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FRC Annual Report and Accounts 2014/15

ANNUAL REPORT AND ACCOUNTS OF THE FINANCIAL REPORTING COUNCIL - INCLUDING THE REPORT OF THE INDEPENDENT SUPERVISOR YEAR TO 31 MARCH 2015

The Report of the FRC as the body designated by a delegation order under section 1252 of the Companies Act 2006 and the Report of the Independent Supervisor is presented to Parliament pursuant to sections 1231(3) and 1252(10) of, and paragraph 10(3) of Schedule 13 to, the Companies Act 2006.

Accounts presented to Parliament by command of Her Majesty.

The Report of the Independent Supervisor is also presented, pursuant to section 1231(2), to:

The First Minister in Scotland;
The First Minister and Deputy First Minister in Northern Ireland; and,
The First Minister for Wales and is laid before the National Assembly for Wales pursuant to section 1231(3A) of the Companies Act 2006.

HC325 The Financial Reporting Council Limited 2015

The Financial Reporting Council Limited 2015

The text of this document (excluding logos) may be reproduced free of charge in any format or medium providing that it is reproduced accurately and not in a misleading context.

The material must be acknowledged as FRC copyright and the document title specified. Where third party material has been identified, permission from the respective copyright holder must be sought.

Any enquiries regarding this publication should be sent to us at:

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This document is also available at our website at www.frc.org.uk

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Registered number: 02486368

Our Mission

To promote high quality corporate governance and reporting to foster investment

Group photo of thirteen FRC board members or senior staff gathered around a conference table.

Our Values

We work in the public interest, seeking at all times:

to be joined up to make the most of the breadth of our role
to reach out to our stakeholders to secure their expertise
to be evidence-based to ensure our decisions are soundly-reached and respected
to be decisive to ensure problems are addressed in a timely manner
to show respect to others; recognising the value in different perspectives

Chairman's Statement

Headshot of an older white man with white hair, wearing a suit and pink tie.

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.

Sir Winfried Bischoff

Chairman

2015 marks the FRC's 25th anniversary. Originally established in 1990 to be responsible for setting and monitoring UK accounting standards, the organisation has evolved significantly since then. We have taken on an increasing range of responsibilities, which now also cover corporate governance and investor stewardship, audit and assurance, actuarial work and oversight of the accounting and actuarial professions, and have grown as a result. However, we are and wish to remain a relatively small organisation, even though we will expand further if we are asked to become a competent authority for the regulation of the audit profession under the EU Audit Regulation and Directive. 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

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. The results of the review are reported on page 37.

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

1 Strategic Report

1.1: Chief Executive's Overview

Headshot of a middle-aged white man with graying hair, wearing a suit and patterned tie.

We aim for our codes and standards to be adopted because companies, their investors and the professions believe they make sense.

Stephen Haddrill – Chief Executive

Our Mission

The FRC's Mission is to promote high quality corporate governance and reporting to foster investment. A secure flow of investment into the UK's capital markets, driven by high quality governance and reporting, helps underpin the growth of our economy and our competitiveness.

Our work is designed to encourage the provision of trustworthy information to investors and to encourage trustworthy behaviour by boards of companies and the professions. In addition, we seek to build justified confidence internationally in the UK regulatory framework for corporate governance and reporting.

Our business model:

The FRC is the UK's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment. The diagram illustrates relationships between:

High quality codes and standards
Oversight, monitoring, and discipline
Influencing and thought leadership
Operating in the public interest
Principles-based; "comply or explain"

These contribute to:

Trustworthy information
Trustworthy behaviour
INFORMED DECISIONS

Key questions are:

What makes the FRC different?
How does the FRC add value?

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.

Our stakeholder survey shows, however, that we need to do more in building bridges across the board to investors, listening better to them and achieving this is a focus for us this year.

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:

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.
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.

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, 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 (page 29) 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 (page 29).

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.

As a regulator we must always ensure that we are achieving our goals in the most efficient and effective way.

