As auditors face sweeping changes to the profession with questions about effectiveness and independence at the heart of three major reviews into the future of audit, the FRC’s role is integral of the transformation.

Perhaps most important to restoring trust in auditors is the overhaul of the audit regulator itself, with its long-trailed transformation into the ARGA, a powerful new regulatory body with sweeping statutory powers.

What is the latest on the creation of the ARGA?

‘Up until last Tuesday, we were relatively clear about the timetable for the ARGA. We met the secretary of state on Tuesday to discuss this and we were clear about the future direction, but the reshuffle on Thursday means that we have a new business secretary in charge so we need to have more meetings, but the department [BEIS] is geared up and has all the information it needs.’

Although the cabinet reshuffle may have stalled progress temporarily with Alok Sharma now in charge at BEIS, Sir Jon is confident that significant progress has been made to date, explaining that the government has the three substantive reviews – Kingman, Competition and Markets Authority (CMA) and Brydon – and the ball is in its court.

‘There have been three major reviews and the government needs to give its responses.

‘The government needs to give its response to the public policies in Kingman, for example should the UK adopt Sarbanes Oxley.

‘It also needs to respond to the CMA review, on the main issues such as regulatory oversight of audit committees, joint audits and separation of the audit function in firms.

‘In Donald’s [Brydon] report, there are a number of recommendations that require legislation, but this could be split into two parts. The report has a very broad landscape of recommendations – 64 in all, including public policy issues. The government needs to decide whether it wants to adopt those, and whether it wants to make changes to the Companies Act.

‘There was a legislative slot in the Queen’s Speech for audit reform and we have been giving the government advice on the different aspects of the reports.

‘I don’t think you’d expect draft legislation until the autumn. We still need the government response to the three reports, and then there would need to be consultation with key stakeholders – those who want to respond – and then draft legislation.

The FRC will go ahead with changes which do not require statutory intervention with the likelihood of joint audits high on the agenda

‘But this does not mean we are simply waiting for the government to make their decision.’

Whatever happens at governmental level, the FRC will go ahead with changes which do not require statutory intervention with the likelihood of joint audits high on the agenda.

‘In all three areas, where there needn’t be legislation, we can do a lot on a voluntary basis. We have been probing into as many of the issues as we can, working with other parties and working on a de minimis option for splitting audits, even if not on a regulatory basis.’

The FRC has been talking to the heads of the Big Four audit firms to establish how joint audits could work, for example, and has been assessing their objections, and considering various options for moving forward. The concept of joint audit is likely to be introduced for listed entities outside the FTSE 100, but still requires some thought.

Strategic plan

The publication of the FRC’s 2020-21 budget and work plan gave the regulator the opportunity to set out its priorities in a new strategy document.

‘We set out the objectives when we published our strategy, this included regulatory principles and some clear deliverables that people can hold us to account on, for example when might we conclude Carillion. We are trying to be more transparent.’

One of the hotly debated issues at the moment is the CMA proposal to carve up the Big Four firms, divesting audit service lines from the rest of the business, particularly to remove potential conflicts of interest.

Sir Jon said: ‘I am fairly neutral about it – there can be some conflicts of interest and there are questions about governance of the audit practice. The CMA is asking for legal separation. Ministers now have some choices to make. It is either the CMA option or negotiated principles.

‘I’d be surprised if ministers didn’t support some moves to separate the audit businesses.

‘We have been very engaged with the consultations. We were asked to provide alternatives and we have been able to make significant progress. We have had meetings with all the heads of the Big Four firms in the UK to discuss this.’

Unilateral reform

When asked whether unilateral reform of the UK audit market would be problematic for other global regulators, Sir Jon admitted that the UK position was being closely watched around the world.

Next month he will be heading to the US to meet with the senior management of the Big Four accounting networks and the ramifications of breaking up the Big Four will be a key discussion topic.

If ministers decided to make a significant step there would be a good deal of interest from regulators around the world

‘The regulatory framework does slightly differ in all 58 countries that have a similar regulator. The UK is generally held out to be a good beacon of what you can do in terms of audit governance, regulation. As regulators, we meet regularly, and we learn a lot from each other.

‘If ministers decided to make a significant step there would be a good deal of interest from regulators around the world.’

Recruitment challenge

As the FRC works towards its transformation into the ARGA, the regulator has not stood still and with more responsibilities and regulatory oversight powers, it has had to consider overall staffing levels.

The next 12 months will see an ambitious recruitment programme now that the regulator’s future has been secured with additional funding and a hike in enforcement activity planned for 2020-21.

‘In the last year we have expanded by 60 staff and in the year to come we plan to expand with a further 100 staff. We have changed our pay structure so now we have six grades and have agreed a salary ceiling of £150,000.

‘Another 100 is a challenge, it is not easy, but there are a number of things about working for the FRC; it is very interesting, there is flexibility and it is a good place to work, and it is a challenging time to work here. It is not all about the money.’

When it comes to hiring staff, there are a number of issues beyond salary considerations for staff joining from senior jobs. Arguably any move for an auditor could feel like a reversal of roles, particularly when moving from an accounting and audit firm to the regulator, but Sir Jon is keen to stress that the 100 number is not restricted to one type of hire.

