Comments from ACCA
ACCA is in favour of many of the proposed changes, and welcomes the proposed streamlining of the FRC. For some time, we have maintained the view that the seven-board structure of the FRC is far from ideal. It is the result of piecemeal changes in the past, and would certainly not be the chosen structure if designing a completely new FRC.
We believe benefits of a more integrated approach to standard-setting and compliance should emerge from a structure that allows the FRC to consider the entire ‘financial system’ at a strategic level. It recognises that there is a strong inter-dependency between financial reporting, governance, and audit and assurance which suggests that market confidence will be best enhanced by developing standards and regulatory structures ‘in the round’.
ACCA is of the opinion that the quality of audit work in the UK remains generally high. Similarly, the quality of the UK Corporate Governance Code and the actual standard of corporate governance in the UK are very high. It is agreed that the UK requires a first rate regulatory framework for corporate governance and reporting to ensure continued investment. It is also agreed that, due to the structure of the FRC, the current framework is insufficiently well understood.
The consultation document states that reform is needed to ‘rationalise and minimise the regulatory burdens on market participants’. We would question whether this objective is currently appropriately stated, as it has, in the past, been alleged that the deregulation of banking supervision was a contributory factor to the credit crisis. Instead, the FRC should address the objectives of its regulation, and determine how it may best meet those objectives in a focused and proportionate manner.
ACCA understands the need for regulators to be independent of those they regulate and, therefore, the need for the FRC itself to be independent of accountants and the accountancy bodies. At the same time, it is in the public interest for the FRC to focus its resources and attention on the regulation of those activities that give rise to the highest risk. Provided that accountancy and actuarial bodies can satisfy the FRC that their structures and procedures incorporate acceptable standards of independence and professionalism, we believe that it should remain feasible and justifiable for those bodies to be entrusted to exert agreed levels of regulatory control over their own members. A refocus on outcomes, with FRC intervention being reserved for the areas of greatest concern, would be strongly supported by ACCA.
We believe that a separation of responsibilities of this kind is capable of maintaining public confidence and trust in the activities of accountants and actuaries while also being consistent with the principles of proportionate regulation.
The case for FRC reform
1. Do you have any comments on the case for FRC reform as set out in this document?
We agree that the structure of the FRC is unnecessarily complex, and that part of the solution to this problem would be to more clearly define the scope of the FRC’s regulatory responsibilities. This should go hand-in-hand with a willingness to dispense with some of the current activities of the FRC. However, this should take place with caution.
While we agree that the reformed structure of the FRC is important, it is of greater importance that those within the organisation charged with decision-making and providing technical support to the Board and Committees relating to accounting, auditing and corporate governance issues have the correct skills and market knowledge/experience.
Careful consideration is also required in respect of regulatory independence. While we agree that independence is essential in all cases, we do not believe that this should always necessarily involve total separation between regulator and regulated. Within the existing framework of self-regulation, the major accounting bodies have shown a strong commitment not only to regulating their members fairly but demonstrating that they perform these functions in the public interest. Self-regulation, when carried out responsibly, can be almost as effective and ‘independent’ as regulation carried out by a ‘detached’ body. Indeed, we see a strong case for the continuation and promotion of this co-regulatory environment in which the bodies carry out core regulatory groundwork and the FRC oversees this work from a public interest stance.
Nevertheless, the current procedure whereby, following an audit inspection, the Audit Inspection Unit refers the firm to a committee of the relevant professional body, does not adequately safeguard independence, unless there is a requirement for that committee to have a lay majority. Although a degree of self-regulation is required in order to understand the issues that require professional judgement as well as the technical aspects, an adequate level of independence should exist in decision-making committees in order to protect objectivity and also satisfy public expectations.
