Strategy for 2018/21 and draft budget and levy proposals 2018/19

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1 David Andrews Financial Reporting Council (FRC) 8th Floor 125 London Wall London EC2Y 5AS 23 rd February 2018 By e mail to: d.andrews@frc.org.uk Dear Mr Andrews Strategy for 2018/21 and draft budget and levy proposals 2018/19 PricewaterhouseCoopers LLP (We) welcomes the opportunity to respond to the FRC s Strategy for 2018/21 and draft budget and levy proposals for 2018/19 (the consultation paper), published on 19 December We are supportive of the FRC and its activities, especially taking into account those objectives which we have in common, one of which is the promotion of justifiable confidence in the quality of audit. We will continue to work collaboratively with the FRC, as well as with other regulators and professional bodies, in support of these objectives. We have summarised our key comments on the strategy and the budget and levy proposals below. More detailed answers to the specific questions raised in the consultation paper are in the Appendix to this letter. Audit firm monitoring approach The new audit firm monitoring approach involves a comprehensive evidence gathering exercise in five areas, including audit quality in respect of which the FRC already has an established programme. Based on our experience to date of responding to the FRC s requests for evidence on information security (within the risk management and control area), the evidence gathering exercise has the potential to impose a considerable burden on the six largest audit firms, which is likely to increase as the FRC develops the new approach during We would urge the FRC to consider introducing a clear and well-defined process for evidence requests, which might reduce the potential burden on firms, and avoid a series of requests to provide information over an extended period. The FRC might also consider asking firms to provide existing information under each of the five areas, rather than requiring firms to produce new material to meet the FRC s requests. PricewaterhouseCoopers LLP, 1 Embankment Place, London, WC2N 6RH T: +44 (0) , F: +44 (0) , PricewaterhouseCoopers LLP is a limited liability partnership registered in England with registered number OC The registered office of PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH.PricewaterhouseCoopers LLP is authorised and regulated by the Financial Conduct Authority for designated investment business and by the Solicitors Regulation Authority for regulated legal activities.

2 In relation to the pre-appointment process, we support the FRC s proposal to set out its expectations of the experience, skills and attributes of candidates for key roles at the largest six audit firms, including for independent non-executive roles, the Head of Audit and the Ethics partner, which will ensure that candidates have the ability and breadth to discharge their duties. We are happy to cooperate with the FRC in its proposal for voluntary pre-appointment assessments of the large firms candidates for these roles, on the basis that these assessments will provide an opportunity for the FRC to engage with, and provide information to, the firms candidates. However, we would not support the FRC having the power to exercise a veto (official or otherwise) over the appointment of the firms preferred candidates. We suggest that the FRC considers introducing the assessments for a trial period, which would give the FRC the ability to assess their value and consider how the process could be developed further in practice. In our view, it will be particularly important for the FRC to take account of any evidence which may suggest that the assessments either discourage high quality and diverse candidates from applying for key roles, or prevent a firm s preferred candidate from being appointed. Brexit Part of the FRC s mission in the light of the UK s decision to leave the EU is to ensure that accountants, auditors and actuaries in the UK continue to be world class, and that the UK remains attractive to investors. The UK is known globally for its high standards and trustworthy financial reports. Once the UK leaves the EU these standards must be maintained as they are essential to attracting investors to the UK, and it is vital to the UK s economy that it remains a global centre of excellence. It is essential that the FRC works with international regulators to ensure that the UK continues to exert influence in regulatory trends globally, and to work towards globally consistent regulation wherever possible. The FRC also has a key role to play to support the Department for Business, Energy and Industrial Strategy (BEIS), in particular in promoting high quality International Financial Reporting Standards (IFRS), as well as determining whether, and what, endorsement process might be required for IFRS, subject to the outcome of the ongoing Brexit negotiations. Corporate governance review We are responding separately to the consultation on the revised Corporate Governance Code. We welcome the shorter and sharper revised Code, and agree that a principles based approach will result in a more considered approach to corporate governance. The revised Shareholder Rights Directive (2007/36/EC, as amended by 2017/828) is due to be transposed into national legislation by 10 June We would have expected this to be covered in the FRC s strategic priorities for 2018/21, especially in the light of the proposed stewardship related activity. 2

