management.
The Board of Auditors carried out a limited review during April 2013 in accordance with
Article 30(3) of the ESM Treaty. In line with Article 24(5) of the ESM By-Laws, the Board of
Auditors appointed subject matter experts to support the audit work (audit team). The
findings, which have been discussed with ESM management, are as follows:


The external auditors’ terms of reference are predicated on the standard external
audit rules for short-form reporting. Consideration should be given to expanding the
audit frame of reference, account being taken of the nature of the ESM as an
important public-interest entity, so as to include a long-form reporting mandate
inclusive of a comprehensive risk management assessment. The ESM management
has replied that it does not support this recommendation and feels that this issue
should be discussed with the Board of Governors.



It is essential that, for accounting and reporting (managerial as well as financial)
purposes, the ESM complete an internal accounting manual. The ESM management
has replied that this is one of the priorities for the ESM’s finance and control
function and that an accounting manual is expected to be available by the end of the
third quarter of 2013.

Page 6 of 8

European Stability Mechanism


3.6

Annual Report of the Board of Auditors

The supporting evidence and procedures for the approval of external services
through the EFSF were inadequate; the procedures need to be strengthened and
documented. Invoices should indicate the services provided and give a detailed
breakdown of the time spent on the project. The internal control of invoices should
be strengthened. The ESM management has replied that there is room for enhanced
controls over external providers.

Subsequent events

The Board of Auditors has exchanged views with the ESM management on issues and
developments during the period from 1 January 2013 to 30 May 2013. The Board of
Auditors has also discussed subsequent events with the ESM external auditor.
Based on the knowledge obtained from exchanges of views with the ESM management and
external auditors, and on information in the public domain, the Board of Auditors is not
aware of any significant subsequent events that should have been recognised in the ESM
financial statements for the period from 8 October 2012 to 31 December 2012.

4.

The way forward

During the period under review, since the Board of Auditors was itself in a process of startup, it concentrated primarily on financial reporting and auditing issues and on building its
own infrastructure, rules and procedures. It now plans to shift its focus to address also the
broader issues of governance, risk management, the substance and implementation of
financial policies, efficiency and effectiveness.

5.

In closing

The ESM, for the period under review, was in a start-up phase. The Board of Auditors
understands the strong commitment towards a “lean organisation” governance model.
Nevertheless, the Board of Auditors encourages the Board of Governors to consider the
potential risks associated with internal controls which are only partially operational.
The ESM was constituted as an international organisation, which gives it, in principle, a
free hand in deciding its own legal and regulatory frame of reference. The Board of Auditors
is of the opinion that it would serve the interest of the governing bodies of the institution,
and provide clarity to all other stakeholders, if the ESM were to adopt a cohesive regulatory
framework for its key operating functions. In view of the genesis of the ESM, its mandate,
its position at the heart of the EU and the need for a generally-accepted, internally-cohesive
regulatory framework, the Board of Auditors strongly recommends that the ESM adopt the
EU regulatory framework as its own.
As its accounting framework, the ESM has decided to apply the general principles of the
Fourth Council Directive 78/660/EEC of 25 July 1978, as amended, on the annual accounts
Page 7 of 8

European Stability Mechanism

Annual Report of the Board of Auditors

of certain types of companies, and Council Directive 86/635/EEC of 8 December 1986, as
amended, on the annual accounts and consolidated accounts of banks and other financial
institutions. The Board of Auditors recommends that the Management Board and the
Board of Directors continuously monitor whether the accounting framework adopted is “fit
for purpose” in the light of the ESM’s position as a high-profile public-interest organisation
operating on financial markets.
The Board of Governors is invited to consider these findings and recommendations and
undertake the appropriate initiatives.
Luxembourg, 30 May 2013
Board of Auditors

Page 8 of 8