You could be forgiven for wondering whether Richard Moriarty, six months into his job as CEO of the Financial Reporting Council (FRC), feels torn between pressures to drive up standards or to relax them to promote UK competitiveness.
His remit letter from Kemi Badenoch, Secretary of State for Business and Trade, emphasised ‘the essential importance of the FRC’s statutory growth duty’, dating back to 2015. Investors, however, have expressed disappointment at the watering down of proposed revisions to the Corporate Governance Code.
He shows no sign of feeling such conflicts. His focus is on modernising the FRC, with its public interest duty firmly in mind and its conversion to the Audit, Reporting and Governance Authority (Arga) a given after the next general election.
The key is to have ‘a regime where the regulator has an effective and good relationship with the regulated’
‘It’s really important that we modernise the framework in peacetime rather than on the back of the next potential failure,’ he says.
Directors in sight
So, it follows that company directors should be ‘within our purview’, he says. ‘It’s hard to explain [to the public] that we can only hold to account members of the accountancy profession.’
All directors should be ‘held to the same standards’. That purview should also extend to private companies that provide public services. And a modern authority should have statutory funding and the right to demand information.
‘A watchdog should have sufficient teeth, but 90% of regulatory conversations aim to improve things’
Put this way, the main reform in the latest version of the Corporate Governance Code, in section 4 on audit, risk and internal control, comes to life. It calls for directors to make a ‘declaration of effectiveness of the material controls’ and to describe any ‘which have not operated effectively’.
Sufficient teeth?
Short of a requirement to have this declaration audited, this reform has echoes of the US Sarbanes-Oxley Act (SOX). Yet it will operate in the UK’s non-mandatory ‘comply-or-explain’ regime. Coming from the Civil Aviation Authority (CAA), where non-compliance might cost lives, how does Moriarty find this flexible approach?
The CAA does allow exceptions, he says: ‘It’s not draconian but people are held accountable.’ The key is to have ‘a regime where the regulator has an effective and good relationship with the regulated’. He believes there is ‘a false binary between improvement and enforcement. A watchdog should have sufficient teeth, but 90% of regulatory conversations aim to improve things.’
On deterrence, he says that there is no question of watering down the FRC’s enforcement effort. (The record £21m fine on KPMG for Carillion audits was announced just after he started last October.) With fewer cases being pursued, he says, ‘I like to think that we have all raised our games’.
The idea that the FRC sanctions trivial breaches is ‘utter tosh’
The latest (2023) audit inspection results for Tier 1 firms judged 77% of audits to be good or requiring only limited improvements, up from 67% in 2020. He describes the idea that the FRC sanctions trivial breaches as ‘utter tosh’. It only takes on enforcement cases where there is either misconduct or a serious failure to meet a standard.
Returning to the voluntary code, doesn’t the flexibility of comply or explain open the door to abuse? ‘No, you have to be watchful,’ says Moriarty. ‘It can’t be a race to the bottom.’
Providing a transparent and cogent explanation is a ‘major caveat’. There is a trade-off between worrying about abuse and ‘shoe-horning a company into a straitjacket’. Moriarty disagrees with the argument that the good comply and the bad do not. Explanations require thought; compliance can be mindless.
Attracting listings
So, flexibility for companies to follow their business priorities is part of the mission to support UK growth and competitiveness, including the attractiveness of the UK as a place to list. He dismisses that idea that the short UK code could drive firms to the US – and SOX. ‘The FRC’s role is positive, underpinning market confidence,’ he says. ‘Good corporate governance attracts capital.’
In any case, the FRC is part of a much wider regulatory framework. The Financial Conduct Authority’s proposals to make the UK listing regime more accessible include abolishing the premium category in favour of a simplified single category. Should application of the code – a listing requirement only for premium companies – extend to all main market constituents?
‘The code, given its flexibility around comply or explain, can apply to a much broader range of companies,’ he says. It is already seen as ‘a good benchmark’ outside the FTSE 350. ‘As you go down the spectrum, there are more explanations from smaller, younger businesses.’
‘It’s not a failure if the Big Four continue to dominate the FTSE 100’
But the success of an approach that treats companies as individuals depends on investors and other users of accounts reading the explanations and exercising a nuanced judgment on divergence.
The other shoe to drop is the behaviour of fund managers, asset owners and their proxies, hence the fundamental review of the Stewardship Code just launched by the FRC. This ‘year of consolidation’, as the FRC puts it in its 2024-25 plan and budget, is also being used to study the market for sustainability assurance, a subject of keen interest to investors.
Quality above competition
On competition in the audit market, Moriarty makes it clear that this cannot be at the expense of quality – and ‘it’s not a failure if the Big Four continue to dominate the FTSE 100’. Without Arga-related legislation, mandating shared or joint audits lies in the long grass. Meanwhile, the FRC is helping to build capability at the smaller firms, where the average audit-quality score in Tier 2 and 3 is only half as good as that for Tier 1. Last September the FRC created the Audit Firm Scalebox to help them improve.
Moriarty’s final remarks address the pressures that can arise from what some see as a multi-stakeholder constituency. He says the FRC’s role is ‘not to be representative and to please everyone; it is to do the right thing in the public interest’. This means being ‘clear what the FRC’s primary and secondary purposes are: protecting users and the public interest must come first, in a way that supports competitiveness’.
More information
See also the AB articles ‘Audit reform’s unfulfilled promises’ , ‘Bad time for reform row-back’ and ‘London Stock Exchange in crisis’