We acknowledge that, theoretically, the oversight of the Recognised Supervisory Bodies (RSBs) and Recognised Qualifying Bodies (RQBs) by the Professional Oversight Board (POB) currently can only bring about change by influence. However, we would argue that the reality is somewhat different, particularly as POB now ‘names’ in its annual report those RSBs/RQBs where improvements to arrangements have been recommended. We therefore believe that the current system operates well, and the persuasiveness of POB in the light of the transparency of its recommendations and regulatory processes (together with the transparency of the RSBs and RQBs) would suggest that significant change may be unnecessary. Care should be taken to minimise the likelihood that any future changes to the system of oversight of the RSBs and RQBs could be seen as an indication of serious failings in the current system, and so threaten the public perception of integrity within the accountancy profession.
2. Do you agree that the proposals for reform will bring benefits and increase the effectiveness of the FRC?
It is of utmost importance that the FRC is seen to be sufficiently independent of those it regulates, and that it is able to effectively challenge failure to meet the standards of behaviour expected. It is also important that the FRC retain its broad remit but focus its intervention on those entities that pose a systemic risk to the economy.
Streamlining the responsibilities of the FRC into a simpler, more easily understood, organisation is viewed positively by ACCA. Currently, the impact of the seven different bodies working to achieve the common objective of high quality corporate reporting and governance presents regulatory risk for the FRC, and inefficiencies for preparing bodies and the professions in terms of the volume of regulation and guidance emanating from the FRC. The public and the profession would be able to better understand the role that a streamlined FRC plays. We also believe that a restructured FRC may be more effective in delivering its strategic aims.
However, we note that the consultation document, while setting out in paragraph 2.7 its current major activities, does not attempt to map a complete list of its on-going responsibilities to a list of responsibilities that would be retained under the proposed new structure.
Paragraph 2.4 of the consultation document includes the following sentence:
‘The FRC is proposing that it will continue to maintain an appropriate framework of UK accounting and audit standards that address the needs of smaller companies.’
There is no other reference to small or medium-sized entities throughout the document, and we are concerned that the interests of this crucial business sector may be under-represented on the Board Committees, and particularly on the accounting Advisory Council. With a primary focus on larger and listed entities, it appears that the Advisory Councils would, through necessity, be populated with expertise in such entities. This is likely to leave a gap in knowledge concerning issues affecting smaller entities (which account for a large proportion of the UK economy). Such expertise is currently provided through the input of the Committee on Accounting for Smaller Entities (CASE) and the SME Audit Sub-committee.
It appears that the Board Committees would have the power to appoint panels and specialist groups, but these are not explained in the consultation document. In this respect, we believe that the consultation leaves several questions unanswered. However, it appears that the panels and specialist groups would be formed to meet specific needs as required, and not appointed so as to replicate the current Board structure. Similarly, it appears that the proposal is that the Advisory Councils referred to in the document would advise the Executive, so that all decision-making responsibility would rest with the Board.
Advisory Councils are expected to be effective so long as they comprise people of the appropriate calibre and experience. This will require the correct balance, and the active involvement of practitioners, rather than being predominantly comprised of theorists.
No assurance is given in the consultation document that the bodies recognised by the FRC for the purpose of developing Statements of Recommended Practice (SORPs) would continue to enjoy the support of the FRC. Therefore, we (and bodies such as The Charity Commission and the National Housing Federation) are concerned that gaps may arise, leading to a deterioration in the quality of financial reporting in these specialist areas.
3. Do you have any comments on the consultation stage impact assessment?
The costs of the proposals are anticipated to be almost £500,000, which would be met by the FRC reserves, leaving normal contributions from stakeholders unchanged. The anticipated annual benefits are calculated as £1.33m. The quantified annual savings envisaged are those of the FRC alone, arising largely from the early settlement of disciplinary cases (£750,000, but see our comments under 15 below) and the FRC activities relating to a smaller set of responsibilities (£280,000). However, there is a narrative suggestion that the proposals would strengthen the framework for corporate governance and reporting, which would also benefit the UK economy.
It may be said that the impact assessment is inward-looking. For example, if option 3 was selected, it may act as a deterrent or incentive in relation to listing on the UK market, but this aspect is not acknowledged.
An investment focus for the FRC’s activities
4. Should the primary focus for regular FRC activity in relation to codes and standards for corporate governance, accounting and auditing, and for monitoring the quality of corporate reporting and auditing, be publicly traded companies and large private companies?