3 Effective enforcement Following the independent review of the FRC s sanctions regime, and the FRC s stated intention to consider those recommendations to ensure that the enforcement regime is robust and proportionate, we recommend that these are considered in the wider context of the audit market and the culture of the accounting and auditing profession. A vibrant and competitive audit market is fundamentally important to the future of audit, as well as to the success of the FRC s strategic priority of promoting corporate governance and investor stewardship with a long term focus. As highlighted in our response to the call for evidence on the independent review of sanctions 1, an overly punitive enforcement regime could have the unintended consequence of a negative impact on competition and choice in the audit market, and could damage the attractiveness of audit as a career. We welcome the FRC s intention to ensure that not only are investigations progressed efficiently, but are also concluded more quickly, particularly given the stress on engagement teams when under investigation. We would also welcome greater clarity around the practical implications of the FRC s updated memorandum of understanding with the FCA (issued in December 2017), and also when the temporary arrangements between the FRC and the Insolvency Service (published 18 January 2018) will be finalised. The FRC s culture and people The consultation paper highlights the importance of good corporate culture, and we are pleased to see that the FRC intends to develop its own organisational culture to follow the key themes identified for companies, and we look forward to hearing more about this. In the light of the FRC s designation as a public body, and the consequent requirement to follow principles and guidance set by Government, we also look forward to seeing further details of the governance framework to be applied by the FRC, as well as any impact that this may have in relation to the FRC s powers. We would welcome the opportunity to discuss this further with you. If that would be of assistance, or you have any questions, please contact me on Yours sincerely PricewaterhouseCoopers LLP 1 PwC letter to the Review Panel (Enforcement Procedures Sanctions) dated 28 June

4 Appendix: Detailed comments on the FRC s strategy for 2018/21 and draft budget and levy proposals 2018/19 1. Do you have any comments on our strategic priorities - are they in line with your expectations or are there other issues on which the FRC should focus? We have grouped our comments below under each of the strategic priorities. Promoting corporate governance and investor stewardship with a long term focus In the light of the consultation on the revised UK Corporate Governance Code (the Code), and the proposed consultation on a revised Stewardship Code, the prominence that these are given in the strategic priorities for 2018/21 is appropriate. We welcome the shorter and sharper revised Code, and agree that refocusing on the principles of the Code will result in a more considered approach to corporate reporting. We are responding separately to the consultation on the revised Code. Page 8 - We will closely monitor reporting on the new Code - including the way in which companies have reported meaningfully on how they have applied its Principles. Even before the revised Code was discussed, the FRC wanted to extend the remit of the Corporate Reporting Review Team (CRRT) to the governance report. This has not happened, but we understand that the FRC will still review governance reports on a voluntary basis. It would be helpful to set out in the strategic priorities what is envisaged for the FRC s monitoring activity, which we support, including whether this would be general monitoring across the market with a report in the style of Developments in corporate governance and stewardship 2, or whether the review would be a company by company CRRT style review. Page 9 - in the areas that the FRC will consider in relation to the strategic priority of promoting corporate governance and investor stewardship, we suggest that consideration be given to including a focus on the quality of comply or explain explanations. We suggest that the FRC considers revisiting What constitutes an explanation under comply or explain - report of discussions between companies and investors 3 (February 2012). We would also welcome further information as to how the FRC will assess the quality of nominations committee reporting on board diversity and succession planning, to ensure that an objective assessment of progress may be made. Page 9 - we welcome the announcement on 30 January 2018 that James Wates CBE is to lead an industry group to draw up governance principles for large private companies. The role of the FRC will be central to any extension of corporate governance and governance reporting, to private companies that follows as a result of the work of this industry group, and in particular whether, and to what extent, it will be based on the proposals set out in paras of the BEIS paper Corporate governance reform - the Government s response to the green paper consultation. The 2 Governance-and-Stewardship-2016.pdf (January 2017) 3 4

