PROPOSALS TO REFORM THE FINANCIAL REPORTING COUNCIL

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1 9 January David Andrews Financial Reporting Council 5 th Floor Aldwych London EC2B 4HN Dear Mr Andrews PROPOSALS TO REFORM THE FINANCIAL REPORTING COUNCIL IMA represents the asset management industry operating in the UK. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pension schemes. They are responsible for the management of 4 trillion of assets, which are invested on behalf of clients globally. These include authorised investment funds, institutional funds (e.g. pensions and life funds), private client accounts and a wide range of pooled investment vehicles. In particular, the Annual IMA Asset Management Survey shows that IMA members managed holdings amounting to just over 40% of the domestic equity market. In managing assets for both retail and institutional investors, IMA members are major investors in companies whose securities are traded on regulated markets. Therefore, we have an interest in the FRC s role as an independent regulator responsible for promoting high-quality corporate governance and reporting. The FRC was formed in the early 1990s and was charged with promoting good financial reporting through two operating bodies: the Accounting Standards Board, and the Financial Reporting Review Panel. Today it is comprised of seven separate operating bodies, each with its own board and distinct responsibilities. The issues the FRC deals with are interrelated and whilst the IMA agrees that there is great value in increasing the level of cooperation and collaboration between the separate entities, it is not clear that the proposed structural change is the best way to achieve this. We set out below our key concerns and our answers to the specific questions raised in the attached Annex. 65 Kings wa y Lo nd on W C2B 6TD Tel:+44(0) Fax:+44(0) w w w. i n v e s t m e n t u k. o r g Investment Management Association is a company limited by guarantee registered in England and Wales. Registered number Registered office as above.

2 The proposed Board Committees would have all the decision-making power but too broad a remit to be necessarily technically proficient in all areas, and Advisory Councils with technical knowledge but no power. This splits responsibility from ability, and runs the risk of governance failure. In addition, both the Accounting Standards Board (ASB) and the Auditing Practices Board (APB) are well established and respected, and replacing them with Advisory Councils could adversely impact the UK s influence internationally. It is also possible that neither the ASB nor APB would be able to retain and attract the specialist technical expertise they currently have resulting in an erosion of their capabilities and influence internationally. Moreover, the ASB is one of the three major standard setters within EFRAG where it plays an important role. It is not clear how it would be replaced, nor is it clear how the Advisory Councils would operate in that it is important that they continue the same due process and consult with a wide group of stakeholders as the ASB and APB do currently. Whilst the FRC s primary focus should be publicly traded companies and large private companies, the unlisted sector and smaller companies still use UK accounting and auditing standards. The recent debate over the future of UK GAAP is testament to the fact that the FRC/ASB will still have an important role in setting standards for entities that are outside the listed sector, and for the authorised funds our members manage. Whilst the Chair and Deputy Chair of the FRC Board are appointed by the Secretary of State, we understand the ultimate decision on who is appointed to the FRC s Board will rest with the Board itself. It would seem reasonable for all the FRC s major stakeholders to have some role in the selection and appointment of Board members and for appointment procedures generally, not only to the Board but to the Board Committees and Advisory Councils, to become more transparent. The FRC is largely funded through voluntary arrangements which could raise concerns about its independence and accountability - in particular, a certain amount of funding is provided by the accountancy bodies. Whilst we do not consider this has been an issue to date, such arrangements could affect the FRC s objectivity in the future and for the FRC to have credibility, it needs to have sustainable funding that does not infringe on its independence. In appropriate circumstances, we agree the FRC should be able to propose sanctions which can be accepted without having to bring the matter to a full public hearing. An ability to resolve cases more quickly is not only in the interests of investors but also the wider public. It is not clear whether a mechanism for a FRC inquiry into issues affecting corporate governance and reporting is necessary or whether it would be an expensive duplication of BIS s work in this area. There are, however, some of our members that would support such investigations to ensure lessons are learnt, to ensure the process is transparent and that there is a single point to which they could refer concerns. The consultation states that the FRC plans to implement the changes in April We consider that a measured approach should be taken to implementation to ensure that the international influence is not diminished and that the proposed Committees and Councils continue to attract high caliber individuals. It would also be helpful that the key structural changes were subject to a further consultation. 2

