Chairman's Statement

The fact that successive governments and the market have asked the FRC to take  on additional responsibilities suggests that we have a track record of exercising them effectively. But no matter how good our past record has been, we cannot take our future success for granted.

When I succeeded Baroness Hogg as Chairman in May 2014 after her four successful years in the role, I was keen to make my own assessment of whether we are well placed to deal with the challenges ahead. We set in hand the necessary work to develop our next three year strategy, for 2016/19, including the way we raise our funds and develop our people. We are evaluating the impact of the reforms to our structure and statutory powers in 2012. And we have instituted a review of the effectiveness of our monitoring of the quality of corporate reporting and auditing.

I have personally spoken to many of those we regulate, those who benefit from our activities, and those whom we seek to work with and influence. We have also undertaken a stakeholder survey to understand better how we are viewed.

Overall the feedback has been positive. The FRC is seen as being close to the markets, consultative and willing to listen, with greater coherence and focus to our structure and statutory powers than before the 2012 reforms. We are also seen as influential by those organisations we deal with in the EU and internationally.

Of course, there is room for improvement. In common with other regulators, we have begun to see signs of regulatory fatigue amongst those with whom we deal. We also heard that we need to do more to understand the views of, and impact of our work on, investors.

During the year we undertook an internal review of the effectiveness of our board, committees and advisory councils, and assessed progress following the independent evaluation carried out in 2013/14.

In addition, the Nominations Committee has reviewed the FRC's non-executive succession planning across the full governance structure. We concluded that the skills and stakeholder representation were appropriate but identified the need to appoint to the Board individuals with actuarial experience and experience in the non-listed sector. I am pleased that John Coomber and Ray King will join the Board shortly. Ray will now chair the Audit and Assurance Council and both will join the Codes & Standards Committee.

While we will not underestimate the challenges facing us, I believe we are in a good position to cope with them.

In developing our three-year strategy for 2016/19 we must not lose sight of our primary mission to foster investment and must keep the needs of investors at the front of our mind. We need to remain focused on our priorities, measuring success by the impact we make, not by our level of activity. We need to maximise that impact by continuing to work collaboratively with fellow regulators and others such as the professional bodies. We need to avoid imposing unnecessary burdens on those we regulate, taking a non-regulatory approach wherever possible, being particularly mindful of any adverse impact on small, growing companies.

We will continue to improve how we communicate with all of our stakeholders, including a number of initiatives focussed on the investor community. We are particularly keen to engage closely with Government and Parliament to ensure there is good understanding of our work and its effectiveness. And we need to make sure we have the right structures, people and resources to carry out our responsibilities effectively and efficiently.

Our approach to governance has enabled us to focus on key strategic issues, with our Board, Committees and Councils taking on much of the 'heavy lifting' on matters that require detailed scrutiny. This has enabled us to make further progress in delivering the priorities we set for our 2013/16 strategy - including updating the UK Corporate Governance Code to promote a clearer focus on risk, internal control and the assessment and reporting of companies' longer-term viability.

I should like to take this opportunity to thank the many Committee and Council members who support the work of the Board and also to thank Stephen Haddrill and the executive team for their continuing support and commitment.

In January 2015 we announced that Jim Sutcliffe had stood down from the Board and from his Chairmanship of the Codes & Standards Committee, having formerly served as Chairman of the Board for Actuarial Standards. His contribution in these capacities has been highly valued. John Stewart stood down from the Board and the Codes & Standards Committee from July. I would like to take this opportunity to thank both Jim and John for their advice and commitment to the work of the FRC.

Sir  Winfried Bischoff

Chairman
13 July 2015

Overview

Our Values and Approach

We have a wide range of responsibilities in relation to corporate reporting and audit quality. However, we do not rely on legal powers alone. We also set codes and standards and promote best practice. We aim for our codes and standards to be adopted because companies, their investors and the professions believe they make sense, rather than because they have to comply. We achieve this through reaching out to our stakeholders – consulting with all parties in developing our proposals, seeking always to listen and adapt to better ideas.

We also try to ensure that our codes and standards are based on principles that promote the exercise of good judgement by directors and others. They are not sets of rules to be followed without proper thought. In some areas, such as corporate governance, we enable companies to ‘comply or explain’. This gives them time to think through new priorities and to take steps that best meet the needs of their shareholders. Knowing there is such flexibility, companies have sometimes supported more radical proposals.