5 consultation paper notes that the FRC will monitor the new reporting by private companies; it would be useful if the FRC could explain what form this monitoring is likely to take. Page 9 - the FRC indicates that the extent and effectiveness of investors engagement with companies will be surveyed. In our opinion this is an important indicator, as we understand that, for instance, many audit committee chairs do not receive questions or comments from investors relating to reporting, while some investors complain that some companies boards are unwilling to engage on certain areas. We would welcome further details of the measures that will be used to assess effectiveness, and whether both companies and investors will be surveyed. We would have expected that the possible transposition of the revised Shareholder Rights Directive (2007/36/EC, as amended by 2017/828) into UK law would have been addressed, especially in light of the FRC s plans for stewardship related activity. We note that the consultation on the revised Corporate Governance Code discusses the Shareholder Rights Directive and, in particular, how the measures could best be introduced but, in our opinion, this is a strategic issue that should be addressed in the priorities for 2018/21. Promoting true and fair reporting One apparent omission from the strategic priorities for 2018/21 is the FRC's responsibilities in relation to developing and maintaining UK financial reporting standards. The first triennial review of FRS 102 concluded in December 2017, but the next will commence during the period under review (even if it is a quadrennial rather than a triennial review). In June 2017 the FRC committed to keep under review the UK experience of adopting IFRSs 9, 15 and 16 in order to determine whether and when aspects of those standards might be brought into FRS While we might not expect firm proposals in that regard during the period, we would recommend that consideration is given to adding this to the strategic priorities. Page 10 - The extent to which the UK adopts IFRS as adopted by the EU, as issued by the IASB, or as endorsed by a new UK process will depend largely on the outcome of Phase 2 of the Brexit negotiations, which are expected to have concluded with agreement at a political level by late October The use of the word aspects in the penultimate line of the third paragraph could be taken to indicate that the FRC is making the assumption that the UK will have its own endorsement process which will allow for, in effect, partial endorsement (i.e. with UK specific additions or carve outs). At this stage in the Brexit process, we are not able to confirm our support or otherwise for this. We continue to be supportive of the work of the Financial Reporting Lab but, as suggested in our response to the Draft Plan and Budget for 2017/18 5, we would suggest that the FRC considers commissioning an independent review of the work of the Lab to measure its effectiveness. In particular, we recommend that it would be appropriate to consider to what extent investors are satisfied with the work of the Lab, and to what extent has it had a positive influence on companies reporting. One of the considerations to be considered in assessing progress in the area of true and fair reporting (page 10) is the FRC s assessment of the impact of the Financial Reporting Lab s initiatives relating to business model reporting and risk and viability reporting. We believe PwC letter to the FRC, dated 16 February

6 that an independent assessment would result in a more meaningful, and less subjective, assessment. There are other references in the consultation paper to surveys or assessments, and we believe that consideration should be given in each case to determine whether an independent view would be helpful. Page 10 - We support the FRC s intention to use evidence to assess the progress made in promoting true and fair reporting, and in particular the intention to survey evidence on the understanding and effectiveness of the FRC s corporate reporting review role. In relation to this, and the other evidence referred to in the consultation paper, we think the FRC should survey different groups of stakeholders to take account of the wider public interest; we suggest that this should cover a wide range of investors, accounting firms and customers, to obtain a range of views from stakeholders with different perspectives. In the event of a company failure, the FRC focuses on the role of the auditor, but it would be a useful exercise to consider whether, why and how corporate reporting failed. We suggest that consideration is given to reviewing this in the strategy period under review, possibly as a project for the Financial Reporting Lab, where it might complement the work of the Lab in relation to business model reporting and risk and viability reporting. Promoting high quality audit and assurance Page 11 - we understand that the FRC is to report following its thematic review of audit firm culture in May In the meantime, we would be grateful if the FRC could provide some details as to how it proposes to engage with the firms' respective leadership teams to make sure that the good practices identified in the review are adopted. Page 11 - the work of the FRC in monitoring both public interest audits, and the firms that carry out those audits, is vital in ensuring improvements in audit quality. However, it would be helpful if the FRC were to review when, and how, monitoring work is performed and reported on, to ensure that issues and themes identified either for a specific firm, or across the profession as a whole, can be addressed in the next reporting cycle, to ensure that opportunities for improvement are not missed. We have commented on the proposed new audit firm monitoring and supervisory approach in question 2 below. Page 12 - The audit of the future - we welcome the FRC s support for, and involvement in, the work of the proposed coalition to address the audit of the future; we understand that this coalition will be independently led. Establishing this coalition is a positive move, which we support and we will be happy to input and provide resource as appropriate. This work will provide an opportunity to review the purpose of the audit in the light of the public interest, as well as to address the expectation gap of a number of stakeholders in relation to what an audit is, and is not, intended to achieve. It will also enable the audit process to be "future proofed" by using technology to improve the effectiveness and quality of the audit, which will in turn reflect the use that companies are making of developing technology. Without the project and the collaborative approach proposed, there is a real danger that audit could become outdated in a rapidly changing world. Page 12 - we support the FRC s priority of testing the current statutory audit model to improve its effectiveness, better service the public interest and to take account of new technologies and 6