3 Please contact me if you would like clarification on any of the points in this letter or if you would like to discuss any issues further. Yours sincerely Liz Murrall Director, Corporate Governance and Reporting 3

4 THE CASE FOR FRC REFORM 1. Do you have any comments on the case for FRC reform as set out in this document? The FRC was formed in the early 1990s and was charged with promoting good financial reporting through two operating bodies: the Accounting Standards Board, and the Financial Reporting Review Panel. Today it has grown into seven separate operating bodies, each with its own board and distinct responsilbities. It is appropriate for this framework to be reviewed to see if it still operates effectively. 2. Do you agree that the proposals for reform will bring benefits and increase the effectiveness of the FRC? The issues the FRC deals with are interrelated and while the IMA agrees that there is great value in increasing the level of cooperation and collaboration between the separate entities, it is not clear that the proposed structural change is the best way to achieve this. 3. Do you have any comments on the consultation stage impact assessment? Except as noted elsewhere in this response, we are content with the impact assessment. AN INVESTMENT FOCUS FOR THE FRC S ACTIVITIES 4. Should the primary focus for regular FRC activity in relation to codes and standards for corporate governance, accounting and auditing, and for monitoring the quality of corporate reporting and auditing, be publicly traded companies and large private companies? IMA supports the FRC s primary focus in relation to codes and standards for corporate governance, accounting and auditing, and for monitoring the quality of reporting and auditing, being publicly traded companies and large private companies. These entities are of more relevance to our members as investors in companies. However, it is also important that the FRC focuses on the unlisted sector and smaller companies which operate under a framework of UK accounting and auditing standards. The recent debate over the future of UK GAAP is testament to the fact that the FRC will still have an important role in setting standards for entities that are outside the listed sector, and for the authorised funds our members manage. 5. Is the definition of large private company for this purpose an annual turnover of 500m or more - appropriate? Subject to our comments under question 4, we agree that a large private company for this purpose should be defined as one with an annual turnover of 500m or more. 6. Should the scope of the FRC s accountancy disciplinary arrangements be narrowed to cover the quality of work and conduct of accountants in relation to the preparation and audit of annual reports and other reports for the capital markets, leaving other cases of potential misconduct to the professional bodies? We support the scope of the FRC s accountancy disciplinary arrangements being narrowed to cover the quality of work and conduct of accountants in relation to the preparation and 4

5 audit of reports, and subject to our comments under question 10, other cases of potential misconduct should be dealt with by the relevant professional body. 7. Are there other areas of activity from which the FRC could appropriately withdraw? We are not aware of other areas of activity from which the FRC could appropriately withdraw. A STREAMLINED STRUCTURE 8. Do you agree that streamlining the FRC s governance and structure will bring the benefits described? As noted under question 2, the issues the FRC deals with are interrelated and better cooperation and communication could help it in its activities. Nevertheless we have concerns about that the changes proposed. The proposed Board Committees would have all the decision-making power but too broad a remit to be necessarily technically proficient in all areas, and Advisory Councils with technical knowledge but no power. This splits responsibility from ability, and runs the risk of governance failure. In addition, both the Accounting Standards Board (ASB and the Auditing Practices Board (APB) are well established and respected, and replacing them with Advisory Councils could adversely impact the UK s influence internationally. It is also possible that neither the ASB nor APB would be able to retain and attract the specialist technical expertise they currently have resulting in an erosion of their capabilities and influence internationally. Moreover, the ASB is one of the three major standard setters within EFRAG where it plays an important role. It is not clear how it would be replaced, nor is it clear how the Advisory Councils would operate in that it is important that they continue the same due process and consult with a wide group of stakeholders as the ASB and APB do currently. 9. Do you have any comments on the proposed reformed FRC governance and structure? The FRC, like all such bodies, is a product of its history but it is important that it evolves as its importance grows. Whilst the Chair and Deputy Chair of the FRC Board are appointed by the Secretary of State, the ultimate decision on who is appointed to the FRC s Board will rest with the Board itself. It would seem reasonable for all the FRC s major stakeholders to have some role in the selection and appointment of Board members and for appointment procedures generally, not only to the Board but to the future Board Committees and Advisory Councils, to become more transparent. Related to this is the question of funding. The FRC obtains the funds it requires on the basis of voluntary arrangements and widespread support for its activities from the major groups which have regard, directly or indirectly, to its regulatory requirements 1. This could raise concerns about the FRC s independence and accountability - in particular, we understand that a certain amount of funding is provided by the accountancy bodies. Whilst we do not consider this has been an issue to date, such arrangements could affect the FRC s objectivity in the future. We believe that for the FRC to have credibility, it needs to have sustainable funding that does not infringe on its independence. 1 Page 25 5