However, there is also a need for strict requirements in certain circumstances, backed by consistent and fair monitoring and enforcement.

Accounting standards must be followed to ensure trustworthiness and comparability of information between companies to aid investment decisions. We therefore monitor compliance with standards, require companies to apply them and, if necessary, take action to secure compliance.

Successive governments and the EU have required companies to have an external, independent, audit. Audit exists to provide investors with confidence in the trustworthiness of the company’s financial statements and it is essential to that goal that the auditor is also worthy of trust. We also, therefore, set, monitor and enforce compliance with auditing standards.

As a final safeguard of quality and integrity, if accountants, auditors or actuaries do not deliver on the professional standards they espouse, we will take disciplinary action to address misconduct.

The monitoring and enforcement of principles-based standards is a challenge. Testing judgements made by companies under principles is harder than assessing compliance with rules. We therefore ensure that our regulatory conclusions are subject to close review within the FRC executive and to governance oversight by experienced non-executives.

Some stakeholders find it confusing that the FRC seeks to be both attentive to the views of its stakeholders and tough if it finds poor performance, but we think this combination of approaches serve investors well, and the FRC does hold to one overriding principle, that across all its operations it should focus on achieving outcomes that are evidence-based and proportionate to the challenge it seeks to address. Nevertheless, feedback from stakeholders makes it clear that we need to communicate more effectively the rationale for our decisions and we are considering how to do this.

Our Strategy

We established our current three year strategy to deliver our mission in 2013 in the wake of the review and reform of the organisation and its powers conducted jointly with the Department for Business, Innovation and Skills (BIS). The strategy sought to address the issues that had emerged from the financial crisis in relation to governance and reporting.

Our analysis of the effectiveness of governance and reporting in the UK at that time was that it was generally strong and compared well with that in other capital markets. However, we also identified some important impediments to the delivery of our mission:

• Some boards had not taken a sufficiently long-term view of their company’s prospects and as a result had failed to identify and report effectively the risks they faced. Indeed, a small number of companies had failed shortly after confirming themselves to be a going concern.

• Although there was generally constructive engagement between the larger listed companies and their shareholders this was not the case across the listed sector or Stewardship Code signatories as a whole.
• Corporate reporting was growing in volume, but not quality. It was not providing a clear agenda for shareholders in relation to their engagement with directors and, in consequence, their impact on boards was sub-optimal.
• There was reduced confidence in the audit profession following the financial crisis.
• The FRC’s work in monitoring the quality of company reports and auditing was generally well regarded. However, our sanctioning of poor performance was felt to be weak and slow, and the lessons of our monitoring work were known to too few directors and others in business

Actuaries came through the financial crisis without such criticism. In this case, the need was to ensure that the FRC’s standards for actuarial work remained up to date, reflecting changes in the nature of actuarial work and lessons from how well the standards were applied in practice.

In the light of this analysis, the FRC adopted five strategic priorities:

• High quality corporate governance and investor stewardship which foster trust in the way companies are run.
• High quality corporate reporting that is fair, balanced and understandable.
• High quality audit and confidence in the value of audit.
• Actuarial oversight and standards which underpin high quality actuarial practice, and the integrity, competence and transparency of the actuarial profession.

• Effective, proportionate and independent investigative, monitoring and disciplinary procedures.

Our progress on each of these priorities is summarised in the next section of the report. We believe we have made significant progress.

We recognised that for effective delivery of our strategy our work needs to be joined up. We aim to create integrated solutions making the most of our range of powers and responsibilities. For example, we have used the UK Corporate Governance Code, auditing standards and audit monitoring together to enhance confidence in audit.

Our work also needs to be pursued in collaboration with other regulators, both in the UK and overseas. Businesses, and the professions, cross national borders. The quality of the audit of a multinational British business, for example, is highly dependent on work done and, in many cases, regulated abroad. The FRC therefore needs to continue to influence and provide thought leadership at an international level. Our work is highly respected and shows leadership in key areas such as extended audit reporting.