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/

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 reporting and 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 also look 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's staff survey consistently shows high levels of job satisfaction, understanding of what is required, and confidence in management. However, we cannot stand still, particularly in developing 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 our plans. 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 better to 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.

Stephen Haddrill Chief Executive Officer

1.2: Progress against 2013/16 Strategy

Overview

First Steps

Our new strategy was designed to be unfolded gradually over 2013/16. We sought initially to strengthen the commitment of boards to the importance of reporting being fair, balanced and understandable. We felt this would stimulate a change in mind-set based on realism and openness and that that would create the right conditions for future change. We also believed this requirement would act as an antidote to formulaic, boilerplate text.

The effectiveness of audit was a central theme for 2013/14. We asked audit committees to report on all significant matters they had discussed, including their assessment of the audit. We believed this would also encourage realism and openness and underpin our expectation that audit committees would more robustly drive audit quality and take greater charge of finding and overseeing the auditor. We reinforced their work by sharing our audit inspection reports with audit committee chairmen and by offering to brief them on the findings.

These steps had value in their own right, but we also felt they were a necessary precursor to the introduction of audit retendering every ten years. We felt that retendering was necessary to help deliver our goal of restoring confidence in the value of audit by revitalising the market, promoting innovation through competition, and enhancing auditor independence.

However, we also saw the risk of price competition undermining the firms' capacity to do quality work. We felt that the best mitigant of this risk was engaged audit committees committed to quality.

The final element of the strategy on audit was the introduction of extended auditor reporting, through which the auditor would give an overview of how they had conducted the audit; including the audit risks they identified and how they had addressed them; and the level of materiality they applied. Our goal was to remove the mystery around audit for investors and, combined with the fuller audit committee reports, give them a better basis for engaging with directors on financial matters and risk. Audit firms responded innovatively and investors welcomed this, which we hope will in turn further reinforce the commitment of audit committees to quality.

We also made progress in other areas: consulting on how the UK Corporate Governance Code covers remuneration, promoting the Stewardship Code, promoting clearer, more insightful company reporting through the Strategic Report, continuing our reforms to accounting and reporting requirements for smaller entities by overhauling UK GAAP, establishing the Joint Forum on Actuarial Regulation and focusing on the overall effectiveness of our conduct activities. Across all these activities, we contributed to EU and international developments.

2014/15

We continued to implement key elements of the strategy during the period covered by this Report and have begun to test its effectiveness.

We amended the UK Corporate Governance Code to promote a better focus on risk, internal control and the assessment and reporting of the longer-term viability of the companies. The changes were intended to address directly the concern of many investors that banks and other companies had paid insufficient attention to risk in the run-up to the financial crisis. They build on the changes already introduced in relation to audit committees and auditors and promote judgement by putting the onus on directors to choose the period over which they report on longer-term viability. Our Financial Reporting Lab looked at the quality of audit committee reporting in

In March 2015 we issued a report on the take-up of requirements on extended auditor reporting. The report suggested that the new requirements were beginning to make key aspects of the audit process more transparent for investors. Some auditors are reporting that audit committees are taking into account audit firm partners' audit inspection results, which suggests they are paying close attention to quality. We hope that, over time, this will lead to improved justifiable confidence in audit. We are now looking at the impact of audit retendering.

We reviewed the implementation and operation of the Audit Firm Governance Code. Our report (https://www.frc.org.uk/Our-Work/Publications/FRC-Board/Consultation-Audit-Firm-Governance-Code-File.pdf), published in May 2015, considered the progress made in terms of governance of UK audit firms following the Code's implementation and sought feedback on strengthening the Code to put more focus on the public interest in, and governance of, audit work within the firms' total business. The report concluded among other things that the firms have taken a major step forward in bringing in Independent Non-Executives. As firms grow their consultancy business, it is important that the principle of external challenge remains focussed on the audit practice as well as across the firm as a whole. It also proposed that the principle of external challenge should be adopted in the international network as well as at national level.

