How will FRC reform the Corporate Governance Code

Natalie Todd, partner at Cooke, Young & Keidan, assesses the key FRC proposals on audit reform and what action it will take before the government legislates for the creation of a new audit regulator

Following on from the government’s response to the consultation on strengthening the UK’s audit, corporate reporting and corporate governance systems, the Financial Reporting Council (FRC) issued a paper on 12 July 2022 setting out how it intends to support the government’s reforms in the transition to the new Audit, Reporting and Governance Authority (ARGA).?

The ARGA will have the powers to investigate and sanction breaches of public interest entities’ (PIE) directors’ duties relating to corporate reporting and audit. A PIE is a private company with more than 750 employees and a turnover of more than ￡750m.

A significant proportion of the proposals contained in the government response require legislation.?The FRC’s paper outlines the actions the FRC intends to take ahead of that legislation in order to drive behavioural change.

The FRC paper sets out its proposed reform in five main areas:

1.?????Revisions to Codes, standards and guidance;

2.?????Strengthening and developing new auditing and accounting standards;

3.?????Setting expectations to drive behavioural change ahead of legislation;

4.?????Developing guidance to address issues outlined in the government response; and

5.?????Setting expectations around future supervision and monitoring activities which will flow from the revisions.

Corporate governance and stewardship

The revisions to the UK Corporate Governance Code (which applies to premium listed companies) will provide for director statements as to the effectiveness of internal controls and the basis for their assessment and will provide board responsibilities for expanded sustainability and reporting of environmental, social and governance (ESG) principles.?The proposals will require directors to report on actions they have taken to prevent and detect fraud.

The FRC will develop for use on a voluntary basis a set of minimum standards for audit committees.?These standards will address how audit committees can support greater market resilience and diversity when tendering for audit services. The FRC is conscious of the need to dilute the dominance of the Big Four.

The intention is for the revised Code to apply to periods commencing on or after 1 January 2024.

Corporate reporting

The FRC recognises the reporting burden on companies and is looking to simplify and improve reporting requirements.

It intends to provide implementation guidance for i) the resilience statement; ii) fraud reporting by directors; iii) the audit and assurance policy and related disclosure requirements; and iv) capital maintenance and dividends, including distributable profits.

The FRC also intends to revise its guidance on the strategic report in recognition of the significant changes and the expansion in proposed reporting to ensure that the strategic report is a source of decision-ready information.

The FRC will engage with the International Sustainability Standards Board (ISSB) to develop a global baseline to support sustainability reporting.

Audit

The government has chosen not to expand the scope of an audit. However, the FRC intends to consult on changes to address some of the policy points in the government response through revisions to standards, including significant revisions to the Ethical Standard to reflect stakeholder feedback, evidence gathered through the FRC’s inspection programme and its enforcement work.

It intends to consult on a revised standard in Q1 of 2023.

Actuarial regulation

The government response makes the case for weaknesses in the current regulatory regime for actuarial work to be addressed. Currently the FRC undertakes its actuarial regulatory roles in the UK on a contractual basis. The government intends to strengthen that regime by putting it on a statutory footing, similar to other regulated professions, including a risk-based monitoring scheme to assess the quality of actuarial work.?

Ahead of the legislation to implement changes, the FRC intends to consider what actuarial work should be considered as being of public interest, and therefore within ARGA’s statutory regulatory scope, conduct a pilot exercise and do other groundwork ahead of the new monitoring and oversight regime.

Additional measures

The paper sets out the FRC’s priorities in order to facilitate the ARGA becoming the systems leader for local authority financial reporting and audit.

The government intends to give ARGA statutory funding so that it can operate on a sustainable and independent basis. ARGA will be empowered to make rules requiring that market participants pay a levy to meet the costs of carrying out its regulatory functions. The FRC intends to collate views on the principles on which the new statutory funding model should be based.

Implications for companies

The FRC’s paper covers proposed reforms affecting corporate governance, corporate reporting and audit. The intention is that it only has to open up each Code, standard or piece of guidance once to address the total reform.

Some serious thought and complex sequencing has been invested to ensure that revisions to Codes, standards and guidance can be addressed in one single go. If they are able to achieve this, this would be an impressive feat. The risk otherwise is that there is confusion and a lack of uniform approach by companies to these reforms.

No doubt, the reforms will lead to more bureaucracy and costs for companies, but the scale of the reforms (if legislation is indeed implemented) will assist with clamping down on rogue businesses and go a long way to assist in the prevention of the collapse of public interest companies such as Carillion and BHS, which caused hundreds of job losses and serious economic and social damage.

The ball lies in the government’s court in implementing the necessary legislation. Without that, these reforms will be toothless.