The Chartered IIA's response to the Independent Review of the FRC

Response to the Financial Reporting Council Independent Review: call for evidence

The Chartered IIA represents 10,000 internal audit professionals in organisations spanning all sectors of the economy, including most FTSE companies, across the UK and in Ireland.

Internal audit is a function that sits within the governance structure but it must be independent of the areas it evaluates, and internal auditors must be free from undue influence from management, so that their judgments can be as objective as possible.

The internal audit profession plays a key role in helping to ensure good corporate governance in public interest entities and therefore has an interest in an effective and well-functioning FRC.

Below are our overall comments on the remit, structure and effectiveness of the FRC. Following on are our answers to the specific questions that are of particular relevance to the Institute.


Overall comments

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

Below are our recommendations on substantial changes to be made to the FRC:

Core work of the FRC – increasing the focus

The FRC is not sufficiently focused and requires more clarity. It is important to identify the mission, focus and core functions of the FRC.

The Chartered IIA suggests 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.

The Chartered IIA suggests that there are two types of work that the FRC currently undertakes, core and non-core. If a role does not fit into the above objective, it is not a core activity of the FRC. Any work that is non-core is a distraction and may take away vital resources from the core work of the FRC.

We set out in the table below the Chartered IIA’s views as to what are the current core and non-core functions of the FRC.

  Area Function Core or non-core

Corporate Reporting

The FRC sets UK accounting standards and works to influence international accounting standards (IFRS).

Core

Through the Conduct Committee, it reviews the financial statements of public and large private companies for compliance with the Companies Act.

Core

Corporate Governance

The FRC monitors and maintains the UK Corporate Governance Code and the Stewardship Code, together with their associated guidance. Compliance with both codes is voluntary although the Listing Rules require companies to report on their compliance with the former.

Core

Audit

As the Competent Authority for audit the FRC has a number of statutory functions including:

• Public oversight of the regulation of statutory auditors by the relevant professional bodies

• The determination and manner of application of technical, ethical and other standards

• Setting criteria for determining the eligibility of persons for appointment as statutory auditors

• Monitoring of statutory auditors and audit work by means of inspections

• Investigations of statutory auditors and audit work; and imposing and enforcing sanctions

Core

In addition, the FRC has responsibility for:

• Recognition (in the capacity of Delegate of the Secretary of State) of the Recognised Supervisory and Qualifying Bodies for audit

Core

• Registration of persons approved to audit non-EU registered companies that have issued securities admitted to trading on EU regulated markets (Third Country Entities and Third Country Auditor) and keeping of the Third Country Audit Register

• Various functions related to local public sector audit

• Independent supervision of Auditors General

• Monitoring of audits of entities listed on an EEA exchange and incorporated in Jersey, Guernsey or the Isle of Man

Non-core

Accountancy

The FRC provides independent oversight of the regulation of the accountancy profession by the chartered accountancy bodies. This is conducted on a voluntary basis by agreement with the relevant accountancy bodies.

Non-core

By private arrangement with the relevant accountancy bodies, the FRC provides independent investigation and/or disciplinary hearings in respect of misconduct by chartered accountants in public interest cases.

Non-core

Actuarial

By agreement with the Institute & Faculty of Actuaries (IFoA), the FRC sets actuarial standards and provides independent oversight of the regulation of the actuarial profession by the IFoA.

Non-core

By private arrangement with the Institute and Faculty of Actuaries (IFoA), the FRC provides independent investigation and / or disciplinary hearings in respect of misconduct by actuaries in public interest cases.

Non-core


Removing the non-core functions would strengthen the FRC by allowing it to focus on its core areas of work. Any work that is non-core should be, ideally, transferred to a different regulator. If this is not possible the FRC could continue to undertake this work, but in a separate ring-fenced division, as to not dilute the FRC’s core work.  

Additional functions for the FRC

The Chartered IIA believes that the FRC would be more effective at regulating good corporate governance with additional responsibilities.

For these reasons, the Chartered IIA recommends that the responsibility of the UK Listing Authority (UKLA) should be moved from the remit of the Financial Conduct Authority (FCA) and combined with the responsibilities of the FRC. 

The role of the UKLA is to monitor market disclosures, review and approve prospectuses and operating the UK listing regime. The Chartered IIA believes that there are substantial synergies between the core work of the FRC and the role of the UKLA. For example, the choice and appropriate implementation of accounting policies is of relevance to prospectuses and preliminary announcements (UKLA oversight) and to audited financial statements (FRC function).

Currently, the FCA regulates these organisations including non-financial services companies listed in the London Stock Exchange even if they are not financial services providers, for example, Unilever.

The Chartered IIA believes that moving this work from the FCA to the FRC would also lighten the load of the FCA and allow them to focus on the providers of financial services rather than issuers of securities.

Proactivity

The Chartered IIA suggests a more proactive approach to the regulatory strategy and tactics of the FRC to increase the avoidance of harm.

We suggest that if the UKLA and FRC functions are combined then the effectiveness of both functions will be enhanced as they will be able proactively to approach companies when they notice a number of risk indicators being flagged. 

Another suggestion is to allocate a specific supervisor, as the FCA do currently, to companies that are systemically important. This would provide the resources and knowledge to undertake real time monitoring of higher risk companies, as well as allowing a requirement to be created for an external auditor to approach their FRC supervisor if they believed that an organisation is potentially in trouble. This would allow for a more effective early warning system to be developed.

Statutory footing and relationship with government

The Chartered IIA advocates for government to legislate and put the FRC on a statutory footing with its renewed mission, objective, powers and sanctions included in the legislation.

We suggest that the legislation establish the FRC not as an arm of government, rather an independent regulator of corporate governance, accountability and transparency, for public interest entities to protect the interests of corporate stakeholders. We believe that this would provide a stronger basis on which to operate as well as providing a clearer message to stakeholders and the public on the role and legal status of the FRC.

The Chartered IIA suggests replicating the relationship between the FCA and government, which involves:

  1. Being independent of government but accountable to the relevant government department (in the FRC’s case, BEIS);
  2. Report to BEIS on progress through an annual report;
  3. BEIS to submit a report to Parliament that examines performance against statutory objectives and how major cases have been dealt with; and
  4. Appear before government committees, answer MPs questions and respond to information requests.

The FRC is designed as a non-departmental public body – this means that the FRC is subject to public sector pay caps. We note that this restriction currently does not apply to the FCA or PRA. We believe this restriction will over time substantially reduce the ability of the FRC to recruit key specialist talent required to undertake their core duties and we suggest this should be reviewed.

Sanctions

The FRC also requires the ability to effectively sanction directors for misconduct.

Currently, the FRC only has the power to sanction chartered accountants. However, it is not appropriate that chartered accountants should have a different set of sanctions to directors who are not chartered accountants given the joint and several responsibilities of directors.

For this reason, the Chartered IIA advocates that the FRC should have a range of sanctions available, including disqualification, which may be applied to directors in respect of accountancy and transparency failings. These should be a statutory power.


Read the full response here

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