Blog: Making the Financial Reporting Council fit for purpose

Directors' Blog: Peter Montagnon

Sir John Kingman will by now be putting the final touches to his report on the future of the Financial Reporting Council. 

Whatever he decides, some change seems inevitable for an organisation whose role encompasses both standard setting and enforcement. Insofar as these roles are combined, he might do well to consider whether the governance approach that seems best for one is also best for the other. The answer could point to the extent to which there is a real need for change.

The FRC may rightly be criticised for doing too little to forestall and address accounting fiascos, but it has got too little credit in the public and political debate for what it does well: setting standards in accounting and corporate governance.

In both areas the UK is a leading international player with, in particular, a long record of pioneering governance and stewardship codes, as well as the concept of comply or explain with its tradition of promoting incremental change in the way companies are governed. More recently it has also been a world leader in promoting understanding of the importance of corporate culture.

It would be a pity to tip the baby out with the bathwater. Failure in enforcement speaks for much tighter government control over its activities, providing there is also strict adherence to due process. Yet independence is critical to its effectiveness as a standard-setter.

The danger of politicians interfering in accounting standards has been clear ever since, some ten years ago, President Chirac tried to alter European accounting standards to protect French banks from having to undertake large write-downs in the run-up to the global financial crisis. That might have been good short term politics but it was hardly conducive to long-term market confidence. Much the same applies to the politicisation of governance standards whose primary purpose is also to build market confidence through the promotion of strong well-run companies with a good long-term future.

This distinction raises important question about governance. An FRC devoted to enforcement would need a strong government presence on its board and a clear accountability line to government departments, subject to due process as mentioned above to. One devoted to standard setting would need governance arrangements that supported its independence with some clear limits on political interference, much as is the case at present.

The question for Sir John is whether the two can be reconciled and, if not, whether the right answer is to split the organisation up.

Proponents of the status quo would argue that the enforcers can learn from the standard setters and vice versa. A close working relationship would certainly be needed, but a separation which merged audit and financial reporting enforcement into existing market regulation would do away once and for all with the worry that a specialised regulator was too close to the accounting profession and too soft on it.

The remaining standard-setting body could indeed rightly be described as a Council, though these days it would need a little more than just the words Financial Reporting in its title.

Posted: 06/12/2018

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