In other words, a Big Four alumni would not be turning into an investigator without the prerequisite expertise and skills to provide independent oversight.

The FRC’s talent requirements are diverse, as is the remit of the organisation, which makes the recruitment scenario far from straightforward.

‘It is important to understand that the FRC does three significantly different things – it sets standards and codes, supervises their application and then we enforce. These are three sets of quite different skills.

‘We need people with strong technical skills, knowledge of the Corporate Governance Code, IFRS, UK GAAP, etc, and this requires a particular set of skills. It is slightly different with supervisory skills - those people have to synthesise the work of auditors, how the audits are conducted, the level of auditor scepticism, their effectiveness, what’s good and what’s bad, and then they have to communicate this to the auditors so that the overall audit work improves. Enforcement is much more forensic, it is all about legal work, forensic analysis, discovery.’

Post-Brexit audit

Looking to the future and still under the shadow of final trade negotiations with the EU, another question is whether a post-Brexit UK could offer any opportunities to reform audit?

The EU Audit Regulation & Directive (ARD) was introduced in June 2016, bringing a statutory 20-year mandatory audit tenure onto the statute books in the UK following EU intervention.

My view is 20 years is too long. We need to question whether someone can operate with independence and the right degree of scepticism after so long

Prior to this the UK followed the ‘comply or explain’ rules set out in the UK Corporate Governance Code, which set a 10-year tender limit and was being followed by all listed entities. The watering down of the rules post ARD was arguably a mistake, something which Sir Jon does not dispute.

‘My view is 20 years is too long. We need to question whether someone can operate with independence and the right degree of scepticism after so long. 20 years seems to be a very long time, even taking into account that the senior audit partner rotates.

‘I have spoken to more than 150 audit committee chairs since I started this job and many of them are rotating auditors or planning to every seven years. This is what is happening across listed companies.’

Despite a number of attempts to widen competition in the audit market, dating back to the first CMA [then Competition Commission] recommendations in 2012, competition is still limited, with the majority of listed audits held by the Big Four.

There is still reticence on the part of major listed entities to drop Big Four auditors for firms outside the top tier. Only five audits in the FTSE 250 are held by mid-tier firms, only one in the FTSE 100. This leaves major questions about an endemic failure to resolve the lack of competition.

More frequent rotation is one factor which Sir Jon thinks could improve competition across the market, but he also points to the CMA as being the body which needs to take this on.

‘I think that rotation could make the market more dynamic, but really it is up to the CMA. Beyond the Big Four, the fifth/sixth/seventh firms are sizeable businesses. But we have to be realistic about what part of the market we are talking about. If you take the audit of HSBC versus a listed entity with a market capitalisation of £250m, then there is no comparison.

‘One of the questions we are looking at is how can we get more diversity in the FTSE 250, and we have given ministers some options. One of those is shared audit – we have set out how this could work.’

When asked about his thoughts on whether a public body authorised to allocate audits was a workable scenario, he gives this short shrift.

‘It would be very odd and not even legal. It is not for the FRC to get between the auditors and the companies. The FRC’s board position is that we would not agree with that.’

The next few months will be critical for the government, faced with finalising plans for the future of the audit profession and a credible timetable for the creation of ARGA.

Culture – FRC versus HMRC

On a final note, with five months under his belt, Sir Jon expanded a little on the difference in culture between the FRC and HMRC, where he was chief executive officer and permanent secretary for three and a half years.

‘There’s a huge difference. At HMRC I was leading an organisation with 65,000 people versus 260 at the FRC. Here you get to meet everyone, you get to talk to everyone and in that sense being the chief executive of an organisation this size is much easier. You can debate the big issues and wrestle with the challenges. It is less rigid as it is smaller.

‘When you manage an organisation of 65,000 people, it is quite different.

‘But the downside is that we don’t have the capacity to do things on the scale we could do at HMRC, for example, research projects and tech support for IT developments. Here we do lots of partnerships, for example on research, on the Parker Review into board diversity where we worked closely with Cranfield [School of Management].’

Another aspect of the job he enjoys is appearing at parliamentary select committees and he will have plenty of opportunity in the next few months. ‘I have been before 87 parliamentary committees, I probably hold the record for being before them,’ he added.

Sir Jon is no stranger to a challenge; early in his career after training as an accountant at EY, he left the comforts of a Big Four firm to work in public sector finance at a failing local authority. Since then, he has not shied away from the big jobs, overhauling finance at the Ministry of Defence in a new role of director general of finance initially and then overseeing the organisation as permanent secretary.

He took over the top job at a troubled HMRC in 2016 after the departure of his predecessor Lin Homer. His stint at HMRC saw the major restructure of the organisation with significant office closures and the opening of a string of regional hubs. He was also instrumental in the introduction of digital tax reporting with the rollout of Making Tax Digital for VAT. 

‘I’m no stranger to a challenge. I left EY to help a council which was in a very major financial mess.

‘I do jobs because they’re challenging and fantastically interesting. We have 170 recommendations on audit reform and we are going to be at the centre of that; we need to change everything, including our own organisation. It is a tremendously exciting time to be here.’ 

By Sara White