AS HE IS such a mild-mannered individual, it is somewhat ironic that Stephen Haddrill’s leadership of the Financial Reporting Council has come at a time when the reporting watchdog is increasingly baring its teeth.
Haddrill’s time as chief executive of the FRC has been dominated by the fallout from the financial crisis, exposing as it did critical failures in the governance, reporting and audit of some of the UK’s most systemically important financial institutions.
Since then, the audit profession and the standard of corporate reporting at the UK’s largest companies have been subject to scrutiny and undergone fundamental change. So, too, the FRC. The reporting watchdog has overhauled its unwieldy structure, beefed up its disciplinary processes and severity of its sanctions, while being handed enhanced duties – not all of them wanted – in inspecting the audits of FTSE 350 companies.
The regulator’s latest proposal, announced at the time of writing, will allow the FRC to essentially name and shame companies that are investigated for failing to provide accurate information in corporate reports. Under the rules, which have been put out to public consultation, companies will be forced to admit when their accounts have been subject to an inquiry by the FRC’s conduct arm.
Part of the FRC’s efforts to keep investors informed about reporting and audit failings, the new measures chime with more punitive sanctions guidance imposed last year as part of changes to speed up the watchdog’s, at times, lethargic disciplinary process.
“We don’t seek to be combative,” Haddrill tells Financial Director. “Public expectations have risen. There is less public trust in business and in the profession than there used to be. We have all got to work harder to win that trust back. To some extent that means the profession and regulators have to raise the bar. That is partly about achieving consistently strong performance. We have broadly got the standards we need – now we need them effectively implemented.”
The FRC’s first attempt to implement its new sanctions guidance, which can now take into account an accountancy firm’s size and profitability when calculating a fine, has left the FRC locked in combat with Deloitte over work it conducted at collapsed UK car manufacturer MG Rover. The Big Four firm was slapped with a £14m fine – £8m more than the previous recorded payout – and damned in an independent tribunal.
Deloitte has appealed the fine and the findings. The case has taken best part of a decade, and with no deadline on how long the tribunal member can take to reach their decision, the end is not yet in sight. However, the outcome could be pivotal for the integrity of the FRC’s new stance on discipline.
“We felt the issues raised by that case were of the upmost importance. That’s why we brought the case and supported the judgment at tribunal. We absolutely continue to fight that case,” Haddrill says. “We fight the case on its merits. Not because we want to look good.”
However, the FRC is not just about wielding the stick. Indeed, the FRC’s raison d’être is to promote high-quality reporting and governance to foster investment. As such, most of its work centres on improving company stewardship through the quality of corporate reporting. Under changes to the Companies Act, annual reports now have to include information about human rights approach, gender representation and greenhouse gas emissions. The amendments have introduced a “strategic report” which includes strategy, business model, and principal risks and challenges.
The FRC advised the government on what should be included in the strategic report. However, Haddrill concedes more disclosure in financial statements – while necessary – doesn’t “sit easily” with the FRC’s other stated aim of cutting clutter from annual reports. “What matters is that the disclosure is relevant to the business and that it reports on those things material to the company,” he explains. “Where this will all go wrong is if companies produce a boilerplate statement instead of giving careful thought to the relevance of the issue. That isn’t going to serve anybody’s interest. The problem with boilerplate is people put the text out there because they don’t want to do the thinking that is required on the issue.”
Holding the ring
Haddrill is honest enough to accept the FRC “had been struggling with how to address cutting clutter”. However, there is hope it will succeed in tackling an issue that has proved a severe headache for regulators, preparers, auditors and investors alike. In many ways, it was a driving force behind the creation of the Financial Reporting Lab, launched in 2011 to provide an environment where investors and companies can discuss reporting issues.
“The best thing to do was bring different sides into a room and we would hold the ring. We wouldn’t dictate the outcome but we would encourage companies that had new best practice ideas to share them with investors,” Haddrill explains. “We haven’t reached the end of road but we felt we could carry on preaching a message and, even if people agree, we weren’t helping them understand how to respond to what we were saying. It was evident that different players had different obstacles. The companies were afraid of innovating when they weren’t clear what their investors wanted.”
Anyone thinking the Lab is simply a case of regulatory navel-gazing should think again. It has already had notable successes, not least when business secretary Vince Cable adopted many of its recommendations as part of the most comprehensive reforms to the reporting of directors’ remuneration in a decade, such as developing a methodology to calculate a single figure for total pay.
A separate report by the Lab also found that investors want audit committee reporting to be bespoke and company-specific and for significant financial statement issues to be tailored to the company each year. Based on the views of 19 companies and 25 investor analyst groups, the FRC found that information on audit committee judgements related to financial statement issues had the most scope for improvement and could help them in developing views on valuation.
There were also specific recommendations that the audit committee chair be more accountable by personalising the report; describe in detail actions taken rather than just the functions served; and depict specific activities during the year and purpose – all using active, descriptive language.
The FRC has also forged ahead in the area of auditor reporting, though this decision has riled some quarters of the profession.
In 2012, the FRC made changes to the UK’s auditing regime, including new reporting disclosures in which auditors must provide an overview of the scope of the audit, showing how it addressed the risk and materiality considerations.
