Government Delay of ARGA Leaves FRC Toothless

The omission of promised audit and corporate governance reforms in the King’s Speech undermines attempts to restore investor and public trust.

The omission of expected audit and corporate governance reforms in the King’s Speech has watered down revisions promised by the UK’s Financial Reporting Council (FRC) and delayed “behavioural change” from corporates. 

“It’s disappointing that the government has not included [audit and corporate governance] reforms in the legislative programme for the coming year – the convergence of the FRC into the Audit, Reporting and Governance Authority (ARGA) depended on it,” Peter Swabey, Policy and Research Director at the Chartered Governance Institute (CGI) UK and Ireland, told ESG Investor. 

In a 2019 report, the UK Department of Business, Energy and Industry Strategy (BEIS) said the FRC is a “weak and ineffective regulator”. 

In March 2021, the BEIS published a consultation calling for an increase in audit firms’ accountability to shareholders, an expanded scope to include non-financial information such as ESG risks, and announced the development of ARGA. The consultation received over 600 responses, with the majority proving supportive of the new regulatory body. 

Without ARGA, the FRC doesn’t have the power to take forward several changes outlined in the consultation on the Corporate Governance Code earlier this year, according to Swabey.  

“The FRC as it stands does a good job within its boundaries, but it simply doesn’t have the power to enforce,” he said. 

“They can report that they don’t think companies are going far enough and they can try and influence behaviour, but they can’t do anything to make companies go further.  

“ARGA would have been able to mandate behavioural change.” 

In response to the omission of related legislation in the King’s Speech, the FRC has published a statement on its recent consultation proposing revisions to the UK Corporate Governance Code. 

The watchdog confirmed that it will still be making a small number of changes that will streamline and reduce duplication associated with the Code.  

However, over half of the original proposals will not be taken forward “as a result of the government’s recent decision to withdraw its Statutory Instrument relating to an audit and assurance policy, reporting on distributable profits, and resilience statement requirements”, the FRC said. 

These include those relating to the role of audit committees on environmental and social governance, as well as modifications to existing Code provisions around diversity, over-boarding and Committee Chairs engaging with shareholders.  

There is broad stakeholder consensus that such reforms are necessary to restore investor and public trust following high-profile scandals, such as the collapse of Carillion. 

The FRC said it was nonetheless “pleased” when, on the 16 October, the government restated its continued commitment to audit, corporate reporting and governance reform, and that it will bring forward legislation “when Parliamentary time allows”.  

“We remain absolutely focused on ensuring our current regulatory toolkit is used to best effect,” the FRC’s statement noted.  

“This includes setting proportionate standards, fostering a culture of continuous improvement and holding to account those that fall short.”  

Swabey said it’s “not unreasonable” for the FRC to temporarily scale back its planned reforms until ARGA is in place.  

In October, the government announced that it would be scrapping a bill aiming to strengthen corporate governance reporting requirements for UK companies with a turnover of more than £750 million (US$911 million) or over 750 employees. They would have had to provide an annual resilience statement, distributable profits figure, material fraud statement, and publish a triennial audit and assurance policy statement.   

Raising the bar 

Swabey said it is important that the FRC and stakeholders continue to consider how corporate governance can be improved in the UK.  

“One of the major advantages of the UK market continues to be the high standards of corporate governance that UK companies have applied compared to other jurisdictions,” he said.  

Improvements are nonetheless needed, Swabey acknowledged.  

The FRC’s latest annual review of corporate governance reporting, published this week, noted that some companies are providing “high quality and insightful reporting”, but many explanations still lack sufficient clarity.  

There were many examples of “boilerplate reporting”, the FRC said, with companies using generic language that failed to meet stakeholder needs for meaningful explanations demonstrating how their governance arrangements benefit the company and shareholders.  

Further, “little improvement” has been seen in disclosures on risk assessments and internal controls, with the FRC calling for more work on demonstrating robust systems, governance and oversight. 

In recent months, the FRC has been paving the way to a higher standard of audit and corporate governance through a series of papers and guidance.  

In March, the FRC updated its ‘Approach to Audit Supervision’ document, which outlines how it supervises audit firms. The document now includes a Public Interest Entities Auditor Registration, supervisor letters, and Single Quality Plans.  

The FRC also took on the role of shadow system leader for local audit, emphasising its commitment to ensuring high-quality audits across the public and corporate sectors. 

Additionally, in August, the FRC published a consultation on revisions to its ethical framework for UK auditors to help bolster to principles of integrity, objectivity, and independence that auditors are mandated to uphold. 

The robustness of the revised Corporate Governance Code without half of the proposed revisions remains to be seen, said Swabey.  

“As shown with the FRC’s [latest annual review], I think we can also expect to see them being more vocal and making statements outlining what they think is being done well and what needs to be improved,” he noted.  

“It’s also important that investors continue to engage with investee companies about the governance issues in which they are interested,” he added.  

“One of the frustrations that we hear from companies is that they go out to their investors to ask them about an [corporate governance-related] issue and sometimes there’s a tumbleweed moment, in that they get no response. Equally, we hear from investors that sometimes they go to companies about these issues and get no response.” 

The updated Corporate Governance Code will be published January 2024. 

“Two sides of the same coin”  

During the consultation on the UK Corporate Governance Code, stakeholders also raised concerns about the UK Stewardship Code, the FRC said in its statement. 

The UK Stewardship Code has over 250 signatories, including UK pension schemes Brunel Pension Partnership and Railpen. 

The FRC is set to review the Stewardship Code next year, and said it plans to continue to engage with stakeholders in the near term on how best to conduct the review, including understanding how it works in practice and what changes may be required to ensure it remains fit for purpose. 

The FRC’s review of 2022 UK Stewardship Code submissions from asset managers and owners identified improvements in the quality of disclosures, including addressing systemic risks, monitoring third parties and extending assessments beyond equity investments. Further improvement was nonetheless called for, such as using both quantitative and qualitative evidence. 

“The Stewardship Code has not been as effective as the Corporate Governance Code,” said Swabey, adding that it would be useful if the FRC finds a way to give it “a bit more in the way of teeth”.  

At ESG Investor’s inaugural Stewardship Summit in May, FRC Director of Corporate Governance and Stewardship David Styles said that corporate governance and stewardship are “two sides of the same coin” and need to be worked on together. 

The FRC has previously attempted to provide investors and companies with more clarity on both corporate governance and stewardship with a ‘myth-buster’ document in February, which included definitions of both topics and outlined the powers the Corporate Governance Code gives the FRC. 

At the time of writing, the FRC has not responded to a request for comment.  

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