FRC issues revised Audit Firm Governance Code
James Barbour, ICAS Director, Technical Policy highlights some of the key points from the FRC’s revised Audit Firm Governance Code.
The Financial Reporting Council (FRC) has published a revised version of the UK Audit Firm Governance Codes (AFGC), which is applicable for financial years beginning on or after 1 September 2016.
The AFGC was originally published jointly by the ICAEW and FRC in January 2010 following the work of an ICAEW led independent working group chaired by ICAS Past President Norman Murray (who currently chairs the ICAS Ethics Board). The AFGC applied to firms auditing 20 or more listed companies.
As well as codifying existing requirements and practice, the original version of the AFGC introduced two concepts:
1. The appointment of independent non-executives within the governance structures of the firms.
2. Dialogue between the firms and investors in listed companies.
The AFGC effectively provided a benchmark of good governance practice against which firms that audit listed companies could report.
Following consultation in 2015 and again in 2016, the FRC has revised the AFCG to seek to further promote good governance of audit, align more with the UK Corporate Governance Code, enhance transparency and improve engagement between firms, investors and Independent Non-Executives.
The FRC's review of the AFGC
The FRC’s review of the AFGC identified a number of issues including:
- The AFGC had insufficient visibility.
- Investors were not clear about the role which independent non-executives (INEs) play and had concerns about their independence.
- Dialogue between the firms and investors has not worked as well as hoped.
- Aspects of the UK Corporate Governance Code could usefully be incorporated into the AFGC.
Following the review and consultation process, the FRC has made a number of revisions to the AFGC which are intended to help:
- Promote good governance of audit in particular;
- To strengthen transparency; and
- To introduce some additional provisions from the Corporate Governance Code.
The FRC has clarified the purpose of the AFGC. This is as follows:
“The Code provides a benchmark of good governance practice against which firms which audit listed companies can report. Its principal objectives are:
- To promote audit quality.
- To help the firm secure its reputation more broadly, including its non-audit businesses.
- To reduce the risk of firm failure, which in relation to the largest firms would be of systemic significance.”
The principles remain unchanged. To facilitate the Dialogue principle, the FRC intends to work to facilitate improved engagement between firms and investors, including by organising meetings attended by investors and INEs from all firms. This is intended to supplement and not replace the firms’ direct interaction with shareholders.
The implications for firms
The FRC believes that transparency is key to addressing several of the matters identified in the review. All firms which audit listed companies are required by regulation to produce annual transparency reports containing, inter alia, information about the operation of the AFGC within that firm. However, these reports are not widely read and have been described as compliance documents of limited interest.
As well as providing information to stakeholders, reporting enhances accountability and helps ensure leadership focus on the key governance and performance issues which it covers.
The FRC believes that the firms should revise their transparency reports to include content which is of greater relevance to investors, regulators and other stakeholders.
In particular, firms applying the AFGC should make sure that their report is fair, balanced and understandable as required of companies by the UK Corporate Governance Code and should include the following:
- A report on the work of the firm’s Board and its INEs including performance against any KPIs in place.
- A separate report from the INEs and/or public interest committee; several firms already do this. This report should include an explanation of how the INEs or public interest committee have overseen the UK audit practice in particular, as well as the wider UK business more generally, over the reporting period.
- What the Board and the INEs have done to satisfy themselves that the appropriate culture exists throughout the organisation.
- An explanation of why the firm has chosen to position its INEs in the way that it has and how it believes that this serves the public interest by helping to ensure audit quality.
- A statement of how the Board and INEs have worked during the year to fulfil the AFGC’s purpose.
- Details of any provisions from the UK Corporate Governance Code which it has adopted within its own governance structures in addition to those already in the AFGC and a consideration of whether there are any others it might adopt in the future.
The FRC intends to conduct regular reviews of transparency reports. As part of this exercise it intends to highlight best practice and innovation in governance.
In its reviews of transparency reports, it will consider the extent to which firms are adopting additional provisions from the UK Corporate Governance Code and whether their formal incorporation into the AFGC would be beneficial.
The FRC is encouraging the firms to focus on those provisions of the UK Corporate Governance Code which are of greatest significance to governance such as the provisions around appointment procedures, Board development and separation of the Chairman and Chief Executive roles may be introduced.
The major firms have global clients and all are members of international networks. The FRC therefore encourages UK firms to promote the AFGC, and in particular the concept of independent challenge within the governance structure, across their networks.
The FRC is itself promoting the concept internationally. However, as audit is undertaken by national firms in accordance with national regulatory requirements the FRC is minded that it is most important that the firms ensure there is good governance at a national level even if the firms are moving towards fully globally managed structures.
The FRC believes that the firms should ensure and report on how their governance arrangements protect the public interest in audit in the most significant national markets and ensure that they have the necessary UK governance in place to fulfil the Code’s purpose.