It is agreed that the FRC should retain its current broad range of regulatory activities, and intervention should be limited to entities that pose systemic risk to the economy. We acknowledge the impact that failure of (or mere controversy concerning) a publicly traded company may have on an economy. Nevertheless, in view of the bedrock of small and medium-sized entities that make up the vast majority of business in the UK, ACCA believes in the merits of ‘thinking small first’, and would encourage standard-setters to do the same. Therefore, although FRC inspections and investigations should be targeted towards the most significant entities in terms of size and risk, its standard-setting responsibilities should be fully capable of being applied to organisations to reflect their scale and complexity, while clearly indicating additional provisions necessary in respect of public interest entities.
As already noted, there is only one reference to smaller entities throughout the consultation paper. This simply states:
‘The FRC is proposing that it will continue to maintain an appropriate framework of UK accounting and auditing standards that address the needs of smaller companies.’
5. Is the definition of large private company for this purpose – an annual turnover of £500m or more – appropriate?
In light of the proposed intervention of the FRC being limited to those entities that pose systemic risk to the economy, it would appear reasonable to have regard to the size of an entity, and the threshold suggested would appear reasonable also. Nevertheless, to define public interest as publicly traded companies and large private companies with turnover in excess of £500m appears too restrictive, and somewhat arbitrary. Other factors could include the number of employees (or other stakeholders) in an entity or the value of its assets. In addition, there are many more factors to consider when addressing the issue of public interest. We believe that the definition of a large private company should either be refined or, alternatively, that the definition of a public interest entity should be open-ended, so that it might include any entity that the FRC considers may be of public interest.
6. Should the scope of the FRC’s accountancy disciplinary arrangements be narrowed to cover the quality of work and conduct of accountants in relation to the preparation and audit of annual reports and other reports for the capital markets, leaving other cases of potential misconduct to the professional bodies?
We agree that this should be the focus of the FRC’s disciplinary function, although any public interest entity should fall within its scope also. In this respect, it is important that the FRC maintains the transparency of its operations. There should be clear procedures established, and published, which should include appropriate independence measures incorporated into the FRC’s disciplinary processes.
7. Are there other areas of activity from which the FRC could appropriately withdraw?
Some of the activities listed on pages 14 to 17 of the consultation document indicate the need for liaison between the functions that maintain and promote standards and the functions that address issues of conduct. This suggests that the future activities scoped for the FRC should not necessarily be defined exclusively in terms of either ‘standards’ or ‘conduct’, and we are pleased to see among the proposed activities of the Conduct Committee that it would ‘provide timely feedback into standard-setting and thought leadership’. However, we have identified no activities from which the FRC should clearly withdraw. It should retain its broad remit, while focusing its intervention on public interest entities.
However, at this time of proposed streamlining and simplification, there is an opportunity to take a broader view of the future scope of the FRC’s regulation. Although the proposal is for just two Committees (Codes and Standards, and Conduct), each Committee would regulate both accountants and actuaries. A clearer focus would be for the FRC to concentrate on the accountancy profession (primarily auditors of public interest entities), and allow another body to oversee the regulation of actuaries in the same way that different bodies are responsible for the proper conduct of solicitors.
A streamlined structure
8. Do you agree that streamlining the FRC’s governance and structure will bring the benefits described?
A more streamlined governance and structure would be welcomed. The division into two sectors – codes and standards, and conduct – would facilitate better understanding of the structure by stakeholders. ACCA has, for some time, maintained the view that the current seven-board structure of the FRC is far from ideal. It is the result of piecemeal changes in the past, and would certainly not be the chosen structure if designing a completely new FRC today.
However, the consultation paper does not explain how the transition to the proposed structure would take place. In order to achieve the benefits described, the FRC must retain credibility with UK authorities and international organisations as well as stakeholders and those it regulates in the UK. Not least of all, it would have to maintain effective relationships with all parties during the transition process. ACCA supports the objective of FRC reform, and would be willing to work with the FRC in order to help achieve transition.
Do you have any comments on the proposed reformed FRC governance and structure?
