The FRC is navigating a long and winding roadby
There have been many changes at the Financial Reporting Council since it was told to get its house in order following the collapse of Carillion. Julia Penny looks at where it might be heading now.
The story starts in 2018 when, on 31 March that year, the Financial Reporting Council (FRC) had 192 employees. But following the collapse of Carillion earlier in 2018 the Kingman review was commissioned, reporting in December 2018 that for the FRC, the regulator with remit over audit, corporate governance and reporting, “it is time to build a new house”.
Even these words were much gentler than the preceding parliamentary select committees, which described the “toothlessness” of the FRC and its “reluctance to use aggressively the powers that it does have”. The select committee recommended that the government should provide the FRC with the necessary powers to be a more aggressive and proactive regulator. And so the long journey towards the creation of ARGA – the Audit Reporting and Governance Authority – began.
Fast forward to the second half of 2023. The FRC’s annual report for the year to July 2023 shows that the headcount has increased to 443 – 251 more staff, or more than twice the 2018 numbers. The FRC plan, per its position paper published in July 2022, was to increase the headcount to 533 by March 2024 and to 600 by 2026/27. But a lot has happened since then, and more specifically in the past few months, so let’s have a look at what’s changed and where the FRC may now be heading.
Changing of the guard
Sir Jon Thompson KCB was brought in to head up the FRC in October 2019 and move it towards its new incarnation as ARGA. He brought the aggressiveness that the government at the time was looking for and some huge fines were issued to auditors because of failings in quality. But in 2023 he moved onto HS2 and a new CEO for the FRC was needed.
In steps Richard Moriarty. An experienced regulator, coming directly from the Civil Aviation Authority (CAA), he appeared to promise perhaps a more measured approach, concentrating on the whole system that builds quality in an industry, rather than on enforcement and teeth-bearing. Of course this may be wishful thinking, but the approach that the CAA appears to have taken to quality seems not to be about vilifying those who do wrong, but genuinely looking at how quality can be improved.
Changing of the mood
In 2018 the government was shaken by the fallout of Carillion’s demise, which impacted employees, with losses to jobs and pensions, and the public when contracts to build hospitals and more were severely disrupted. It wanted the FRC to be rottweiler-like in its pursuit of miscreants, but it possibly didn’t consider the unintended consequences of success; good people might want to stop being auditors (or possibly even company directors).
More than this, Britain was now post-Brexit. It needed to start showing some of those advertised Brexit dividends – making Britain a good place to do business was always at the heart of the desired outcome. So government has been indicating what many believe is a distinct change in direction as evidenced by the following timeline of events.
- 16 October 2023 – The government withdraws the new draft reporting regulations, which would have added requirements for an annual resilience statement, a distributable profits figure, a material fraud statement and a triennial audit and assurance policy to the corporate governance code.
- 7 November 2023 – The King’s Speech did not include parliamentary time to enact the legislation to create ARGA. This means it is likely that ARGA may not be up and running until 2026/27 and, of course, there will be a general election prior to this. (Many of us question whether the legislation will ever be of high enough priority to make it to the statute books).
Later the same day the FRC responds to the withdrawal of the draft reporting requirements and the lack of ARGA legislation in the King’s Speech with a policy update. It says that it is disappointed, but it remains focused on ensuring the current regulatory toolkit is used to its best effect, working closely with stakeholders. This includes, it says, setting proportionate standards, fostering a culture of continuous improvement, and holding to account those that fall short. It is noticeable that mentions of being an “assertive” regulator, made as recently as July in the annual report, are missing.
The policy update also gave clear indications of the elements of the corporate governance code reforms that would not be taken forward. Most of the changes will be dropped, with the exception of requirements relating to internal controls and changes designed to streamline the content.
- 17 November 2023 – Richard Moriarty, CEO of the FRC, states in various press articles that he is more concerned with audit quality and effectiveness rather than competition. His focus is on enhancing public trust and considering proportionate new rules for corporate governance.
- 22 November 2023 – The Rt Hon Kemi Badenoch MP wrote to Moriarty, updating the government’s priorities for the FRC. The desired focus for the FRC is that it keeps growth of the economy as a core objective in all its work. This comes, the letter states, from the statutory growth duty embedded in the Deregulation Act 2015, but while this is not new, the message from Westminster is loud and clear. Growth is a priority and regulation should contribute to competitiveness and growth. The Secretary of State emphasises the importance of flexible governance and stewardship codes, maintaining the comply and explain approach currently adopted (there had been calls for stricter requirements, rather than an option to explain why there is no compliance). The letter encourages the FRC’s continued work to:
- drive up audit quality
- engage with government officials to review non-financial reporting with the aim of simplifying and streamlining it
- enable companies to report on sustainability matters in a consistent and proportionate way, by supporting assessment of the IFRS sustainability disclosure standards.
Overall, the letter states that it is important for the FRC to strike the right balance of supporting continuous improvement, pursuing sanctions against those who flout the rules and acting proportionately and in the public interest.
- 22 November 2023 – Moriarty’s response to the FRC remit letter, thanked the minister for her letter and welcomed the clarity on how the FRC’s work contributes towards the government’s broader vision. (We can only imagine the possible sentiment behind these polite and public letters, but while it may seem like the driver is sending the car in an entirely different direction, at least the car now knows where it is going).
Less competitiveness, more quality
So where does that leave us, or more importantly where does it leave the FRC and its impact on the profession and the businesses that it audits? This is a clear move towards a more deregulatory government, with a focus on growth and on making sure the UK is an attractive place to do business. The FRC has no choice but to amend its direction along these lines, but as Moriarty stated before the most recent exchange of letters with the government, he wants less focus on competitiveness within the auditing profession and more on quality. But a balance may be needed.
Given the new instructions from government, the FRC will surely need to reconsider how it regulates, so as not to create a huge deterrent for new entrants to the market, outside the Big Four, for PIE audits. At present, as soon as a firm comes under the regulatory remit of the FRC – even for just one audit – the time, money and angst involved are a powerful disincentive for most firms to get involved.
What lies ahead?
So what does the future hold? Will we see a switch to a more proportionate regulatory approach? One that doesn’t instil terror, but a genuine desire to learn about how to improve quality? One which doesn’t cost so much that it isn’t worth doing audits under the FRC’s regulatory remit at all. And one where we don’t see further huge increases in the levy charged to firms and companies to fund an FRC that is currently still intending to expand its headcount to 600 from the current 443, which is up from 192 in 2018?
It looks to me like the effective blank cheque that the government signed for the FRC, by demanding a much more robust and assertive approach to regulation, enabling hugely increased levies to be charged each year, has just been stopped. But has the FRC heard this too? Will it be replanning its future growth and activities as we speak? I hope so. Because while quality is essential, and auditors should be working hard to ensure the quality of their work, regulation comes at a cost to all involved and if we are not careful, we will regulate listed company auditors out of existence.
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Julia Penny is the principal of JS Penny Ltd which provides technical and training consulting on anti-money laundering procedures, auditing and financial reporting. Julia is a member of ICAEW Board and Council, chair of the ICAEW Ethics Advisory Committee and past chair of the ICAEW...