7 business models. We would welcome further details of what the FRC is proposing in this area, for example, new audit methodologies, using technology and AI, and consider that this would be an interesting project for the Audit and Assurance Lab. Promoting high quality actuarial work Page 14 We welcome the FRC s intention to undertake a post implementation review of the revised framework of revised technical actuarial standards towards the end of the strategy period and, in due course, will welcome more details on the focus of the review. In the meantime, we recommend that the emphasis should be on the implementation by industry. Page 14 the references to the FRC s support and contribution to the work of the Joint Forum on Actuarial Regulation (JFAR), and the oversight of the regulatory work of the Institute and Faculty of Actuaries (IFoA) are very generic, and it is unclear what this will involve. In particular, it would be helpful to understand what the risks are to the public interest for which actuarial work is relevant. Effective enforcement Following the report of the independent review of the FRC s sanctions regime published on 21 November , the timeline on page 18 indicates that revised sanctions guidance, incorporating some or all of the recommendations in that report, will be introduced in 2018/19. Additionally, in 2018/19 there will be updated enforcement procedures based on the FRC s experience of the new Audit Enforcement Procedure. An indication of the timescale in which the FRC intends to change both the sanctions guidance as well as the enforcement procedures would be helpful, and we would welcome a public consultation on any changes proposed, particularly if they are not aligned with the recommendations of the independent review. Page 15 - the FRC s proposed actions in relation to enforcement refers to the sanctions regime as a deterrent to misconduct and poor performance. In our experience audit failures are rarely, if ever, driven by egregious behaviours or deliberate wrongdoing and, as a profession that relies on professional judgement, a zero failure rate is unlikely to be achievable. Consequently, we do not believe that the deterrent effect is relevant, and suggest that the FRC focuses on a more balanced narrative that emphasises the role of the sanctions regime as addressing the root cause of the problem. Further, the continued emphasis of the deterrent effect of the sanctions regime could, in our opinion, have a negative impact on the attractiveness of audit as a profession, due to the increased risk of high financial sanctions and damage to reputation (which is potentially irreversible). Page 15 - our response to the FRC s consultation on the Audit Enforcement Procedure 7 recommended that the FRC should consider introducing indicators to track progress and performance in the area of professional discipline. The published KPI of two years between commencement of an investigation and the service of the Proposed Formal Complaint is helpful, but we wonder whether there are other indicators that should also be considered. Additionally, and in the interests of transparency, we suggest that the FRC publish details of its own performance in relation to investigations against key indicators PwC letter to the FRC, dated 6 May

