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Position paper: Audit regulator reforms

April 2020

Chartered IIA’s position

The Chartered IIA believes that the Financial Reporting Council (FRC) is no longer fit for purpose and must be reformed. We advocated a range of policy ideas for reform as part of our response to the Independent Review of the Financial Reporting Council led by Sir John Kingman, and we were pleased to see that many were reflected in the review’s final report.

We support the review’s central recommendation to abolish the FRC and replace it with a new audit regulator (the Audit, Reporting and Governance Authority - ARGA), putting it on a statutory footing with enhanced powers, renewed mission, objectives and sanctions.

Given recent corporate collapses, most notably Carillion, but BHS before it, and more recently Patisserie Valerie and Thomas Cook, we believe it is critical that the Government now takes urgent action to replace the FRC with ARGA. Such reform is vital in order to strengthen the UK’s corporate governance framework, to help identify issues early and prevent future collapses before they occur, as well as to restore trust and confidence in business.

Although we were pleased to see the Government commit to audit reform in the Queen’s Speech in December 2019, we remain concerned about the pace of change on audit reform – notably those reforms that require legislation, such as putting the audit regulator on a statutory footing. This legislation is crucial in order to give the new audit regulator the powers it needs to do its job effectively.

Key reforms

Changing the FRC’s mission and objectives

The current scope of the FRC is too broad, too high-level and its mission and objectives need to be clearer. The audit regulator would benefit from a sharper focus and clarity on its purpose, which should result in increased effectiveness.

We previously suggested that the mission statement and objective of the FRC should be to: “promote high standards of corporate governance, transparency and accountability in public interest entities.”

We were pleased to see that the sentiment of our proposal was reflected in the strategic objective suggested by Sir John Kingman in recommendation 4 of his final report:

“To protect the interests of users of financial information and the wider public interest by setting high standards of statutory audit, corporate reporting and corporate governance, and by holding to account the companies and professional advisers responsible for meeting those standards.”

We support this strategic objective.

A new name to better reflect the FRC’s purpose

The FRC’s name should be changed to better reflect its new mission and focus. In our response to Sir John Kingman’s review we suggested changing the name to “Regulator of Standards in Corporate Governance”. However, we also support the name put forward by the review, the “Audit, Reporting and Governance Authority”.

New powers to ensure the FRC/ARGA can do its job properly.

The FRC should be given stronger and broader powers, including the power to effectively sanction all directors for misconduct, regardless of whether they are chartered accountants or not. Currently, the FRC only has the power to sanction chartered accountants. This is not appropriate given the numerous joint responsibilities of directors.

We advocate that the FRC should have a range of sanctions available, including disqualification, which may be applied to all relevant directors in respect of accountancy and transparency failings. We believe these sanctions should be a statutory power.

A more proactive approach

In the past the FRC has not been quick and effective enough to act on warning signs regarding corporate governance, which leads to a perception that the FRC only investigates a company once a failure has occurred. To help address this, we suggest the FRC should adopt a more proactive approach to its regulatory strategy and tactics in order to increase the avoidance of harm.

We also believe the FRC/ARGA should allocate a specific supervisor (as the FCA currently does) to companies that are systemically important. This would mean an external auditor would have to approach their FRC/ARGA supervisor if they believe an organisation to be in trouble, allowing for an early warning system.

The governance of the FRC/ARGA

We previously supported introducing a smaller board for the FRC/ARGA and were pleased to see this recommendation in the review’s final report. The current FRC board is larger than that of many commercial companies. With a smaller board, it is all the more important that each board member plays their role and adds sufficient value.

We also support the review’s proposal that the posts of Chair and CEO should be subject to confirmation hearings with the BEIS Select Committee. This would be an appropriate mechanism for ensuring parliamentary scrutiny of the new regulator’s Chair and CEO. Whilst we appreciate that the BEIS Select Committee already has the power to call whomever they wish to appear before them, there could be value in formalising such an arrangement as this would ensure greater accountability.  

Funding and budget of the FRC/ARGA

We welcome the proposal by Sir John Kingman that the new regulator should be paid for by a statutory levy. However, we do have concerns that the budget for the new regulator will be set in future by BEIS. This could create a situation where the board and CEO of the new regulator are held accountable for delivering very challenging objectives, but do not have complete control over the budget and resources required to deliver those objectives. We therefore advocate that the proposal is brought in line with the arrangements for the FCA and PRA, where relevant boards are responsible for setting the budgets, subject to the need to consult with relevant stakeholders.

With regards to remuneration, we support the Government’s proposal that the FRC/ARGA should not be subject to public sector pay caps, but instead the arrangements for remuneration should mirror those of other financial regulators such as the FCA and PRA. We are concerned that if left in place, the current restrictions on pay could, over time, substantially reduce the ability of the FRC/ARGA to recruit key specialist talent.

There is an inconsistency here from the Government, between their proposal for remuneration where they support similar mechanisms to those used at the FCA and PRA, and their proposal for funding and budget where they don’t. To ensure consistency we think the funding, budget and arrangements for remuneration for the FRC/ARGA should follow the same rules as those for other financial regulators like the FCA and PRA.

Putting the FRC on a statutory footing

Government should change the law to put the FRC/ARGA on a statutory footing with its new mission, objectives, powers and sanctions included in the legislation. The legislation should say that the FRC/ARGA is not an arm of Government, but an independent regulator of corporate governance, accountability and transparency. Essentially, the relationship with Government should be similar to the FCA, with the FRC/ARGA reporting and being accountable to the Department for Business, Energy and Industrial Strategy.

Appendix

Sir John Kingman’s Independent Review of the Financial Reporting Council

Chartered IIA responses to the Independent Review of the Financial Reporting Council

Press releases