The independent survey we commissioned of perceptions of the quality of actuarial work (https://www.frc.org.uk/News-and-Events/FRC-Press/Press/2015/April/Actuarial-profession-must-face-up-to-new-challenge.aspx), and our own testing of opinion, have shown a high level of confidence by users in actuarial work. We have, however, reviewed and are consulting on our technical standards.

Further details of actions taken during 2014/15 to address our five strategic priorities, our international activities and our assessment of progress against those priorities, can be found on pages 17 to 24.

A woman with blonde hair, wearing a black top and white lanyard, is talking animatedly to a man with short brown hair, wearing a suit and patterned shirt, in an office setting.

2015/16

In 2015/16 we intend to complete the delivery of our three-year strategy by building on or embedding actions taken in the previous two years. We will continue the programme of work to promote audit that is of a consistently high standard and meets investor needs. We will take forward our work on corporate governance and investor stewardship. We will promote clear and concise corporate reporting, including through our project to help smaller listed and AIM companies with the quality of their reporting. We will continue to focus on the quality and value of audit. And we will finalise the project to identify and respond to public interest actuarial risks and update our technical actuarial standards.

Major new projects will focus on company culture and succession planning and how to promote good practice in both areas.

A significant element of our work during the year will be to support BIS in implementing the amended EU Audit Regulation and Directive. During 2015/16 we will take on a number of additional responsibilities as a result of the Competition and Markets Authority recommendations on the audit market. Both these developments will require the expansion of some of our teams and will widen the range of the work we do to monitor audit quality.

We will consider the overall effectiveness of our work to review the quality of corporate reporting and auditing; and continue to enhance the pace and effectiveness of our independent disciplinary arrangements.

The details of our plan and budget for 2015/16 are at https://www.frc.org.uk/FRCplanandbudget.

This section describes our work in 2014/15 for each of our strategic priorities.

Corporate governance and investor stewardship

Corporate governance

The FRC sets the UK Corporate Governance Code. The Code is based on the underlying principles of good governance including: the exercise of judgement, accountability, transparency, probity and a focus on the sustainable success of an entity over the long-term. It includes a clear principle that boards should provide annual reports and accounts that present a fair, balanced and understandable assessment of the company's position and prospects.

During 2014/15, we have:

Revised the Code. The aim was to enhance significantly the quality of information investors receive about the long-term health and strategy of companies and to raise the bar for risk management. We also included amendments to the remuneration sections to introduce a longer-term focus.
Commenced an assessment of the quality of board succession planning. This is frequently identified in board reviews as an area where improvements can be made, and consideration given as to how to develop best practice.
Initiated a project on how best to assess culture and practices and how they embed good corporate behaviour.
Reviewed the impact of the revised 2012 UK Corporate Governance Code including changes in relation to audit committee reports, and developed practical guidance for audit committees on assessing audit effectiveness, published in May 2015.

Effectiveness indicators

The FRC publishes an annual report on the impact and implementation of the UK Corporate Governance and Stewardship Codes which draw on a wide range of quantitative and qualitative evidence. The latest report, issued in January 2015, suggests that:

94% of FTSE 350 companies state that they have complied with all, or all but one or two, of the Code's provisions (2013: 85%).
99% (2013: 97%) of smaller listed companies have a separate chairman and CEO; while 93% (2013: 96%) and 99% (2013: 99%) adopt the audit and nomination committee composition requirements respectively.
Board diversity has been improving since 2012; the headline figure for female directorships in FTSE 100 companies is up from 18.9% to 22.8% when combining executive and non-executive directorships.
Approximately two-thirds of FTSE 350 audit committees provide detailed discussion of significant accounting issues.
27 FTSE 350 companies disclosed in their 2013/14 annual report that they had carried out an audit tender, with 19 changing auditors as a result.

Investor stewardship

The FRC also sets the UK Stewardship Code. This Code sets out the principles of effective stewardship by institutional investors, which help build confidence in the system and give force to the 'comply or explain' system as well as increasing accountability to clients and beneficiaries.

