Julia Irvine 20 Aug 2018 04:50pm

FRC done nothing to improve audit market competition, says BDO

BDO says the Financial Reporting Council (FRC) has failed as a regulator and is calling for it to be split in two

In a highly critical response to Sir John Kingman’s call for evidence about the audit watchdog’s role and governance, the UK’s sixth largest accountancy firm says the FRC’s failings are partly due to the conflict of interest engendered by its dual responsibilities for standard-setting and compliance, and partly through its “negative” impact on the audit market place.

It suggests that this current dual role means the watchdog is “marking its own homework”.

“It is our view the FRC’s reputation for standard-setting is good. It is our view that the FRC’s reputation for regulation is poor,” it says.

“Because of this second point, the FRC’s reputation for standard-setting has been, and will continue to be, undermined. For this reason alone, we believe that the two functions should be separated into different bodies.”

There are other cogent reasons for separating the roles, BDO continues, not least because of the necessity of employing former and current auditors and accountants in the governance of the FRC.

“Public perception seems to be that any past involvement with an audit firm by an individual never perishes,” it points out.

While acknowledging that this perception is understandable, BDO says it doesn’t take into account that “accounting and auditing are complex subject matters that take many years of experience to master” and that the experience these individuals bring provides enormous value to the regulatory environment.

“However, the failure of the FRC as an effective regulator has given the impression that the presence of ex-Big Four accountants on any FRC committee is somehow suspect,” it adds.

“This has been a particularly damaging criticism of the FRC and has done much to undermine public confidence and trust in not just the FRC but also the large accounting firms themselves.”

BDO reserves its most stinging criticism for the regulator’s failure to play a meaningful role in the debate over competition in the audit market place, “other than the fact it has brought to the fore the need for market reform”.

And it takes the FRC’s chief executive, Stephen Haddrill, to task over his evidence to the Carillion inquiry in January this year, which “speaks of a complete failure by the FRC to engage with supply-side issues”.

BDO points out that the FRC’s increasingly aggressive approach to the audit quality reviews it carries out of PIE audits will put off smaller firms from joining a reformed audit market because of “the cost in resources and professional reputations”.

This is deeply worrying, given the “strong possibility” that the reforms could well lead to the Big Four divesting a large number of PIE audit clients to the larger firms outside the Big Four.

On the buy side, the firm finds that the FRC’s contribution has been minimal, if not downright negative. It accuses the regulator of conniving with PIEs, through its support of audit rotation, to reduce choice in the audit market “because smaller audit firms have left the market”.

It also says the regulator missed an opportunity to drive buy side change by choosing to set best practice for audit committees on the conduct of audit tenders, rather than mandatory standards.

BDO’s recommendations

In suggesting that the standard-setting and regulatory functions should be separated, BDO has taken the opportunity to set out its vision of how the new business model would work.

As far as the new standard-setting body is concerned, it should be given the power to set appropriate standards for the whole of a PIE’s corporate reporting – and not just its financial statements. Responsibility for monitoring the content and quality of the reporting would lie with the separate regulatory body.

The regulatory body would be given powers to regulate all the major players involved in a PIE’s governance and reporting. This would include all the PIE’s directors in addition to the audit firm and members of accountancy bodies who are currently covered.

Ideally, BDO would like the powers to be extended to cover all advisers whose work is involved in corporate reporting – such as chartered surveyors who carry out valuations and remuneration consultants “whose activities in respect of executive remuneration have arguably done serious damage to the reputation of UK PIEs”.

The firm would also like the FRC’s currently narrowly-focused AQRs to focus more on audit quality than compliance issues. It points out that it would be perfectly possible for an audit to have been done in a way that passes the FRC’s AQR process but to have been “poorly executed” in reality.

“The FRC has become fixated on the single tool of reviewing files for compliance,” it says. “An ‘audit’ is more than just a collection of documents, it includes the experience of the audit by the other actors, interviews with these actors – for example, the CFO – gives a broader perspective.”

It suggests the regulator should move away from detailed examination of a small number of files to look at thematic issues within the audit firms. “Where issues are identified, it should adopt an FSMA s166 ‘skilled persons’ approach,” it says.

“As a last resort it would be appropriate to put an audit firm or an office into a period of supervision by an external monitor.”

On disciplinary investigations, it wants the new regulatory body to drop the “one size fits all” adopted by the FRC in favour of a system which makes a distinction at an early stage between those matters that require a full investigation (such as when a company has collapsed) and those that are less serious.

Another suggestion is that the new FRC would have a duty to recommend to government new legislation to change the behaviour of PIEs. “We believe that a highly respected regulator of corporate reporting would be best-placed to understand and recommend the need for legislative change,” it explains.

“If a reformed FRC were capable of doing this, it would be making a dramatic difference to the quality of corporate behaviour in the UK.”

BDO is the latest in a long line of commentators who have responded to Sir John's call for evidence. The deadline was 6 August.