FRC outlines its approach to external private capital in UK audit firms
The FRC outlines its approach to potential changes in audit firm ownership structures, emphasising the need to maintain audit quality, independence, and public interest focus
Private Equity – Letter from the FRC
Given developments in the audit firm environment, the Financial Reporting Council (FRC) has issued a letter addressed to certain audit firms and Recognised Supervisory Bodies (RSBs) regarding its approach to external private capital in UK audit firms. This outlines the FRC's approach to potential changes in ownership structures, emphasising the need to maintain audit quality, independence, and public interest focus; and encourages early engagement with the FRC for firms considering such changes and reaffirms the FRC's commitment to monitoring developments in this area.
UK law requires that audit firms undertaking statutory audit work must be controlled by qualified professionals. It also requires auditors to be independent. Currently there is only a handful of relatively small firms that have any form of external private capital in their ownership structure and rather the UK audit market is dominated by 100 per cent partner owned registered audit businesses delivering audit, wider assurance and related professional services.
The FRC’s letter makes clear that ownership structures are a matter for the firms and that it is not in principle against a greater participation of external private capital in the UK audit market. The FRC’s role is to protect the public interest and support growth and is primarily concerned with outcomes and behaviours by audit firms such as delivering high quality audits, upholding high standards of ethical conduct, and fostering a culture towards always acting with the public interest in mind. More broadly they are interested in the health of the audit market in terms of it being resilient and providing choice.
The FRC recognises that access to external private capital could, in the right circumstances, have potential benefits for the UK audit market. It may generate additional investment that could be used to enhance audit quality within firms that might not otherwise be able to fund such capabilities. Additional investment and expertise could potentially also help drive innovation, choice and growth in the sector.
However, it also highlights that there are important risks that will need to be carefully managed. As with any other major change within an audit firm that has the potential to affect its leadership and culture, a change in ownership structure via external private capital must be able to maintain and enhance over time the important public interest dimension of audit. It must also be able to protect independence as required by law and allow for any threats to that independence as a result of conflicts to be effectively safeguarded.
This public interest dimension of audit services is important because it supports economic growth and confidence in corporate UK as well as trust in the profession. After all, good quality audit carried out by independent professionals underpins investor confidence and enables businesses access to capital to invest and grow. It also supports broader confidence in financial reporting of UK plc from a range of other stakeholders such as pensioners, employees, creditors and broader society.
Like for any other significant change relating to a UK firm, any party interested in a change of ownership by introducing external private capital must be able to continue to provide assurance that it will be able to support the public interest, the independence dimensions of audit and all applicable regulatory expectations. It is important to demonstrate that the legal requirements, including those pertaining to control, are met both in substance and in form.
A firm that is interested in, or considering, a change of ownership to introduce private capital should engage with the FRC (in addition to its Recognised Supervisory Body) at an early stage and with full candour, assured that all such discussions will be treated in strictest confidence. The FRC would also welcome engaging directly and in confidence with any investors considering entering or expanding into the UK audit market to help explain the regulatory framework and expectations.
The FRC will continue to monitor developments closely and may update its position over time.