We have sought an improvement in the quality and quantity of engagement and for asset managers to be more accountable to their clients. In turn, that should generate the demand for effective stewardship and for proxy advisers to be more accountable for the quality of their advice.

To achieve change in behaviour and transparency, we have:

Worked with the markets and investors in the UK and internationally to try to ensure that investors in the capital markets have the information they need to invest for the long-term.
Led the stewardship debate in the UK and internationally, including influencing the development of the new Shareholder Rights Directive.
Pressed fund managers and asset owners to provide better accounts of their engagement with companies and how they are meeting the expectations of clients and beneficiaries.

A headshot of a smiling man with short brown hair, wearing a suit and patterned tie.

Effectiveness indicators

Surveys carried out by the Investment Association (June 2015) and National Association of Pension Funds (November 2014) show that among the respondents:

74% (2014: 83%) of asset managers have mandates that refer explicitly to stewardship, while just over 50% of pension funds have awarded such mandates, with a further 30% considering doing so in the future.
90% (2014: 92%) of asset managers report to clients or beneficiaries with approximately three quarters doing so regularly (most commonly on a quarterly basis). 68% (2013: 46%) of pension funds were very or quite satisfied with the standards of these reports.
18% (2014: 18%) of asset managers had obtained an independent opinion on both their voting and engagement processes in the previous 12 months

Corporate reporting

Our aim is to encourage all those involved in the financial reporting process to focus on communication and the clear presentation of information and materiality.

A smiling woman with dark hair, wearing a patterned top and black blazer, sits at a conference table with a laptop, looking towards someone off-camera. A title "Our aim is to encourage all those involved in the financial reporting process to focus on communication and the clear presentation of information and materiality." is overlaid.

During 2014/15, we have:

Undertaken our annual programme of review of corporate reports, with a particular focus on companies of economic significance where a material error could have implications not just for the individual company but for confidence in the market as a whole. We will separately report on these activities and share our findings on areas where there is opportunity for improvement and where we had particular focus.
Continued to challenge companies whose strategic reports were either inadequate or incomplete or where there appeared to be inconsistencies with the balance of their reporting. We will remind boards of quoted companies that we expect their significant accounting policies to reflect key aspects of their business model, which they are now required to describe.
Published an analysis of steps companies have taken to make their annual reports more clear and concise, and the first of a series of Financial Reporting Lab case studies supporting the Clear & Concise initiative.
Initiated a project with the aim of looking at whether the quality of reporting matters to investors in smaller quoted companies and how to support companies to improve the quality of their reporting. In June 2015, the FRC published a report on the first phase of the project which set out our assessment of the root causes of poor quality reporting and the actions that the FRC proposes to take to address its findings.
Continued to influence the IASB's agenda, particularly its work on the Conceptual Framework, focusing on promoting the exercise of caution and stewardship; its work on disclosures (including the proposal for a debt reconciliation following the Financial Reporting Lab's work on debt and cash flows); and also working on the development of a new leasing standard and on the post implementation review of IFRS 3 on business combinations. We have initiated research to influence developments in cash flow reporting to help influence the IASB's work in this area.
Following the restructuring of the European Financial Reporting Advisory Group (EFRAG), we are now represented on its Board and Technical Expert Group, supporting its work to reinforce the EU's contribution to the development of IFRS. We are pleased that Roger Marshall was appointed as acting President of EFRAG.
Published through the Financial Reporting Lab, a report on accounting policy disclosure and integration of related financial information, and developed a project on dividend policy and capacity in groups. In May 2015, we also published the first Lab report on digital reporting, looking at how companies and investors are using digital means of reporting at present. In 2015/16 we will build on this to identify how to optimise the opportunities digital corporate reporting offers to companies and investors.
Continued to support the implementation of new UK GAAP to improve standards of reporting by non-listed entities. We have responded quickly to resolve implementation issues identified by reporting entities and their advisors by issuing amendments to the new standards before they are first applicable. We have overseen the completion and publication of all Statements of Recommended Practice (SORPS) and developed the digital tagging taxonomies for the new UK GAAP to enable companies to report in eXtensible Business Reporting Language (XBRL) format. We have consulted on the implementation of the EU Accounting Directive into our standard framework and will issue the various changes to the finalised standard in 2015/16.

