FRC position paper: restoring trust in audit and corporate governance

The Financial Reporting Council’s (FRC) has published its Position Paper setting out a roadmap for supporting the Government’s plans for audit reforms as the FRC transitions into the Audit, Reporting and Governance Authority (ARGA).

The planned reforms were set out in the Government’s Response to the consultation on strengthening the UK’s Corporate Governance, Corporate Reporting and Audit systems published on in May 2022 (“the Government Response”). Our analysis of the Government Response can be found [here].

The Position Paper primarily deals with actions the FRC intends to (and can) take ahead of primary or secondary legislation implementing some of the key areas subject to reform such as a revised definition of Public Interest Entities (“PIEs”); regulation of directors by ARGA; and Managed Shared Audit. Given the tumultuous political climate we find ourselves in, it remains to be seen when (or if) that legislation will make it on to the parliamentary agenda.

We have summarised the main ingredients of the FRC’s position paper below highlighting when further consultation can be expected:

Corporate Governance and Stewardship:

• The Corporate Governance Code will be revised to:
  • Reflect the wider responsibilities of Boards and Audit Committees for expanded Sustainability and ESG reporting.
  • Support existing Code provisions where reporting is currently weaker and revise the parts of the Code directed towards ensuring effective internal controls as well as introducing consideration by Boards of how the audit tendering process supports market diversity.
  • Address proposed changes to the legal and regulatory requirements detailed in the Government Response, including strengthening reporting on malus and clawback arrangements.

• The FRC’s intention is that the revised Code will apply to periods commencing on or after 1 January 2024.

• The revised Code will be supported by updated Guidance relating to Audit Committees, board effectiveness and internal control and the FRC will develop for use, initially on a voluntary basis, a set of Minimum Standards for Audit Committees to address the issues relating to competition and effectiveness of the statutory audit market raised by the CMA’s review. Roundtables to discuss this will take place in the second half of this year.
• In the expectation that whilst the legislative detail is awaited, annual reports (which together with the accounts will be subject to review by the Supervision Division’s Corporate Reporting Review team) should include corporate governance disclosures, the FRC will include these in the first year of Code implementation.

Consultation on the revised Code and supporting material can be expected from Q1 of 2023.

Corporate Reporting:

• Whilst legislation is awaited, the FRC will develop implementation guidance for, among others areas, (a) the Resilience Statement; (b) fraud reporting by directors; (c) the Audit Assurance Policy and related disclosure requirements; and (d) capital maintenance and dividends.
• The FRC will also revise its guidance on the Strategic Report once the Government has set out its policy in respect of the use of International Sustainability Disclosure Standards in the UK.
• The FRC also intends to include new reporting disclosures in its review processes from the date at which any new reporting requirements commence, subject to the extension of Corporate Reporting Review powers. To further support implementation, the FRC Lab will carry out a series of projects to assist with the development of the new reporting requirements.
• Finally, together with the Department for Business, Energy and Industrial Strategy (BEIS) the FRC intends to work to reduce the burden of corporate non-financial reporting.

Audit:

• The FRC states that it will make revisions to a range of standards including the Ethical Standard to address some of the policy points in the Government Response and to take account of feedback and evidence from inspection and enforcement as well as to reflect changes to international ethical requirements.
• Significant changes to the Ethical Standard will include, among others, (a) revisions to take account of the new proposed framework for PIEs that contains three levels of PIE (historical; new proposed PIEs; and new PIEs caught as a result of changes to the international definition); (b) a consultation on whether it is desirable to exclude sustainability assurance work from the UK aspect of the non-audit services fees cap; (c) any changes necessary to address the expansion of audit-related assurance work driven by sustainability and ESG; and (d) “necessary revisions" to address issues identified as a result of our Supervision and Enforcement work.

A Consultation on a revised standard will take place in Q1 2023.

• In order to address the useability and informative nature of the audit process for stakeholders, the FRC will consult on a number of existing ISAs (UK) including those relating to reporting and communication as well as reporting to regulators (involving the recommendations by Brydon regarding a “duty to report”). In approaching these revisions, the FRC will be seeking to minimise divergence between the UK and international standards.
• The FRC will consult on performance standards to support a consistent approach to assuring internal controls reporting and the new resilience statement.
• Having consulted on a new PIE auditor registration process in Spring 2022, the FRC expects to transition to the new process from Autumn 2022 onwards. The FRC will continue to develop its audit supervision model, including assessing the Big Four firms’ progress in voluntarily implementing operational separation. It will also consult on its approach to meeting the competition/market resilience objectives set for ARGA.
• Policies and procedures supporting the full set of supervision powers including those dealing with expert reviews (akin to the FCAs “skilled person reports”) will be developed.
• The importance of talent management is highlighted and a consultation on improvements by the auditor professional bodies on qualification, training and skills is expected in late 2022/early 2023 with implementation in 2023-24.
• The newly developed “Audit Sandbox will be used to assist with the implementation of new or revised requirements in auditing and ethical standards. It is intended to operate as a “safe regulatory space” for auditor and regulator dialogue on audit and competition policy related issues.

Additional steps:

• Actuarial Regulation: the FRC will begin work in anticipation of the statutory regulation of actuaries including establishing what actuarial work should be considered as being of public interest and therefore within ARGA’s statutory regulatory scope.

• Local Audit Systems Leader: The FRC has recruited a director to lead work towards improving the landscape for local authority financial reporting and audit.
• Transfer of Independent Supervision of the Comptroller and Auditor General to Parliament: The Professional Oversight Team will support this transition working with BEIS to achieve this.

Funding:

• Views on the high level principles underpinning ARGA’s statutory funding model will be sought in Summer 2022.