U.K. Financial Reporting Council receives scathing review

In an 18 December review of the Financial Reporting Council (FRC), Sir John Kingman, chairman of the financial services group at Legal & General, called the agency “a hangover from a bygone era.” Kingman said the regulator should be replaced by a new body called the Audit, Reporting and Governance Authority (ARGA) and should operate with “a new mandate, new clarity of mission, new leadership, and new powers.”

He compares the FRC to a “ramshackle house, cobbled together with all sorts of extensions over time” that is “serviceable, up to a point,” but which “is built on weak foundations”—so bad, in fact, that “some of the biggest and most important economic actors in the United Kingdom (i.e., audit firms) are still regulated not by an independent body but, in effect, by their trade association.”

“In a number of important areas, notably oversight of regulation of the actuarial profession and local authority audit, the FRC’s powers are limited or even nonexistent, leaving it in the unfortunate situation of having been given responsibility without power.”

Sir John Kingman, Chairman, Financial Services Group, Legal & General

He added that “in a number of important areas, notably oversight of regulation of the actuarial profession and local authority audit, the FRC’s powers are limited or even nonexistent, leaving it in the unfortunate situation of having been given responsibility without power.”

The FRC regulates auditors, accountants, and actuaries in the United Kingdom, sharing this responsibility with professional membership bodies like the Institute of Chartered Accountants of England and Wales (ICAEW).

The agency, however, has no power to sanction those executives without an audit, accounting, or actuarial background, leading to fears—and criticism—that directors who may be culpable for boardroom failures can effectively walk away scot-free. The FRC has flagged this as a serious concern and asked the government earlier this year for stronger powers to be able to sanction any director for serious corporate governance failings.

The regulator, however, has also been criticised for taking a timid approach to enforcement and oversight and for hiring former partners and employees of Big Four firms as staff, leading to accusations that the FRC is too cosy with the firms it is meant to monitor. For example, nine out of the FRC’s 16 senior executives have come from one of the Big Four firms, with five alone coming from PwC.

In April, Business Secretary Greg Clark commissioned Kingman to conduct a “root and branch” review of the FRC after a Parliamentary committee had slammed the regulator for being “useless” and “ineffective” for its failure to spot trouble at construction giant Carillion, which went into liquidation in January.

His review largely confirms findings by Members of Parliament. It says that the FRC has failed to lead the charge in reforming the audit market or ensuring audit quality; has failed to ensure that annual reporting has improved and become more meaningful (rather than more voluminous); has failed to guarantee that its Stewardship Code—meant to ensure greater investor engagement—has been effective; and has failed to engage or coordinate with other regulators.

The report sets out 83 recommendations about how a new regulator should work in practice. Key among them are:

• The new regulator should be independent with clear statutory powers and objectives;
• The new body should be accountable to Parliament, with the chair and CEO subject to a pre-approval hearing with the Business, Energy & Industrial Strategy (BEIS) select committee, which they will appear in front of annually;
• The regulator should have an overarching duty to promote the interests of consumers of financial information, not producers;
• A new board should be appointed (and all appointments should be public appointments) that does not seek to be “representative” of stakeholder interests;
• The current self-regulatory model for the largest audit firms should end;
• The regulator’s corporate reporting work should be extended to cover the entire annual report—not just financial reporting;
• The regulator should ensure that a “consistent approach” is taken in enforcement action against auditors, accountants, and responsible non-member directors by putting in place schemes that are equivalent to the FRC’s current Audit Enforcement Procedure (AEP);
• The regulator should be required to promote brevity and comprehensibility in accounts and annual reports, to engage meaningfully with investors and asset owners about their information needs and to ensure the proportionality and value of reports;
• The regulator needs to engage at a more senior level in a much wider and deeper dialogue with U.K. investors;
• The regulator should develop a robust market intelligence function to identify emerging risks;
• The regulator should be able to deploy a range of responses, appropriate to the circumstances, including powers to order the removal of the auditor or an immediate retendering. In the most serious cases, the regulator should also be able to recommend to shareholders that they consider a change of CEO, CFO, chair, or audit committee chair, or that they reconsider the payment of dividends;
• The regulator should consider requiring further enhancement to the independent auditor’s report to include “graduated” audit findings.

The government says it “will take forward the recommendations set out in the review to replace the FRC” but has not specified a timeline for doing so. A BEIS spokesperson added that it is “not certain” that a new regulator will be created.

Responding to the review, FRC Chairman Sir Win Bischoff said in a statement that he welcomed Kingman’s recommendations, adding that “they have the potential to bring about significant improvements to the work we do in protecting the interests of investors and the wider public.”

“Sir John has addressed the gaps in our powers that have been identified and set a course for a stronger, new regulator to emerge from the FRC. We look forward to playing our part to ensure his review is implemented speedily,” he said.