Julia Irvine 12 Jul 2018 11:04am

FRC sets out bucket list of powers

The Financial Reporting Council (FRC) has set out a long list of new powers that it believes are fundamental to ensuring it is able to carry out its regulatory role properly

In particular, it wants statutory powers to give it greater control over larger accountancy firms’ leadership and senior appointments, and enable it to investigate and discipline non-accountant directors.

In the regulator’s response to the joint select committee’s report on Carillion, FRC chief executive Stephen Haddrill complains that the UK’s audit watchdog lacks powers of intervention, both in the audit market and in response to warning signs that companies might be beginning to fail.

For example, while he shares the MPs’ concerns about the Big Four’s dominance of the public interest entity audit market, he points out that the regulator is unable to take effective action.

“It is…worth noting that at present the loss of an audit contract gives a firm an opportunity to pick up better remunerated consulting work,” he writes. “The market does not therefore fully incentivise high quality performance. We have a responsibility to monitor these risks but do not have the powers to intervene.”

The FRC also wants to be able to warn investors when it comes across issues in reviewing audits of companies that appear to be in danger. This will not prevent the failure of every problem company, “especially through the backward-looking lens of audit”, Haddrill says. “However, we do feel it would be valuable to investors if we could do more to signal concerns before problems become terminal.”

Another area where he would like to see the FRC’s monitoring powers extended is those parts of the annual report that deal with governance. The collapse of Carillion, he believes, has emphasised the importance of boards being aware of their own effectiveness and willingness to enhance their own performance.

“Statements by companies in the annual report about their governance can fail to provide real insight and investors can find them hard to challenge,” he says.

“The FRC has no power to challenge these parts of the annual report. We believe this should be addressed by extending the scope of our corporate reporting review powers, combined with a power to undertake or commission a report into the quality of governance akin to the powers of the FCA [Financial Conduct Authority].”

Haddrill recognises that implementation of the Audit Regulation and Directive in June 2016 went a long way towards strengthening the FRC’s regulatory regime but gaps remain, particularly when it comes to monitoring the larger audit firms and the performance of their leadership, the suitability of those being appointed to their senior audit positions and the strength of their businesses.

Despite the fact that the voluntary monitoring scheme which the FRC recently set up with the large firms is working “satisfactorily”, Haddrill is keen for it to be put on a statutory footing. “We believe that in view of the systemic importance of the major firms and the variation in audit quality within each firm, a statutory basis for scrutiny and challenge of leadership roles in protecting the sustainability of the business and driving consistency in quality is especially important,” he argues.

He would also like to see the FRC’s monitoring regime extended to cover all directors and not just those who are members of the accountancy bodies it regulates. He points out that the FCA and the Insolvency Service already have such powers and if the FRC were granted “limited concurrent powers”, it would be in a better position to provide a “more efficient and holistic regulatory framework”.

And while he is on the subject of investigations, he alerts the select committee members to the fact that the regulator is forced to use two different processes for investigating auditors and accountants in business. So the current investigation into the role of KPMG as Carillion’s auditors is being carried out under the Audit Enforcement Procedure (AEP), while the investigation into the behaviour of the accountants who were employed by Carillion is being run under the Accountancy Scheme.

The AEP requires the investigators to establish that a breach of relevant requirements has been committed while the scheme has to prove misconduct, a much higher test. “We believe that the scheme should be replaced with a new statutory regime and its tests should be aligned with and similar to those in the AEP,” Haddrill adds.

He also takes the opportunity to admit that it would have probably been better for the regulator not to have held up Carillion’s dividend disclosures as an example of best practice in its Financial Reporting Lab report on disclosures.