FRC reports ‘significant progress’ on transformation

The Financial Reporting Council (FRC) has had a year of ‘significant progress’ in implementing its transformation into a new regulatory body, but has been hampered by the lack of legislation and recruitment challenges, according to its latest annual report and accounts

Former FRC chairman Simon Dingemans, who resigned in May after only eight months in the role, said that over that period ‘the reform agenda in front of the FRC has become even more expansive and complex’.

There have been three separate reports over the last eighteen months making the case for reform of the FRC itself and the activities that the FRC regulates: Sir John Kingman’s independent review of the FRC,  the Competition and Markets Authority’s final report on its statutory audit services market study,  and Sir Donald Brydon’s review into the quality and effectiveness of audit.

Dingemans said the FRC is working closely with the Department for Business, Energy and Industrial Strategy (BEIS) to bring these proposals and recommendations together into a unified transformation programme.

Sir John Thompson, who replaced Stephen Haddrill as head of the FRC in October last year and is charged with overseeing its transformation into a new regulatory body, the Audit Reporting and Governance Authority (ARGA), said: ‘We have now implemented 20 of the 83 recommendations in the Kingman Review. We are progressing as much as we can whilst waiting for the legislation to establish the ARGA on a statutory footing.

‘The totality of the transformation agenda is huge. It requires primary legislation for it to be fully delivered and the resulting regulator will be much larger, more proactive and communicate better. There is a lot to do to deliver this and we are embracing the necessary changes.’

Both Thompson and Dingemans stated that the FRC’s focus during the year and for the forthcoming months is on driving  up audit quality, given recent high profile corporate failures and the fact that the FRC’s own inspection cycle has shown continued weaknesses in specific areas.

Over the past three years nearly half of the drivers of FRC reviews requiring more than limited improvements have been in the same three audit areas: impairment of goodwill and intangibles; revenue and contracts; and provisions, including loan loss provisions.

The FRC’s response has included the recent proposals that the Big Four firms separate operationally their audit practices from the rest of their business so that they are focused on achieving audit quality.

Dingemans said: ‘Although it remains early days, there is substantial additional investment into audit and active engagement with our proposals for operational separation of the audit businesses of the larger firms in the UK which will give the FRC, as regulator, clearer visibility of the state of those businesses.

‘Supervision of the major audit firms is also deepening. This will be a new type of supervision for the firms. Sustainable improvements will take time, but these steps are moving in the right direction.’

Resourcing

However, the FRC’s annual report also showed that the regulator carried out fewer audit quality reviews this year than planned, and fewer than in previous years, due to resourcing constraints.

According to its annual report, the FRC had 243 employees at 31 March 2020, compared to 210 the previous year, despite acknowledging that ‘as part of our transformation into the ARGA we need to recruit many new colleagues to help us deliver on our new purpose and expanded activities’.

In its Plan & Budget 2019/20, the FRC indicated it intended to recruit 80 new staff during 2019/20. According to its annual report, although it has filled 47 positions during the year, and at the year end had ten new staff ready to join in the first few months of 2020/21, the overall increase in staff numbers is fewer than might have been expected. This is partly due to leavers; although voluntary staff turnover remains low at 11.4%.

The most significant change in employee numbers is in the supervision division, where the FRC has recruited additional staff across all areas, audit inspections and supervision, corporate reporting review and professional oversight.

The annual report states: ‘In 2020/21 we are again seeking to recruit people into new roles to expand our activities and transform into the ARGA.

‘Our Strategy 2020/21 forecasts over 100 new roles during the year, in addition to replacing any leavers. Our ability to recruit enough people with the requisite skills and experience is a significant challenge to our strategy; during the COVID-19 pandemic we adapted our processes enabling us to continue to welcome new colleagues into the organisation.’

Investigations

The FRC has 42 investigations ongoing, having concluded 13 full enforcement action cases during the year and opened a further 14.

Total financial sanctions imposed were £11.3m, and included £3.5m for KPMG in relation to BNY Mellon entities (discounted from £5m) and £4.6m for PwC in relation to Redcentric (discounted from £6.5m for settlement).

The regulator said it is working to bring cases to a conclusion more swiftly, and this year 44% were decided within two years, compared to 35% the previous year.  It is increasing resources to progress cases on a timely basis, but that some very large and complex cases necessarily take time to conclude.

One of these is the investigation into the audit and preparation of the financial statements of Carillion, which it said was ‘exceptional’ in scale and complexity, covering a four year period and numerous audit areas. The FRC says it expects to complete the first stage of its investigation this summer.

The FRC also said that one of the key elements of the transformation plan has included a thorough review of the FRC’s governance. This review is now complete, and a number of proposed changes have been announced which are designed to streamline and simplify the structure, clarify accountabilities between the board and the executive, and improve the effectiveness and speed of decision making.

The FRC needs to consult on a small number of these changes but, in light of the COVID-19 pandemic, this has been deferred until the autumn with the intention that the new arrangements will take effect from 1 January 2021.

FRC annual report 2019/20 is here: https://www.frc.org.uk/getattachment/d3201f4b-2946-4e50-aa27-3a131ae17750/Annual-Report-2019-20.pdf

By Pat Sweet

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