Audit Market Supervision
Published: 25 September 2023
4 minute read
Background
The FRC has three teams that work together to undertake the regulation of UK statutory auditors and audit firms and for monitoring developments, including risk and resilience, in the market. We aim, through our supervision and oversight, to develop a fair, evidence-based and comprehensive view of these firms, to judge whether they are being run in a manner that enhances audit quality and supports the resilience of individual firms and the wider audit market.
Our supervisory approach is forward-looking – identifying and prioritising what firms must do to improve audit quality and enhance resilience. Our three teams Audit Market Supervision, Audit Firm Supervision and Audit Quality Review balance an assertive approach, holding audit firms accountable, while also acting as an improvement regulator, identifying and sharing good audit practice to drive further improvements across the sector.
Audit Market Supervision takes a cross-market approach to areas of importance to audit quality and firm resilience, including firmwide inspection work to ensure compliance with the International Standard on Quality Management (ISQM 1). Staff have a range of backgrounds (governance, risk management, internal audit, culture, regulation, and audit) representing the broad subject matter within the team’s remit. Our work is carried out under the pillars as described below.
Audit practices’ Systems of Quality Management
The new quality management standards (ISQM 1 & ISQM 2) which came into effect on 15 December 2022, require firms to approach their quality management in a more tailored, iterative and holistic way, with an increased focus on continuous improvement. They set out the quality management requirements for firms that perform audits, reviews of financial statements and other assurance and related engagements. ISQM 1 requires firms to establish and maintain a system of quality management, centring on establishing quality objectives, identifying and assessing quality risks, and designing and implementing responses to them. While ISQM 2 specifically covers the requirements relating to the use engagement quality reviews in this system.
Our work assesses the firms’ ongoing design and operation of their systems of quality management, including how they are tailored to firms’ specific circumstances. We use benchmarking to identify good practice and areas for improvement. We review how firms monitor their system of quality management, how they identify and assess findings, and how they design and implement remediating actions.
This work also includes monitoring the firms’ compliance with the Revised Ethical Standard 2019 and reviewing their reporting of ethical breaches.
Audit Market Resilience
Enhancing the resilience of the UK audit market is a key FRC objective. Therefore we assess and monitor various aspects of firms’ risk management frameworks – including financial, operational, regulatory, and network risks that could all have consequential impacts, and the firms’ crisis and contingency planning. We also monitor firms’ liquidity and access to credit, as well as the adequacy of firms’ professional indemnity insurance coverage.
We published some minimum standards with good practice guidance for the Big Four audit firms in relation to the recovery planning process. Read the Minimum Standards Guidance (PDF).
Operational Separation
The Big Four (Deloitte, Ernst & Young, KPMG and PwC) are transitioning to operational separation of their audit practices, with a final deadline in 2024. The FRC published Principles for Operational Separation of Audit Practices in July 2020 (updated in February 2021), which these firms have agreed to meet.
The objectives of operational separation are:
- to improve audit quality by ensuring that people in the audit practice are focused above all on delivery of high-quality audits in the public interest, and
- to improve audit market resilience by ensuring that no material, structural, cross-subsidy persists between the audit practice and the rest of the firm.
Read the Principles for Operational Separation (PDF).
Our supervision of operational separation is evolving. In each transition year we assess the effectiveness of the arrangements in place and the progress of the firms’ transition plans, and report our findings privately to the firms. After the end of the transition period in 2024 we intend to publish an assessment of the effectiveness of the Big Four firms’ arrangements for operational separation.
Culture and Conduct
Audit firms need the right culture to drive the right behaviours, which in turn are necessary for high-quality audits. We undertake work to assess and monitor various aspects of the culture at the firms, with a specific focus on the behaviours and mindset that correlate to high-quality audit. We also expect firms to have an ethical culture, and we monitor ethical conduct matters, including non-financial misconduct.
Governance and leadership
All firms in Tier 1 and the majority in Tier 2, fall within the scope of the Audit Firm Governance Code (revised 2022). The scope of the Audit Firm Governance Code is based on a threshold of a firm auditing 20 PIEs or one or more FTSE 350 companies. We review firms’ application of the Audit Firm Governance Code, and assess the effectiveness of firms’ governance arrangements.
We monitor whether firms are complying with their obligation to publish transparency reports. We review the content of firms’ transparency reports and provide feedback. We check that of the required disclosures have been in made in respect of the Audit Firm Governance Code, Retained Regulation (EU) No 537/2014 and Local Auditors (Transparency) Regulations (2020). We also assess whether transparency reports are fair, balanced and understandable overall.
We will begin reviewing FTSE 350 audit committee practice against the new standard, Audit Committees and External Audit: Minimum Standard.
Audit Market Monitoring
We have created an Audit Market Monitoring function within the AMS team, with the aim of:
- Enhancing our understanding of the structure of the audit market, for both PIEs and all statutory audits;
- Horizon scanning for short, medium and long-term risks, trends and impacts on the audit market in areas; whether they be driven by economic, political, legal, technological, socio-demographic, environmental or reputational sources.;
- Monitoring the developments of international audit regulators;
- Monitoring the supply chain for the audit market, including the availability of professional indemnity insurance, and the availability and capability of resources at all levels of the firm, including those sourced offshore;
- Overseeing the implementation of key regulatory policy initiatives that are designed to have a positive impact on the market;
- Monitoring, and periodically reporting on, the state of the audit market.