Effectiveness indicators

On the evidence of our Corporate Reporting Review (CRR) Team's reviews this year we have seen a good level of corporate reporting by large public companies while smaller listed and AIM quoted companies face a different set of challenges. We had proposed to review the adoption of FRS 101 – Reduced Disclosure Framework to help assess its fitness for purpose. However, given the small number of early adopters there is currently insufficient data for an effective review. Whilst we understand companies are considering whether to adopt FRS 101, many will not adopt the new standards before the effective date of

Once data is available, we will initiate a project to assess adoption and fitness for purpose of FRS 101.

The Financial Reporting Lab continues to build its base of project participants, which have now included over 130 individuals from 65 companies and 160 individuals from 60 investment community organisations. We continue to, in particular, target increased participation from smaller listed companies, with 17% of participant companies coming from FTSE 250, and 12% below that.

A man on the left is holding a phone to his ear, looking at a laptop screen. A woman on the right is looking at a document with "The LAB" printed on it, smiling.

Audit

The FRC is taking forward a series of reforms designed to enhance the quality of audit and its usefulness for companies and investors. For this to succeed we need to see a number of different interests and incentives work together. The FRC has a role in encouraging boards and audit committees to take a close interest in audit; and in setting high quality auditing standards, which we monitor and enforce. It is essential that within audit firms there is a commitment to delivering consistent and rigorous audit quality.

During 2014/15, we have:

Undertaken and reported on our annual programme of work to monitor the quality of individual audit engagements. Based on the 126 engagements we inspected, our assessment is that the quality of individual audits continued to show an improvement; and the proportion of audits assessed as requiring improvements or significant improvements reduced. To promote further improvements we require firms to develop action plans to address the weaknesses identified in individual audit engagements and firm-wide procedures, and to undertake a detailed root-cause analysis of the factors contributing to the issues arising from our inspections.
Made use of our new Auditor Regulatory Sanctions Procedure to impose sanctions where poor quality audit work is identified. Of the matters arising from our 2014/15 inspections which were considered under this procedure, two were concluded with sanctions determined and another was reported to the relevant accountancy professional body's disciplinary procedures.
Undertaken a thematic inspection to review the progress made by the major firms in improving the audit of loan loss provisions and related IT controls in banks and building societies.
Ensured that the recent UK audit reforms are implemented effectively, including by: reviewing extended audit committee and auditor reporting for sound and meaningful implementation; and articulating what audit quality is and how it might be assessed, in particular by audit committees.
In particular, published a survey of the use of extended audit reports to determine how auditors have provided greater transparency and value for investors in their first year of application (https://frc.org.uk/Extended-auditors-reports.pdf). We concluded that the take-up of the new requirements has been positive. The requirements for auditors to describe assessed risks of material misstatement, materiality and the scope of audit were beginning to make more transparent a process that had previously been seen as a 'black box' by investors.
A small thumbnail image of a document cover titled "Audit Firm Governance Code: Consultation - A review of its implementation and operation".
Published a report on the implementation and operation of the Audit Firm Governance Code, which, as noted on page 15, sought feedback on strengthening the Code to put more focus on the public interest in, and governance of, audit work within the firms' overall business.
Undertaken and reported on our independent oversight of the regulation by the UK accountancy professional bodies of those of their members practising as statutory auditors. We describe the outcome of this work in the Appendix to this Report and identify specific areas of focus based on the findings of our 2014/15 reviews. The conclusions from our work in this area are largely positive: much of the regulatory work we see continues to be of a high standard and we receive good cooperation from the bodies. Even so, we continue to have some concerns about the effectiveness in improving audit quality from the measures that the bodies may impose on firms following an audit monitoring visit that is graded unsatisfactory.
We undertook five third-country auditor inspections, covering four audits in 2014/15. The results of these inspections are now incorporated within our Audit Quality Review's Team (AQR) Annual Report.
Continued to contribute significantly to the work of the International Auditing and Assurance Standards Board (IAASB) on the new suite of audit reporting standards, the International Forum of Independent Audit Regulators (IFIAR) and the European Audit Inspection Group (EAIG).

