UK Financial Reporting Council consults on revisions to its Ethical Standard

The long-delayed transition of the Financial Reporting Council (FRC) into the new body the Audit, Reporting and Governance Authority (ARGA) was initially intended to have been fully implemented during the course of this year, but is now expected in the course of 2024.

The implementation of ARGA is intended to bring more effective oversight over audit work and address the "concentration" in the audit industry of the Big Four.

Despite the delays, the FRC continues to pursue the objectives of its agenda set out in its second three-year plan by implementing further reforms and issuing new consultations on the scope of its powers, and strengthen the impact of its enforcement action.

Standard revised

Following on from the recent announcement of changes to its Audit Enforcement Procedure, the FRC is now consulting on revisions to its Ethical Standard.

In June 2022, the FRC published a position paper on restoring trust in audit and corporate governance. The paper proposed revisions that would bring the UK standards in line with the International Ethics Standard Board for Accountants' (IESBA) Code of Ethics, respond more effectively to issues identified through audit inspect and enforcement cases, provide greater clarity around ethical prohibitions and requirements, and consult on the withdrawing of the "other entities of public interest" category to streamline the regime.

On 8 August 2023, the FRC published a consultation on revisions to its Ethical Standard proposing a number of reforms focused on threats to objectivity, independence and integrity (part A) as well as more specific changes focused on reporting, audit partner rotation, client-relationships, and the provision of non-audit services.

Reporting changes

The FRC proposes the introduction of specific requirements for firms to:

• Design controls that are effective in identifying reportable breaches.
• Consider the perspective of an objective reasonable and informed third party when assessing the implications of a breach.

It also introduces guidance on where firms should report to the FRC in a more timely basis, and what may constitute an "inadvertent breach"

Independence obligations

The FCA proposed clarification of prohibitions and requirements in respect of personal financial independence for staff at audit firms and where audit partners should be rotated on audit engagements. It looks to enhance prohibitions on economic over-reliance on fees from entities connected in substance if not in legal form.

It also calls for alignment with IESBA Code (particularly around providing additional services to audit services).

If approved, the proposals would come into effect by the end of 2024.

Osborne Clarke comment

At the heart of these proposals is the FRC's core aim of increasing confidence in audits in the wake of mounting concerns around audits following a series of high-profile corporate collapses. Compliance with the Ethical Standard sits at the centre of a culture of regulatory compliance and strong audit independence and it is no surprise that the FRC continues to strengthen and expand these requirements.

The new language proposed around reporting mirrors closely the Financial Conduct Authority's requirement under principle 11 to report anything of which the regulator "would reasonably expect notice" sooner than as part of the existing biannual reporting obligations.

The update to the provision of non-audit services within a network should also give firm's cause to reconsider the safeguards which have been put in place to ensure independence in providing such services and/or whether the continued role of the auditing firm remains appropriate.

Audit firms that already embody such a culture may well feel that these additional provisions are helpful guidance providing them with comfort as to the appropriateness of their existing compliance procedures.

However, the re-emphasis on principle rather than rule-based regulation should give all audit firms reason to revisit their policies and ensure that they are prepared for what is likely to be just one further step towards more rigorous regulation and intervention in enforcement.

The FRC is requesting comments on this consultation by 31 October 2023.

If you would like to discuss any of the issues raised by this consultation, please contact one of our experts.