UK Corporate Governance Code: The FRC’s Revisions

By James Barbour, Director, Technical Policy

5 May 2016

James Barbour highlights the FRC's changes to its UK Corporate Governance Code and Guidance on Audit Committees.

The revised Code applies to all companies with a Premium listing of equity shares regardless of whether they are incorporated in the UK or elsewhere for accounting periods beginning on or after 17 June 2016.

The Financial Reporting Council's (FRC) revisions pertain to Section C.3 of the Code and to the related Guidance on Audit Committees.

At code provision C.3.1, the Code is revised as follows (amendments in bold italics and strike through where applicable):

“The board should establish an audit committee of at least three, or in the case of smaller companies two, independent non-executive directors. In smaller companies the company chairman may be a member of, but not chair, the committee in addition to the independent non-executive directors, provided he or she was considered independent on appointment as chairman. The board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience. The audit committee as a whole shall have competence relevant to the sector in which the company operates.”

At code provision C.3.7, the Code is revised as follows:

"The audit committee should have primary responsibility for making a recommendation on the appointment, reappointment and removal of the external auditors. FTSE 350 companies should put the external audit contract out to tender at least every ten years.  If the board does not accept the audit committee's recommendation, it should include in the annual report, and in any papers recommending appointment or reappointment, a statement from the audit committee explaining the recommendation and should set out reasons why the board has taken a different position."

At code provision C.3.8, the Code is revised as follows:

"A separate section of the annual report should describe the work of the committee in discharging its responsibilities. The report should include:

  • the significant issues that the committee considered in relation to the financial statements, and how these issues were addressed;
  • an explanation of how it has assessed the effectiveness of the external audit process and the approach taken to the appointment or reappointment of the external auditor, information on the length of tenure of the current audit firm, when a tender was last conducted and advance notice of any retendering plans; and
  • if the external auditor provides non-audit services, an explanation of how auditor objectivity and independence are safeguarded.

FRC Rationale

Relevant Financial Experience

  • The FRC had originally proposed to amend Code provision C.3.1 to bring it into line with the wording from the EU Directive that “at least one member of the audit committee shall have competence in accounting and/or auditing.” The FRC decided against this change on the basis that most respondents preferred the current formulation, “recent and relevant financial experience”, as this was considered broader, more flexible and was felt to be well understood.

Sectoral Competence

  • The FRC decided to go ahead with the proposal regarding competence relevant to the sector. The FRC considers that given the amendments to the Guidance on Audit Committees (Guidance) to provide that a range of skills, experience, professional qualifications and knowledge are important in meeting the requirements of the Code, they do not consider the formulation overly narrow when the Code and Guidance are read together. Rather, they consider that sectoral competence is broader than sectoral executive experience. The FRC has also included in Section 4 (paragraph 81) of the Guidance a recommendation that the company disclose “how the audit committee composition requirements have been addressed” in the audit committee section of the annual report, if not provided elsewhere.

Tendering

  • The FRC has removed the requirement to retender on a ‘comply or explain’ basis, as this is now redundant (related references also removed from Guidance). They have, however, for clarity purposes retained the sentence noting the audit committee’s responsibility for the external auditor.
  • The FRC has included a provision that Code companies should provide advance notice of a tender but only where there is any such intention. It has done this by inserting the word “any” into the text (C.3.8).

AQR and CRR Reviews

  • The proposal to increase transparency by audit committees of the work of the FRC’s Audit Quality Review (AQR) and Corporate Reporting Review (CRR) teams has been retained. From 2017, the FRC will publish the names of those companies or company audits which have been the subject of AQR or CRR review. The FRC will revise its Conduct Committee’s operating procedures to help facilitate this. The FRC believes that the publication of the names of the companies that were subject to CRR or AQR review will encourage those entities’ respective audit committees to report, even if there were no significant issues to report, in order to avoid speculation. The FRC highlights that there is a need for disclosure of AQR and CRR reviews to be factually accurate, fair and balanced, in order for the market to understand and avoid the need for further public clarification.

Advisory Report on Audit Committee Report

  • In light of responses received, the FRC does not consider it necessary to include a recommendation for an advisory vote on the audit committee report to be introduced.

Guidance on Audit Committees – Other Matters

  • In the Guidance on Audit Committees, the FRC has:
    • Clarified the role of the audit committee in relation to the fair, balanced and understandable statement (Paragraph 37 of Guidance) “Where requested by the board, the audit committee should review the content of the annual report and accounts and advise the board on whether, taken as a whole, it is fair, balanced and understandable to inform the board’s statement on these matters required under Section C.1.1 of the UK Corporate Governance Code. To assist the board to make that statement, any review would need to assess whether other information presented in the annual report is consistent with the financial statements.”
    • Sought to increase clarity by revising the internal control and risk management sections and those relating to the role of Internal Audit.
    • More clearly marked those elements which stem from requirements listed in other statutory or regulatory instruments to better differentiate these from best practice.
    • Referenced via footnote other important matters e.g. the FRC’s Ethical Standard’s rules on non-audit services.
    • Advised that the intention of existing guidance about the policy on non-audit services is to provide that an audit committee should set a policy for the pre-approval of non-audit services only where such services are considered ‘clearly trivial’, Each item above the pre-set limit should be approved by the audit committee.

The revised UK Corporate Governance Code and Guidance on Audit Committees can be viewed here.

Topics

  • Corporate and financial reporting

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