Effectiveness indicators

The FRC inspected 126 individual audit engagements in 2014/15 (compared with 101 engagements in 2013/14).

The findings from the FRC's annual audit quality inspection activities for 2014/15 published in May 2015 found that:

67% of audits inspected were assessed as either good or requiring only limited improvements compared with 60% in 2013/14.
33% of audits inspected were assessed as requiring improvements or significant improvements compared with 40% in 2013/14.
A benchmark YouGov survey, 'Improving Confidence in the Value of Audit', commissioned by the FRC in 2014 (https://www.frc.org.uk/Our-Work/Publications/Audit-and-Assurance-Team/Research-Report-Improving-Confidence-in-the-Value.aspx) indicated that stakeholder perceptions of audit quality and value seem to vary according to their involvement with, and experience of audit. A further study will be undertaken in 2016 to identify any changes in stakeholder perceptions.

These changes to our role have required us to recruit additional staff with the necessary skills and have required changes to the structure and governance of our audit inspection and oversight activities.

A bar chart showing audit inspection results for 2013/14 and 2014/15.

Audits inspected as good: 60% (2013/14), 67% (2014/15)
Audits not requiring improvements: 60% (2013/14), 67% (2014/15)

Actuarial oversight and standards

Actuarial work is central to many financial decisions in insurance and pensions and is an important element in other areas requiring the evaluation of risk and financial returns. High-quality actuarial work promotes well-informed decision-making and mitigates risks to users and the public.

The Joint Forum on Actuarial Regulation was established in 2013 by the FRC, the Institute and Faculty of Actuaries (IFoA), the FCA, the PRA and the Pensions Regulator to coordinate within the context of its member bodies' objectives, the identification of, and response to, public interest risks to which actuarial work is relevant.

During 2014/15, we have:

Issued jointly with the IFoA a statement on actuarial standards. This confirmed the FRC and IFoA's respective responsibilities for setting actuarial standards but introduced scope for greater flexibility in the way these responsibilities are discharged. The FRC's Memorandum of Understanding with the IFoA was updated to reflect this greater flexibility and to give the FRC a reserve ability to issue ethical standards for actuaries when it considers such action necessary and in the light of consultation with the IFoA.
Developed and consulted on, with the assistance of the Joint Forum, an assessment of the risks to the public interest associated with actuarial work.
Engaged with the Department for Work and Pensions (DWP) and other regulators on the implications for Actuarial Standards of the Pensions Reforms announced in the March 2014 budget statement, including the role of AS TM1 in pensions illustrations and the wider approach to defined contribution pensions.
Worked with the Prudential Regulation Authority (PRA) and IFoA to influence the development of an effective competence and standards regime for the actuarial function and other actuarial roles in the run up to the implementation of Solvency II.

Building signage with large numbers '125' and a sign for 'London Wall EC2' with the City of London logo.

A pie chart indicating "96% confident in the integrity of the profession".

Effectiveness indicators

The FRC's 2015 survey of perceptions of actuarial quality (https://www.frc.org.uk/News-and-Events/FRC-Press/Press/2015/April/Actuarial-profession-must-face-up-to-new-challenge.aspx) suggested that the actuarial profession continues to be held in high regard by stakeholders. Of those surveyed 96% (93%: 2012) were fairly or very confident in the integrity of the profession.

Our monitoring, investigative and disciplinary procedures

We have continued to develop our Supervisory Inquiries function to enable the FRC to respond to matters of public concern and provide the Conduct Committee with a good evidence base to make informed decisions before launching disciplinary investigations. Companies and audit firms have continued to co-operate with our requests for information to be provided to us on a voluntary basis.

