Audit sector needs a bold new regulator

The recommendations of Sir John Kingman’s review of the Financial Reporting Council (FRC) have received significant public support. Government has also welcomed his proposal to create a new regulator– the independent Audit, Reporting and Governance Authority (ARGA) – as the perfect opportunity to “transform the audit and accounting sector” and “ensure the UK is the best place to invest, start and grow a business”.

It is clear that it intends to give ARGA a new mandate, new leadership and stronger statutory powers than those currently held by the FRC. The Kingman Review also rightly identifies that ARGA must also focus on outcomes and prioritise regulatory activity on the basis of risk, as well as promoting competition in the statutory audit market.

Four key principles

The advantage it has is that it will have a fresh start in setting of high standards of statutory audit, corporate reporting and corporate governance. However, recent research carried out by PA showed that there will be real challenges for a new regulator in rebuilding the trust in the audit and accounting sector in the eyes of public. It will need to make sure that it really puts the interests of consumers first and has effective powers to ensure regulated companies comply with their obligations.

Our research provided a cross-industry assessment of how regulators are seen to be working today, and how they might need to work differently in the future. This reflected the huge changes that are taking place in society such as the impact of Brexit, technology and changing consumer expectations. That research identified four key principles which are essential to effective regulation. The two most important to ARGA are the need to have a strong voice and to use it and to develop new styles of leadership to drive innovation.

Use its voice on behalf of consumers

The Review recommends a significant increase in the scope of ARGA’s powers with the new body reporting to Parliament annually on its enforcement performance.  However, this is not enough. The public is looking for more from their regulators: a move away from merely being industry watchdogs to becoming consumer champions. ARGA must find more and different ways to use its voice on behalf of consumers. This means being able to step beyond its statutory obligations and looking to influence behaviour, using the power of social media and public statements to call out poor conduct and make risks more visible to the public.

An example of a regulator which has been doing just that is Ofwat which has been taking a very public stance on what it wants from regulated water companies. In a chain of public letters, the regulator has set out key areas where the industry needs to improve to regain public trust. Ofwat has positioned itself as a participant in the debate on what it sees as the key issues facing the water industry. ARGA will need to do the same for the audit and accounting sector.

A leader who can shape the agenda

Our research has shown that regulators need to be far more comfortable with trialling new approaches and techniques and driving change in their industry. This resonates with the points made in the Kingman Review about the need for ARGA to be forward-looking, anticipating and, where possible, acting on emerging corporate governance, reporting or audit risks as quickly as possible.

Appointing the right leader for ARGA will be key and will set the tone for the future organisation. Traditionally regulators have been led by someone who is an expert in that sector but in changing times a new approach might be needed. Undoubtedly ARGA will need experts in audits and accounting within its ranks. But it will be the leadership’s ability to adopt innovative solutions, speak strongly on the issues of the day and show how progress can be made quickly and effectively that will define whether the regulator is a success, not the length of their combined years working with accounts.

Having the right skills to stay ahead of the industry

The Kingman report says that ARGA should use market intelligence and have access to skilled people to deliver on its agenda. In particular, this will mean ensuring it has the expertise to respond to the rise of big data and analytics which provides ever increasing opportunities to predict and prevent issues before they can impact the public.

To be successful ARGA will need to stay ahead of its industry, but this requires rapid acquisition of skills, and a regulator can rarely compete for talent with its industry. To deal with this, ARGA should learn lessons from the approach of the financial services regulators. The PRA and FCA operate Skilled Person Reviews to provide in-depth expertise on specific firm issues and it is welcome that a similar regime is proposed for ARGA. These reviews are undertaken by specialist private sector organisations on behalf of the regulator and funded by the firm being reviewed, and have proved effective in providing the regulator with access to the right level of expertise.

Be bold

The establishment of ARGA is an ideal opportunity to redefine the regulatory relationship with firms and to rebuild trust. To do this, it will need to be a progressive, bold and vocal regulator that builds relationships with its industry, enabling it to keep pace with innovation – to do this its new leadership team will need to go beyond the formula in the Kingman report.

For more information on PA’s work with regulators, visit: www.paconsulting.com/rethinkingregulators

• Let us know what the replacement for the FRC needs to do to regain trust in the comments below.