6 INDEPENDENT SUPERVISORY AND DISCIPLINARY ARRANGEMENTS 10. Do you agree the FRC should be given powers to determine and require a recognised supervisory body to impose proportionate sanctions, subject to appropriate safeguards, on an audit firm and/or individual auditor in respect of poor quality work? The consultation paper proposes that the Conduct Committee will have an express power of referral or enforcement following findings of poor audit quality, which neither the POB nor AIU currently have. IMA agrees that the FRC should be able to require a recognised supervisory body to impose sanctions on an audit firm and/or an individual auditor in respect of poor quality work. The current arrangements are too fragmented and do not recognise the role the FRC s bodies play in monitoring audit quality. 11. If not, what are your concerns and how do you believe this issue should be addressed? Not applicable. 12. Do you agree the FRC should have the ability to make its own rules for the independent disciplinary arrangements without being required to obtain agreement of the professional bodies? IMA agrees that the FRC should have the ability to make its own rules for disciplinary cases in relation to the performance of statutory audits. It is important that this should be independent of the professional bodies in that the FRC should not be required to obtain their agreement. 13. If not, how would you propose the FRC demonstrates its independence in this regard? Not applicable. PROPORTIONATE REGULATION 14. Should the FRC be able to take more proportionate, nuanced action against a Recognised Supervisory or Qualifying Body and therefore be given a wider range of enforcement powers against the recognised bodies? In particular, should the FRC be able to: Issue an enforcement order, requiring the body to take specified actions by a specified date, without the need for a court order? Impose conditions on continued recognition as an RSB or RQB? Impose fines on an RSB or RQB and if so, at what level? IMA agrees with the FRC being able to take more proportionate, nuanced action against a Recognised Supervisory or Qualifying Body and therefore be given a wider range of enforcement powers. A more graduated range of powers should sharpen their responses, the timeliness of actions, and enhance the independence of the FRC s oversight role. 6

7 15. Should the Companies Act and the AADB Schemes be amended to allow for the conclusion of cases without public hearings where appropriate and where agreed by the parties? The AADB Accountancy Scheme currently provides that where a decision to prosecute is made the matter must proceed to a full hearing before disciplinary action can be taken. In appropriate circumstances, we agree the FRC should be able to propose sanctions which can be accepted by firms or individuals without having to bring the matter to a full public hearing. An ability to resolve cases more quickly is not only in the interests of investors but also the wider public. 16. Do you agree that the FRC should develop a mechanism to enable it to undertake supervisory inquiries into matters of concern, either of individual market events or wider market interest, initially building on its current powers to secure information? In general we have concerns about the FRC developing a mechanism to enable it to undertake supervisory inquiries into matters. It is not clear from the consultation paper how this would work in practice and relate to the work that BIS undertakes in this area, or whether it would be an expensive duplication. There are, however, certain of our members that would support such investigations to ensure lessons are learnt and to determine whether further investigations or actions are necessary. They would welcome a more transparent process and a single point to which investors could refer matters. 7