Those changes differ slightly from recommendations considered at a global level by the IAASB. For instance, the IAASB proposals require going concern statements to be made in all cases while the FRC’s requirements do not.
Additionally, the FRC’s requirement to report on the application of materiality would be dealt with as an ‘other matter’ rather than a ‘key audit matter’ under the IAASB’s proposals.
However, its decision to set auditing standards before the emergence of international consensus drew the ire of the ICAEW, which claimed the FRC’s actions would damage its global standing and create confusion for investors. In a letter sent to the FRC, the institute suggested that, by acting alone, the FRC is “likely to weaken the UK’s influence internationally”.
“I thought it was misguided,” Haddrill says. “If you listened to what the chairman of the IAASB has to say, he has found FRC work influential and useful. Frankly, I didn’t understand it.”
Acting first also fits with the FRC’s stated aim of influencing international debate on accounting standards and corporate governance. Indeed, it has not been shy in airing its displeasure that the IASB, the body responsible for setting global accounting standards, is yet to reinsert the concept of prudence into its conceptual framework.
With the appointment of Sir Win Bischoff as the next chair of the FRC, that criticism will likely become more vocal. What makes Bischoff stand out, other than his banking background – he is the current chairman of Lloyd’s Banking Group and a former chief executive and chairman at Schroders and Citigroup – is his views on accounting reform, given current flaws in bank reporting and concerns about the quality of auditing of banks.
Experts have pointed to inherent flaws in IFRS that allowed banks to pay out on unrealised profits by failing to make adequate provisions for loans that could go bad. This is an area in which Bischoff has previously had a lot to say. In March last year, he called for a return to traditional accounting standards and suggested that mark-to-market accounting made it impossible for banks to make general provisions against future losses.
However, this is not an area where Bischoff has direct control. Any impact will rely on how he influences the IASB, the body responsible for setting international accounting standards.
“I’ve found out a bit more about his views, and he is very thoughtful on this subject. I commend his views to our people. We need to be thoughtful; there is always a tendency to introduce a high degree of religious fervour into these debates,” Haddrill says. “His views are quite consistent with what the FRC has been saying about the need to re-establish prudence in the conceptual framework.”
An ongoing concern
The appointment should also bolster confidence in the FRC’s ability to tackle ongoing problems in bank reporting, auditing and governance.
In December, the FRC announced a review into why improvements of bank audits have failed to materialise. Among other things, the FRC’s review will focus on the issue of loan loss provisions. But the real thorn in the FRC’s side is its botched attempts at implementing Lord Sharman’s recommendations on going concern, culminating in a further consultation announced as part of wider changes to the corporate governance code , following criticism from investors and a key member of original panel of inquiry.
The FRC consulted on going concern – a principle in accounting that assumes a company will continue to operate in the foreseeable future – for the second time earlier this year. But it admitted to sister title Accountancy Age that it plans to launch a fresh consultation in response to what it describes as “investor concerns”.
Lord Sharman’s investigation into going concern was set up in 2011 to look at audit and financial reporting shortcomings in the wake of the financial crisis, particularly how banks’ disclosures were given a clean bill of health by auditors just before they needed to be bailed out by the state. The original recommendations, published in 2012, for a more broad-based going concern assessment that takes into account solvency as well as liquidity risks, received widespread support from the profession.
The FRC’s most recent consultation, which combines Sharman’s recommendations with wider changes to how companies and auditors disclose risks in annual reports, was launched in response to a barrage of criticism from the profession about how the meaning of going concern was defined.
Critics of the original proposals had warned that the FRC’s definition of going concern had “blurred the distinction” between the stewardship and accounting purposes of the assessment and that confusion would arise as a result.
In response, the FRC attempted to make clearer distinctions of the meaning of going concern and sought to combine previous guidance on risk management and internal control with assessment of the going concern basis of accounting as part of changes to the UK corporate governance code.
In January, however, David Pitt-Watson, a key member of the Sharman inquiry, warned that the FRC was in danger of departing from some of the original recommendations. In an email sent to investors and institutional representatives seen by Accountancy Age, he urged them to take part in the consultation after the definition of going concern had drifted from its common-sense meaning to one that only applies to its technical use.
The panel was of the opinion that the common sense interpretation was, de facto, the higher hurdle, and an important one for investors. But, in the most recent round of consultation, where a large proportion of the respondents were accounting bodies, this position changed, he said.
Now, going concern is only to apply to the technical issue of whether it was appropriate to use going concern accounting standards, not to the common-sense meaning of the phrase.
“There is a very high level of agreement about Lord Sharman’s objectives. Turning them into something that works has not been easy but the objectives are right,” Haddrill says. “We are determined to settle it. Since David [Pitt-Watson] issued his call to arms, we have had further engagement with investor bodies. We are moving towards an understanding as to their needs in a way companies can respond to positively.” ?
IN BLACK AND WHITE
2009 – present Chief executive officer, Financial Reporting Council
2005 – 2009 Director-general, Association of British Insurers
2002 – 2009 Director-general, Fair Markets Group at the Department of Trade and Industry
1998 – 2002 Various positions, Department of Trade and Industry
1990 – 1994 Member of governor’s central policy unit, Hong Kong Government