In December 2018, the Kingman Review produced its final report and, in doing so, appears to have begun the process that will see the FRC’s abolition. This brief blog post looks at the FRC, the circumstances that led to its effectiveness being questions, and the principal recommendations of the Kingman Review.
A brief history of the FRC
The FRC was established in 1990 to oversee the process of updating accounting standards (a role it still holds). Since then, its remit has expanded substantially in several ways, including:
- in 1992, it became responsible for corporate governance issues and so is responsible for updating the UK Corporate Governance Code and the recently published Wates Corporate Governance Principles for Large Private Companies;
- in 2005, it became responsible for regulating actuaries and actuarial standards;
- with the publication of the first UK Stewardship Code in 2010, it became responsible for updating this Code (as it did in 2012 and will do in 2019);
- in 2016, it was designated the Competent Authority for Audit by regs 2 and 3 of the Statutory Auditors and Third Country Auditors Regulations 2016, meaning that it became statutorily responsible for overseeing statutory auditors in the UK.
For a more detailed account of the FRC’s role, see the FRC’s own report on its roles and responsibilities.
The beginning of the end
Following the collapse of Carillion plc, a report published by the BEIS and Work and Pensions Select Committees was extremely critical of the FRC, stating that:
- it had little faith in the FRC’s ability to complete investigations in a timely manner;
- the FRC was too passive in relation to Carillion’s financial reporting;
- whilst the FRC identified failings in Carillion’s reporting, it failed to monitor whether these failings were remedied and was ‘happy to walk away after securing box-ticking disclosures of information;
- the FRC was timid in challenging Carillion on the ‘inadequate and questionable nature of the financial information it provided and wholly ineffective in taking to task the auditors who had responsibility for ensuring their veracity.’
It therefore came as little surprise when the government announced that it was launching an independent review of the FRC, headed by Sir John Kingman.
The Kingman Review
The Kingman Review reported in December 2018 and, unsurprisingly, was critical of the FRC’s remit and effectiveness (although it did acknowledge that a number of the FRC’s deficiencies were the result of constraints placed on it by successive governments), stating that:
- the FRC had not been effective in shaping the debate on major issues relating to its work;
- its work on audit quality does not command the same respect as similar regulators in other countries;
- it has not been an effective champion for the need for comprehensible annual report and accounts;
- its relationships with the investment community are not as deep as they should be;
- the UK Stewardship Code is not effective in practice.
The Review described the FRC as
an institution constructed in a different era – 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 of the house have sought to patch and mend. But in the end, the house is built on weak foundations.
It was therefore no surprise that the Review concluded that ‘[i]t is time to build a new house.’ The Review recommended that the FRC be replaced by a new regulator, entitled the Audit, Reporting and Governance Authority. The principal objective of this new regulator will be:
To protect the interests of investors and the wider public interest by setting high standards of corporate governance, corporate reporting and statutory audit, and by holding to account the companies and professional advisers responsible for meeting those standards.
The core functions of the new regulator will be:
- To set and apply high corporate governance, reporting and audit standards;
- To regulate and be responsible for the registration of the audit profession;
- To maintain and promote the UK Corporate Governance Code and the UK Stewardship Code, reporting annually on compliance with the Codes;
- To maintain wide and deep relationships with investors and other users of financial information;
- To monitor and report on developments in the audit market, including trends in audit pricing, the extent of any cross-subsidy from non-audit work and the implications for the quality of audit; and
- To appoint inspectors to investigate a company’s affairs where there are public interest concerns about any matter that falls within the Authority’s statutory competence.
These functions are broadly similar to those already undertaken by the FRC, but the new regulator would be given increased powers in relation to these functions. Its remit would also be broadened. For example, the new regulator would be subject to a new competition duty that would provide that the regulator ‘must, so far as is compatible with advancing its other objectives, discharge its general functions in a way which promotes effective competition in the market for statutory audit services.’
Reaction to the Kingman Review
The Review’s recommendation to replace the FRC with a new regulator appears to have been broadly welcomed. Greg Clark, the Secretary of State for BEIS, stated that ‘t]he government will take forward the recommendations set out in the Review to replace the FRC with a new independent statutory regulator with stronger powers.’ The FRC itself welcomed the Review, with its chairman Sir Win Bischoff stating:
Sir John has carried out a thorough review and consulted numerous organisations and individuals. He 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 welcome Sir John’s recommendations. They have the potential to bring about significant improvements to the work we do in protecting the interests of investors and the wider public. We look forward to playing our part to ensure his review is implemented speedily.
Accordingly, it appears that the FRC will be abolished and replaced, but no timeframe has been put on this. The full implementation of the recommendations of the Kingman Review will require the passing of primary legislation, so it will be interesting to see when this legislation will be forthcoming given the extent to which preparations for Brexit (notably increased preparations for a ‘no deal’ Brexit) appear to be taking up governmental and cicil service resources.