The consultation paper makes no mention of the size of membership of the Board and each of the Committees. If all the experience and expertise of the current Boards are absorbed into the Codes and Standards Committee and the Conduct Committee, it is assumed that these committees would carry a significant number of members and, in turn, the FRC Board would be large. We foresee this as presenting a challenge to the FRC which remains unaddressed in the consultation paper. The question is whether the FRC Board would be able to achieve consensus and so be able to conduct business effectively.
We note that the consultation document does not describe the composition of the Committees. It states that they would each have a lay majority of members, but would largely comprise market participants. In this context, the term ‘lay’ is not defined. The capabilities of members of the Board and all those who would serve on its Committees are of the upmost importance, even of those Committee members not also serving on the full Board. Similarly, little is said in the consultation document about the Advisory Councils and panels – the number of members, balance of expertise, etc.
No details are given in the consultation paper regarding sub-committees (and only passing references are made to specialist groups and panels). ACCA considers it essential that small and medium-sized practices and reporting entities are adequately represented within the proposed structure, such that their interests are upheld. (We say more about this under question 2 above.)
The publication of Guidelines on the criteria that the FRC would use in making decisions on conduct issues is welcomed. This would provide transparency in this area, ensuring that stakeholders are better informed, and helping to uphold all the principles of better regulation.
With regard to the activities of the FRC in respect of audit, International Standards on Auditing are now, in effect, adopted and so there remain only two aspects to the work of the current Auditing Practices Board. The first is international representation of UK interests. This is considered vital, even if, in many instances, the UK view does not prevail.
The second aspect is the production of standards and guidance for the work of UK auditors that are not subject to international standards. (A recent example would be the Bulletin on providing assurance on client assets to the Financial Services Authority.) We should like to caution that the streamlining of the FRC should not hamper attempting to keep such matters at the forefront of developments in the UK and, as industries such as banks, pension schemes and financial institutions depend on the involvement of auditors and the conduct of auditors in accordance with UK produced standards and guidance, the impact on the economy could be significant if these matters are not properly safeguarded. ACCA believes that, under the current governance and structure, the Auditing Practices Board is performing its functions very well, and whatever contraction of focus the FRC undergoes, it will be important to maintain those capabilities into the future.
The only reference in the consultation document to the Republic of Ireland is in paragraph 2.9, which acknowledges that accounting and auditing standards are applied by the relevant authorities in the Republic of Ireland, and that the FRC will ‘liaise as appropriate with these authorities on the proposals and any potential impact on the Republic of Ireland’. We should expect such liaison to be ongoing, and this should extend to appropriate representation and participation by Irish stakeholders in the new FRC structures.
For the FRC to continue to ensure that the UK has a world class regulatory system it must continue to be consultative with stakeholders, including investors, preparers of financial statements and regulatory organisations. This is critical to achieving engagement, and encourages ‘buy-in’ by those expected to implement the standards and those who advise and monitor the implementers.
Independent supervisory and disciplinary arrangements
10. Do you agree the FRC should be given powers to determine and require a recognised supervisory body to impose proportionate sanctions, subject to appropriate safeguards, on an audit firm and/or individual auditor in respect of poor quality work?
The RSBs are aware of the importance of the involvement of the FRC in the monitoring and disciplining of auditors, and are unlikely to act contrary to the recommendations of the FRC. However, it is agreed that appropriate regulatory independence of the FRC is vital to underpin confidence in the accountancy profession.
Therefore, we agree with the proposal that, under certain circumstances, the FRC should be able to require an RSB to impose proportionate sanctions, provided clear procedures are published by the FRC. Nevertheless, we acknowledge that there are arguments against the FRC gaining such powers. These include the right to a fair hearing prior to sanctions being imposed.
The RSBs must also be seen to be regulating their members effectively. The imposition by the RSBs of sanctions determined by the FRC, based on statute, could undermine the authority of the RSBs and weaken their ability to regulate their members. Nevertheless, we acknowledge the need for the regulatory committees of the RSBs to demonstrate sufficient independence from those they regulate. ACCA’s disciplinary and regulatory committees are independent of the profession – having lay majorities – and its arrangements for regulation and discipline are overseen by an independent Regulatory Board.