At the same time, investors and those we regulate have a reasonable expectation that UK regulators will be joined up to ensure their work is effective, without gaps or overlaps. To that end, the FRC has signed Memoranda of Understanding covering its relationships with other regulators and meets regularly with them to identify emerging risks. This year the Joint Forum on Actuarial Regulation, for example, produced a map of risks in actuarial work to help regulators and the profession focus on and mitigate risk.

Challenges to our strategy

The effectiveness of the FRC’s strategy could be thrown off course by unintended consequences of the changes we have introduced. These concerns are reflected in the principal risks to our ability to deliver our mission and include:

• That strengthening the framework could undermine confidence in the short term by highlighting deficiencies. We recognise this risk. However, we feel it is more important to demonstrate that material concerns are being tackled.

• That new requirements could create exhaustion with regulation rather than higher standards, with directors and other professionals responding in formulaic ways rather than by enhancing the quality of their judgement and communication, resulting in more clutter and ‘boilerplate’ in reports undermining transparency for investors. We have therefore monitored implementation closely, such as through our review of extended auditor reporting; promoted clear and concise reporting; and supported implementation through the work of the Financial Reporting Lab.
• That more competition in audit could undermine rather than stimulate quality. We are therefore monitoring the impact on pricing and on quality. Initial signs are that there is emerging competition, primarily on grounds of quality rather than price, in relation to large companies’ audit retendering, and that audit committees are paying more attention to the results of our audit inspections

These concerns are reflected in the principal risks to our ability to deliver our mission.

We also face a mixture of challenges of an on-going nature, to which we are applying close attention:

• That investors do not meet the expectations of the Stewardship Code and make the most of the changes to reporting through good quality engagement with companies. We have worked closely with the Investment Association and Investors’ Forum to understand the quality of engagement and are now reviewing the Stewardship Code and its impact.
• That the FRC’s leadership and staff may not keep pace with the changes in the market and the way companies approach governance and reporting. We must aim continually to improve. We are wholly committed to being a great place to work that invests in its people. We have introduced a regular and detailed Board-led review of executive succession planning and invested more in staff development, including a ‘Future Leaders’ programme.

• As noted above, the pace of our disciplinary work has been a concern. Our 2013/16 Strategy included a step increase in the speed and effectiveness of our disciplinary processes whilst at the same time clearing the backlog of cases, and we have made good progress. However, the MG Rover disciplinary case highlighted the challenge of operating the disciplinary scheme efficiently. This is the first case under our accountancy disciplinary scheme that has gone through the full process of investigation, prosecution, tribunal and appeal tribunal. The appeal tribunal supported a number of the original tribunal’s findings in favour of the FRC and rejected others. It also correctly drew attention to the length of time it took to complete the investigation, the quality of the expert advice and the cost of the investigation. The reforms to the disciplinary scheme since 2012 address many of these issues. We will reflect very carefully on the lessons of the MG Rover case and consider whether further reforms are necessary.
• Our oversight of the actuarial profession was reviewed in 2013. We have since consulted on changes to our technical standards. We have also established the Joint Forum on Actuarial Regulation (JFAR) with the Prudential Regulation Authority, Financial Conduct Authority, the Pensions Regulator and the Institute and Faculty of Actuaries. We now need to address the monitoring of actuarial work. At present, in the absence of monitoring, we lack hard evidence of the effectiveness of the regime. Following on from the publication of its Risk Perspective, JFAR will conduct a number of in-depth reviews into specific risks where actuarial work is relevant, including understanding the size of any potential issue, defining the relevant actuarial work more precisely and testing controls

• We are supporting BIS in their consultation on the implementation of the new Audit Regulation and Directive, which was introduced in June 2014. The work of the FRC is likely to expand however the legislation is implemented, with a significant increase in the number of audit firms to be monitored and a new arrangement for the oversight of the professional bodies in relation to audit matters. The legislation requires the new regime to be in place by June 2016. Given the scale of change required this timeframe is very tight. We have had to commit considerable resource to planning and implementation at the expense of some delay to other projects.
• As a regulator we must always ensure that we are achieving our goals in the most efficient and effective way. The implementation of the Audit Regulation and Directive will represent an important step in our regulatory responsibilities for audit. It should also be a moment when we consider more generally how well we go about our job as a regulatory authority. Our approach should be proportionate; our standards should promote quality without inhibiting innovation; our monitoring and enforcement activities should support the achievement of high standards. And we must ensure that we are, and are seen to be, accountable to investors and all those with an interest in our work. As part of committing to continuous improvement we have contracted McKinsey to undertake a major review of how our monitoring work can be most effective.

