Julia Irvine 18 Dec 2018 09:02am

FRC is a "hangover from a different era" and must go

The Financial Reporting Council (FRC) is a “hangover from a different world” and needs to be replaced by a new independent body with more powers to make a difference, according to Sir John Kingman

This new regulator, to be known as the Audit, Reporting and Governance Authority (ARGA), will have a different culture: it will have a statutory objective to serve interests of users of accounts. It will be forward looking and will promote competition in the audit market.

And significantly, it will take over responsibility for licensing and regulating the large audit firms involved in public interest entity audits from the UK accountancy bodies, in particular ICAEW.

The ARGA is at the heart of 83 recommendations that Kingman unveiled today following his independent “root and branch” review of the FRC. This was commissioned by business secretary Greg Clark in April after questions were raised about the FRC’s role in the wake of the collapse of BHS and Carillion.

“I have concluded that the FRC needs to be replaced with a new organisation with new leadership, new mission, new powers and new funding,” he said at a briefing yesterday.

The FRC was constructed in a different era, he explained. “I talk about it as a rather ramshackle house cobbled together with all sorts of extensions over time.

“The house is just serviceable up to a point but it leaks and creaks sometimes badly. The inhabitants in the house sort of patch and mend but in the end the house is built on weak foundations and we need to build a new house.

“What we have to aim for is a new body which has a clear and precise sense of purpose and mission; second, and this is very important, one that is firmly focused on the interests of consumers of financial information, not the producers; one that is respected by those who depend on its work and, where necessary, feared by those who it regulates, one that has the right powers and resources that it needs to do its job and one that is able to attract the highest quality people.”

Compared to other regulatory bodies, the FRC is an anachronism. It has “no meaningful statutory basis” which is extremely unusual for a regulator, for most of its history it has been a private company and not a public regulator and it has taken “an excessively consensual approach to its work”.

Kingman also found the fact that it is funded partly through a voluntary levy “a very odd thing”.

The FRC has followed instructions from successive governments to rely on professional self-regulation to the maximum extent possible, he said, and although its powers are weak and limited, it has failed to make the case for stronger ones.

“I think that an ideal FRC would have made much more impact on these large public debates about audit, particularly about competition in audit, about the relationship between audit work and non-audit work and the expectations gap. These are big topics and it would have been good to see the FRC doing more of the running on them.”

It has adopted a “surprisingly informal way” of making board and key committee appointments, rarely advertising and sometimes using the alumni networks of the Big Four, which Kingman found surprising.

He said that a very senior international stakeholder had told him that “you need to make the FRC a place where people go to enhance their career, not the place they go to end it”.

The FRC had also failed to establish a relationship with the investment community which was not “of the depth or breadth” that he would have expected of a regulator. And he was taken aback by the number of leaks around its affairs. “You do not generally see that with other regulators.”

The FRC was not all bad, however. Kingman stressed that it was reasonably respected in the international regulatory community, it was an effective custodian of the corporate governance code, and it had been willing to act beyond its limited powers “in a good way”.

He praised the Financial Reporting Lab and other innovations that the FRC had introduced. And he welcomed the engagement of the FRC staff with his review. “I did not find them defensive or resistant to change. On the contrary they see this review to fix a lot of things that need to be fixed.”

Many of those staff, he suggested, would move across to the new regulator along with a few members of the FRC board. However, the ARGA board will be more slimline and the appointments of chair and chief executive subject to select committee approval.

As far as directly regulating the major audit firms is concerned, Kingman said that the FRC has enforcement powers relating to problematic audits but no powers over audit firms and the way they are run. “This is unusual compared to other respected regulators internationally.

“At the moment the firms are regulated by their professional bodies, that is to say effectively their trade associations. I am suggesting that this should cease and that they should be regulated properly by the new regulator.”

He said that ARGA will also gain wider enforcement powers covering directors who are not members of professional bodies as well as those who are.

The new body will be more transparent, publishing audit quality reviews and corporate reporting reviews. Corporate reporting reviews will be extended to cover the whole annual report, including for example the remuneration report, corporate governance disclosures.

It will also have a backstop power for the remaining self-regulatory functions which would give it power to intervene if this is in the public interest.

Kingman also wants to see ARGA take on a more proactive role. “I’m not recommending that we turn the FRC into a companies regulator that attempts to regulate every company in the economy, but I do think the FRC’s work is currently really essentially all backward looking and I think it should and ought to be empowered to do more that is forward-looking.

“In particular, I think this regulator is in a good place to gather and collect intelligence and particularly to look for warning signs and where it sees them, it should be give the power to commission and if necessary publish reports.”

This, he says, would align their powers more closely to other regulators – like the Financial Conduct Authority and the Prudential Regulation Authority – which have the power to send inspectors into firms to see what is going on and make recommendations.

He recommends that ARGA should be given new powers, including requiring a change of auditor, restatement of the accounts or recommendations to the shareholders involving, say, a strengthening of the board or a change in dividend policy.

“I am also recommending that we should create a duty on auditors if they have concerns to go and talk to the regulator about them. That is done in other countries,” he said.

Kingman said that he had decided against recommending changes to the way auditors are appointed, although there are good arguments for requiring investors to do it but the regulator should have the right to step in and appoint the auditor in specific situations, such as where there are significant audit quality issues, where the auditor and audit client have parted company or where there has been significant shareholder revolt against the audit.

He also recommends that the regulator should have a right to approve the audit fees if it thinks there is a case for doing so on audit quality grounds.

Other recommendations include transferring oversight of the actuarial profession to the PRA and setting up a separate new body for local government audits.

Kingman said that many of his recommendations could be implemented straight away – such as shifting the FRC’s mission and purpose, changing the FRC’s framework agreement with BEIS reshaping the board and developing a new resource and capability plan and pay structure.

Others,  however, would need primary legislation. This is unlikely to happen in the short term, given the current focus on Brexit.