11. If not, what are your concerns and how do you believe this issue should be addressed?
In addition to the concerns expressed under 10 above, ACCA would be uneasy receiving directions from the FRC on how to discipline its members in situations in which ACCA had not been a party to the investigation or the determination of the sanction. The sanction may not be in line with current ACCA policy or practice. ACCA’s Disciplinary Committee is independent (always consisting of a lay majority), and the proposed level of intervention by the FRC would radically change the way that it operates. In addition, ACCA’s disciplinary arrangements relate to its members globally and, therefore, any impact on these arrangements that affects only UK members may be perceived as preventing a ‘level playing field’.
12. Do you agree the FRC should have the ability to make its own rules for the independent disciplinary arrangements without being required to obtain the agreement of the professional bodies?
We agree that, subject to appropriate consultation with the professional bodies, the FRC would be perceived as being a more independent regulator of the accountancy profession if it were to have the ability to amend the Scheme without the agreement of the professional bodies. This alone would go a long way to achieving the aims of this consultation.
13. If not, how would you propose the FRC demonstrates it independence in this regard?
See question 12 above.
14. Should the FRC be able to take more proportionate, nuanced action against a Recognised Supervisory or Qualifying Body and therefore be given a wider range of enforcement powers against the recognised bodies? In particular, should the FRC be able to:
- Issue an enforcement order, requiring the body to take specified actions by a specified date, without the need for a court order?
- Impose conditions on continued recognition as an RSB or RQB?
- Impose fines on an RSB or RQB and if so, at what level?
ACCA takes the FRC’s findings and recommendations very seriously. The transparency of the regulatory procedures of the FRC and the professional bodies (particularly regarding the issue of public reports) is a significant factor in that willingness to cooperate. It also serves to demonstrate the effectiveness of the professional bodies within a largely self-regulating profession.
Nevertheless, we acknowledge the potential benefits to be achieved through the FRC gaining intermediate-level enforcement powers (so long as those determining which actions are proportionate are appropriately informed and competent to make those assessments). Any such powers afforded to the FRC must be accompanied by proper due process and an effective appeal mechanism. Clear procedures must be established and published, including clarity regarding the thresholds for intervention and the types of serious breaches and failings that might give rise to such intervention proceedings.
We note the statement in paragraph 5.4:
‘Whilst the recognised bodies generally take the FRC’s findings and recommendations seriously, a more graduated range of powers should sharpen their responses, in particular, the timeliness of actions…’
We believe that there are more effective ways of improving the timeliness of actions by the recognised bodies, and it is hoped that the efficiencies brought about by streamlining the FRC would reduce the time between an FRC inspection of a recognised body, the issue of the ensuing report by the FRC, and the agreement of actions, based on that report, between the FRC and the recognised body.
15. Should the Companies Act and the AADB Schemes be amended to allow for the conclusion of cases without public hearings where appropriate and where agreed by the parties?
If sanctions are to be agreed without referral to a public hearing, there must be a mechanism whereby the relevant professional body may have access to the investigation completed by the FRC, so that the professional body may take the appropriate regulatory action also.
More fundamentally, we must consider whether agreeing sanctions without referral to a public hearing would be in the public interest. While each case should be assessed on its merits, it is difficult to conceive of a situation in which such an agreement between the regulator and the professional accountant would be perceived as sufficiently transparent, bearing in mind that these investigations will involve matters of public interest. If consent orders are to be used, the process must be transparent, and orders must be published.
Do you agree that the FRC should develop a mechanism to enable it to undertake supervisory inquiries into matters of concern, either of individual market events or wider market interest, initially building on its current powers to secure information?
We agree that supervisory inquiries would be a useful function of the FRC, and it would appear to be in the nature of streamlining. (Such inquiries may alternatively be carried out by a number of different organisations.)
However, we believe that costs associated with such inquiries may be significant and unpredictable, and stakeholders in the FRC would require assurances in respect of their own financial obligations.