8 Once any new sanctions regime is in place, we recommend that the FRC carries out a post implementation review to ensure that the revised regime is achieving its stated objectives. 2. Do you have any comments on our proposed audit firm monitoring approach? Audit firm monitoring approach The proposed new audit firm monitoring approach (AFMA) involves a comprehensive evidence gathering exercise in five areas, including audit quality in respect of which the FRC has an established programme. The evidence gathering exercise has the potential to impose a considerable burden on the largest six audit firms, which is likely to increase as the FRC develops the new approach during Based on our experience to date of responding to the FRC s requests for evidence on information security (within the risk management and control area of the proposed AFMA), it has required considerable time and resources on our part. One way in which the FRC might reduce the potential burden on firms would be to introduce a clear, well-defined process for evidence requests. This would avoid firms being asked to provide a series of documents over an extended period. The FRC might also ask firms to provide existing information under each area, as opposed to requiring firms to produce new material for the purposes of the FRC s requests. Pre-appointment process We support the FRC s proposal to set out its expectations of the experience, skills and attributes of candidates for key roles at the six largest audit firms, including those firms candidates for independent non-executive roles, the Head of Audit and the Ethics partner, to ensure that candidates have the ability and breadth of experience to discharge their duties. We are happy to cooperate with the FRC in its proposal for voluntary pre-appointment assessments of the candidates for these roles, on the basis that these assessments will provide an opportunity for the FRC to engage with, and provide information to, the firms candidates. However, we would not be supportive of the FRC having the power to exercise a veto (official or otherwise) over the appointment of firms preferred candidates. We suggest that the FRC considers introducing the assessments for a trial period, which would give the FRC the ability to assess their value and consider how the process could be developed further in practice. We also suggest that the FRC ensures that there is sufficient evidence to evaluate the assessments going forward. In our view, it will be particularly important for the FRC to take account of any evidence which may suggest that the assessments either discourage high quality and diverse candidates from applying for key roles, or prevent a firm s preferred candidate from being appointed. This consideration would apply equally to independent non-executive roles, and to the Head of Audit and Ethics partner roles in audit firms. 8

9 3 Do you have any comments on our key deliverables? The paper outlines the strategy for the three years to 2021, and there are, understandably, few specific details on the actions. Our comments on the strategic priorities are in question 1 above. We look forward to seeing further details of planned actions in due course, and would welcome the opportunity to comment as appropriate, as the FRC announces the commencement of each stream of work. We note that there is no mention on pages 17/18 of a specific project on technology and the impact on auditing standards to reflect its use in audit work, and we would be grateful if the FRC could clarify whether this has been omitted, or whether this work falls within one of the other projects listed. In our experience the need for auditing standards to reflect the increasing use of technology in audit is a matter of concern for investors and, as a result, should be included in the FRC s projects for the next three years. 4. Do you have any comments on our draft budget and funding requirements for 2018/19? We welcome the inclusion of the forecast spend for 2017/18, as this puts the budget for 2018/19 into context, and enhances understanding of the proposed budget for 2018/19. The draft budget indicates a 1% decrease in the budgeted costs for corporate governance compared to 2017/18 forecast. In 2018/19 there is ongoing work on corporate governance, including the proposed consultation in 2018/19 on a revised Stewardship Code, and we question whether this reduction in costs is realistic. The draft budget shows no increase in the budgeted costs of 0.2m in relation to XBRL. In the light of ESMA s final draft Regulatory Technical Standard relating to the European Single Electronic Format (ESEF) initiative, with ixbrl as the regulatory platform, and the FRC s call for a UK committee of affected regulators to address the potential implications of ESEF (which is expected to come into effect from January 2020), we suggest that there may be additional costs to be reflected in the final budget. Page 18 of the consultation paper includes Review the pilot project to develop an Audit and Assurance Lab for 2018/19, but we note that there appears to be no associated costs in the draft budget, unless these are included under another heading. In the interests of transparency, it would be helpful to show these costs separately. Page 22 refers to the possibility that the FRC may require additional resources, particularly in delivering standard setting and other regulatory responsibilities as a result of Brexit. We would welcome more clarity on these Brexit related costs in due course. 5. Do you have any comments on our levy proposals for 2018/19? We note that there will be no increase overall in the preparers levy, or the insurance, pensions or actuarial levies. However, in relation to the preparers levy there is a specific contribution to be made by the responsible supervisory bodies in relation to audit firm supervision. We would 9

10 10 encourage the FRC to work with the professional bodies to ensure that there is greater transparency as to how these levies are allocated to firms, and how each firm s levy is actually spent.