We commissioned an independent review of both our Audit Quality and Corporate Reporting review functions to assess their efficiency and effectiveness. The review is being carried out by McKinsey & Company. McKinsey's work has confirmed that our initiative to improve the efficiency and effectiveness of our CRR and AQR monitoring activity starts from a position of strength. Stakeholders see the FRC as a force for good, having driven substantial improvements in the quality of reporting and auditing, and as a benchmark for peers internationally.

The McKinsey preliminary recommendations focus on: enhanced investor involvement; greater transparency; establishing a 'continuous improvement-focused' regulatory stance; investing in AQR and CRR talent; improving strategic and stakeholder communications and engagement; and standardised and simplified processes.

Professional discipline

The FRC's independent disciplinary arrangements enable us to deal with cases of potential misconduct involving Members and Member Firms of the participating accountancy and actuarial bodies. The FRC addresses cases which raise or appear to raise important issues affecting the public interest in the UK.

Contributing to the overall reforms to the FRC's powers and structure introduced in 2012, the FRC has made a number of changes designed to enhance the efficiency and effectiveness of the disciplinary arrangements. These have included introducing revised Accountancy and Actuarial Disciplinary Schemes and, in June 2014, publishing Guidance on Sanctions for tribunals convened under the Accountancy Scheme. In December 2014, we published updated Accountancy and Actuarial Schemes intended to make the Schemes more efficient and effective by providing for joint Tribunals in cases involving both accountants and actuaries. In May 2015, we published guidance designed to enhance the timetabling of disciplinary and appeals Tribunals.

During 2014/15 the Professional Discipline team closed or concluded nine disciplinary cases. Details of the FRC's work on individual cases are available on our website at (https://frc.org.uk/Our-Work/Conduct/Professional-discipline.aspx).

We highlighted a number of themes arising from the outcome of individual cases and our work generally. These include:

High standards of professional conduct are expected from accountants who take up executive positions in business.
There is a clear message to all major accountants and accountancy firms carrying out advisory work that not only do they have a responsibility to carry out their professional work diligently and in accordance with the applicable technical standards but that they must consider the different and opposing commercial interests of all those involved. Accountants must not allow undue influence of others to override their professional judgements and they must have a clear understanding of who their client actually is.
It is essential that investors in smaller listed and AIM companies are able to rely upon the audited accounts of such companies in informing their investment decisions. In one case, for example, breaches of auditing standards of fundamental importance, in particular in relation to the audit of the accounting for revenue and costs on long-term contracts, had a real impact on the reliability of the financial statements at a critical stage of the company's history, and on investors' decisions.
The central importance of the Ethical Standards for Auditors to the audit process. They are at the heart of trust in the audit process on which public confidence in capital markets and the conduct of public entities depends.

In relation to the case concerning MG Rover, the FRC welcomed the Appeal Tribunal's decision that there were some significant issues of misconduct in this case concerning the need for accountants to act with objectivity. Firms should identify who the client is at as early a stage as possible so that any conflicts of interests can be addressed. In the event of a change in clients it is also essential to inform a previous client of the change and of the need to obtain independent advice. Threats of self-interest in relation to fees must also be safeguarded. These are important measures in safeguarding and maintaining confidence in the accountancy profession and in upholding the standards expected of members.

The FRC will continue its work to pursue individual cases effectively and to ensure that the Schemes support confidence in the Members and Member firms of the accountancy profession and members of the actuarial profession.

Professional oversight - accountancy profession

As part of its non-statutory oversight role the FRC considers complaints about the way in which the six 'chartered' accountancy bodies have handled individual complaints about their members. During the year we conducted a small number of reviews of the handling of particular complaints by professional bodies. These reviews did not indicate any systemic issues with the complaints process at any of the bodies about which we received complaints.

Risk: The FRC takes actions that are ineffective or misguided, with damaging consequences for UK markets and the FRC's reputation