It is five years since Sir John Kingman recommended that the Financial Reporting Council (FRC) should be replaced with a statutory body – the Audit, Reporting and Governance Authority (Arga). Already delayed until 2024, the expected omission of Arga’s formation from the King’s Speech, due in November, has pushed the timetable back until after the next general election, due by the end of January 2025. Let’s say 2026.
Consumers of financial (and other corporate) information have strongly supported Arga’s creation because, according to Kingman, it should have an overarching duty to protect their interests, not those of producers. In the wake of the Carillion and other corporate scandals, this was a central plank of the government’s agenda, ‘Restoring trust in audit and corporate governance’.
This ‘improvement’ approach can compromise the assertiveness championed by the FRC chair
Fortunately, the FRC has not been holding its breath. Roughly half of Kingman’s 81 recommendations – not all were relevant to corporate reporting – have been implemented. Advances in international standards, such as on audit quality management (ISQM 1 and 2), have helped. So has the FRC’s improved record, for both sanctions and timeliness, on enforcement. Less high-profile changes, such as the registration of auditors of public interest entities, also matter because they provide supervisory traction.
Flexibility fudge
However, since the regulator should where necessary be ‘feared’, it is a pity that the power to hold directors to account has been delayed along with Arga. The FRC has instead had to rely on its traditional approach, encapsulated in the Corporate Governance Code, of ‘comply or explain’, along with endless best-practice guidance.
The nagging doubt is that the good comply and the bad do not
My concern with this ‘improvement’ approach to regulation is that it can compromise the assertiveness that has been rightly championed by FRC chair Sir Jan du Plessis. Of the FRC’s four faces, I am keener on the harder ones of supervisor and enforcer than on the softer ones of ‘system partner’ and facilitator. These approaches can of course be complementary, but the nagging doubt is that the good comply and the bad do not. Flexibility can become fudge, which enables abuse.
The most alarming paragraph in the FRC’s consultation on a revised CG Code is this: ‘In our most recent Review of Corporate Governance Reporting we found that more companies are using the flexibility of the ‘comply or explain’ nature of the code, with 27 companies out of the 100 reviewed claiming full compliance with the code this year, compared to 58 companies last year.’
The FRC says this ‘demonstrates the benefits’ of the code’s approach. I think it does the opposite.
The good news
More positively, other pieces of legislation are in the works. The Draft Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023 would implement important parts of the ‘Restoring Trust’ agenda – credit to Sir Donald Brydon’s 2019 review – including an audit and assurance policy and statements on resilience, fraud prevention and distributable profits. These draft regulations should be passed before the end of the year.
It may be difficult for the would-be authority to focus relentlessly on its purpose
This month, the FRC welcomes a new CEO, Richard Moriarty, who held a similar role at the Civil Aviation Authority. He joins a board that is seeking three non-executive directors with institutional investment management, actuarial and local government skillsets, illustrating the overly wide-ranging nature of the FRC’s responsibilities.
Even with resources that are roughly double the pre-Kingman era, it may be difficult for the would-be authority to focus relentlessly on its purpose: ‘to serve the public interest by setting high standards of corporate governance, reporting and audit, and by holding to account those responsible for delivering them’. Statutory backing for its A, R and G core is sorely needed.
