The head of the FRC’s Codes and Standards Committee talks about the watchdog’s new structure and its strategic objectives
A QUICK GLANCE at the level of reforms, revisions, consultations and working papers pumped out by the FRC, and Melanie McLaren could be forgiven for thinking she had taken a job with the in-tray from hell.
McLaren joined the UK reporting watchdog as executive director of its newly formed Codes and Standards Committee (CSC) in June, during arguably the busiest period in the regulator’s 22-year history.
Not only was the FRC in the midst of updating rules on corporate governance, stewardship, going concern and updating financial reporting standards for SMEs, McLaren’s appointment coincided with the biggest structural overhaul at the FRC since its inception in 1990.
Weeks after McLaren joined the FRC board, executive committee and CSC, the FRC received a green light from the government to radically reform its structure, reducing its seven operating arms down to just two. Under the new structure, one division sets governance guidelines as well as some accounting and auditing standards. The other focuses on enforcement and discipline.
Codes and Standards, which McLaren heads alongside chairman Jim Sutcliffe, effectively succeeds the Accounting Standards Board, Auditing Practices Board and Board for Actuarial Standards, with the CSC supported by three councils that will advise on accounting, audit and assurance and actuarial matters.
The argument for change was that the FRC had become cumbersome and unruly with codes and standards being issued by the various boards. The new structure is intended to enable it to operate as a unified regulatory body.
“We have looked at streamlining the reporting. We have actually been very clear about where the accountability and the responsibility lie and the roles of the councils in advising the board directly in some cases and in other cases informing the Codes and Standards Committee,” McLaren tells Accountancy Age.
McLaren’s appointment was announced back in March, when she was headhunted by the FRC from Friends Life, where she worked as interim chief risk officer from August 2011 until her departure in June, having previously operated in the same role at Friends Provident.
“I wasn’t necessarily looking for a move from Friends,” she says. However, moving to the FRC was an “excellent extension” of the work she had been doing in the risk management function at the life insurer.
“It’s about fostering investment and, when you look at where investment is from, it’s around long-term security, economic well-being of individuals and the economy,” she says.” You might use the word poacher-turned-gamekeeper but for me it’s just a continuation of a theme that has been throughout my career.”
In addition to a decade at PwC, where she was a partner within its financial services assurance practice, McLaren says her experience is well-suited to the role the CSC will play within the FRC’s structure.
“Coming from that background you see how interconnected things are; how accounting and what’s reported can inform behaviour – and therefore the principles that underpin it are important. In many ways, previous elements of my career coalesce around this codes and standards role,” she says.
McLaren says the CSC’s role is “oversight rather than a rubber stamping”:
“The reason it needs to be there goes back to this interconnectivity point. What is happening in the accounting world can have implications for how actuaries approach things, for auditors and for corporate governance, and the reverse applies.”
Under the changes, the councils that replace the boards have seen their wings clipped. Previously, each board issued its own codes and standards, whereas now they have become advisory rather than executive in nature.
“The key point is that the boards were about expert input and that’s not being lost,” says McLaren. “Some of the concerns about reform were that we will be taking away some of the expert input – and would we be developing codes and standards which were less relevant and reliable? It’s early days but the structure has been set up such that the board will ordinarily take the advice of the council.”
One criticism was that the imposition of the CSC in between the councils and FRC board is adding an unnecessary layer of bureaucracy, but McLaren does not accept this to be the case.
“The CSC is actually a sub-committee of the board. It is no different to any corporate organisation. You have working layers of non-executives who each bring different perspectives and will have more expertise, knowledge and interest in some areas,” she says.
“There are some matters where you might be doing horizon-scanning, reviewing threats and risks, developing a strategy as to how you tackle something that goes to that committee working level. It is quite clear in the terms of references of the board that the councils are experts and that their advice matters.”
The change from board to council also resulted in a shake-up in membership. The actuarial council was the subject of most change, and was “quite considerably revamped” in terms of its membership with Olivia Dickson, a former senior advisor at the FSA, named as chairwoman, leading a ten-strong team of industry figures.
The audit assurance council also gained some new members, but importantly the accounting council which replaced the ASB has not changed. Prior to the reform, opponents had lobbied hard to retain the ASB, with Geoff Meeks, a University of Cambridge accounting professor and advisor to the ASB, quoted in the Financial Times as warning the restructuring risked “destroying valuable organisational capital”, while Mike Jones of the University of Bristol called it a “retrograde step”.
McLaren says it was important to keep the old ASB members in situ. The board had been working on a new accounting framework for UK GAAP for SMEs – or IFRS for SMEs – expected to come into force for accounting periods beginning on or after 1 January 2015.
“We had begun a process to update UK GAAP, and that has been a fairly major long-term project,” says McLaren. “By the end of this year, we need to have got ourselves to a relatively final position so that the council will be giving advice to the board on the UK GAAP project. It is very important that we have continuity through that critical process.”
Onus on auditors
Possibly the biggest changes underway relate to auditors’ relationships with audit committees and company boards, with auditors now required to improve their communication with committees and increase their reporting levels.
Revisions to UK & Ireland International Standards on Auditing made by the FRC require auditors to be more explicit about their activities in preparing company reports and to report, by exception, if the board’s statement that the annual report is fair, balanced and understandable is inconsistent with knowledge acquired by the auditor.
Auditors will also be required to report when matters disclosed in the report from the audit committee do not appropriately address matters communicated by the auditor to the committee.
“Enhancing the competence and value of audit is undoubtedly part of the post-financial crisis review,” says McLaren. “For us, it demonstrates how the post-reform structure is influential because it provides the ability to look at corporate governance and company reporting and not just audit reporting.
“If you go back to the FRC’s objective of fostering investment, it’s important to have assurance about what is being reported.”
McLaren adds that the FRC also has strategic objectives around enhancing the application of the stewardship code, cutting clutter in financial reporting and making accounts shorter and more relevant.
The latest work focuses on improving the quality of financial reporting disclosures. In particular, the reduction of clutter in financial reports by avoiding duplication in disclosures and using tests of materiality more rigorously.
The aim of the FRC’s latest discussion paper is to develop a coherent framework within which standard setters and other regulators can set disclosure requirements and preparers and auditors can apply them.
More generally, in September the FRC confirmed changes to the UK corporate governance code and stewardship code including audit committees providing shareholders how they carry out their responsibilities,consistency in narrative reporting, tougher rules around comply-or-explain, and tougher disclosures for investors.
Additionally, the updated code included the requirement that FTSE 350 companies put their external audit out to tender at least every ten years. The move represents a split with the European Commission’s stance on mandatory rotation.
“We have gone for a different approach,” McLaren said in response to the proposals being considered in Europe. “We think this is about enhanced quality of audit, and remain unconvinced that mandatory rotation drives quality. Tendering is more likely to assure quality.”