• Across all its work the FRC is affected by EU Law. We work hard to ensure that the strengths of the UK regulatory framework are respected and that new EU legislative proposals reflect UK conditions. We have had particular success in making the case for ‘comply or explain’ in governance and in moderating the costs of the original proposals for audit regulation. In the next two years the UK referendum creates a risk that other EU members will pay less attention to UK concerns. We will therefore work even harder to ensure our expertise is provided and listened to. The FRC Board has, for example, met recently in Brussels to engage with key members of EU institutions

Our future strategy

I believe that the FRC has made good progress in delivering the priorities that we set ourselves in 2013. However, some of the issues we address cannot be solved quickly – particularly where we are seeking to bring about changes in culture and behaviour – and some of the risks and challenges we face will always be with us. Many of these issues will therefore also be major components of our next three year strategy, covering 2016/19.

We have begun to lay the groundwork for the new strategy during 2014/15. As the Chairman reported in his statement, we are reviewing our strategic objectives and our regulatory approach, including by looking at the effectiveness of our monitoring of corporate reportingand audit quality. The results of these considerations will be set out in a draft strategy that will be published for consultation later in 2015. We will alsolook at the effectiveness of our influencing of International Financial Reporting Standards (IFRS).

We are also considering whether as an organisation we are fit for the future. We are assessing and will report in our next strategy whether the reforms to our structure and statutory powers in 2012 have had the intended impact, and whether further changes might be needed as we prepare to take on new and expanded responsibilities. We are also reviewing our funding arrangements and are developing our people to ensure that we have the capabilities to carry out our role effectively and efficiently

Our People

The FRC is a good place to work for both our experienced professional staff and for people in their earlier careers who are looking to gain experience in an organisation that works in the public interest, provides real intellectual challenge and focuses on developing talent. The FRC’s staff survey consistently shows high levels of job satisfaction, an understanding of what is required, and confidence in management. However, we cannot stand still, particularly in developing our people.

Our strategy requires us to have a wide range of skills and capabilities amongst our staff. As a standard setter and monitor of work in the largest and most complex companies, we need people who, for example, are amongst the most technically strong accountants in the country. We also need excellent communicators who can explain the reasoning behind policy and regulatory decisions and demonstrate that those decisions make business as well as technical sense. In these respects we need to invest more in sectoral business knowledge.

Communication and business skills also need to be allied to knowledge of the international environment in which we operate so we can strengthen our influence. Development is also needed to strengthen our talent pool for senior positions. Our efforts are guided by a new approach to performance management that involves development plans for all and systematic succession planning for senior positions. We have also increased our investment in training and development across the company.

Our success also depends on the effectiveness of the relationship between the executive, the Board and its Committees. The governance reviews showed this to be strong and constructive. This is most important to me and my senior team and we commit to preserving it. The executive as a whole particularly appreciate the attention given by the Board to their development, with a number of Board members mentoring staff, and listening to staff issues including through review of the staff survey and the Chairman’s breakfasts with staff groups.

Our External stakeholders

Our effectiveness depends on having good, constructive, and when necessary, appropriately challenging relationships with our stakeholders. We seek to achieve this by reaching out – one of our values– in a systematic series of engagements.We have two public meetings a year to hold ourselves accountable for ourplans. We have regular meetings at every level with the professional bodies who are co-regulators in raising professional standards and with whom we need to maintain a strong partnership whilst properly discharging our oversight role. We have started having an annual policy conference and on individual issues we have regular roundtables. The Financial Reporting Lab alone has involved nearly 300 people in its work. Our stakeholder survey shows, however, that we need to do more in building bridges across the board to investors, listening betterto them and achieving this is a focus for us this year.

Our Funding

We need a stable revenue stream to discharge our responsibilities and pursue our strategy. Many of our responsibilities are imposed by law and cannot be cut. Other work is the subject of strong public expectation that it will be delivered. Some of our funding is provided by the professional bodies on the basis of contractual arrangements; the other elements of our funding are provided on a voluntary basis. We seek to ensure that we continue to have a stable and secure basis on which to operate.