Governance Watch - Issue 40

by Dina Medland

Kingman Review

The consultation period for the independent review led by Sir John Kingman into the Financial Reporting Council (FRC), the UK’s accounting regulator and corporate governance watchdog, has just closed. It is intended to help ensure that the FRC’s role and powers are fit for the future and has come after years of accountancy in the media headlines for all the wrong reasons. 

Remember 2010? The Guardian ran this piece, headlined Auditors’ role in Lehmans collapse unites opposition in calls for reform. Over the last decade we have had a spate of accounting scandals involving a corporate fudging of numbers when it comes to profit. The Financial Times has been looking hard at the debate – mentioned here on Governance Watch numerous times in the past. An FT series, starting with The big flaw: auditing in crisis looks at the history, breaking it down to a possible root cause: the accounting standards themselves. 

The FT report quotes Sharon Bowles, former chair of the European Parliament’s economic and monetary affairs committee: “Accounts have always contained estimates; think of the provisions companies make against foreseeable future losses. But the un-anchoring of auditing from verifiable fact has become endemic.” As the setters of standards have dismantled the system of historical cost accounting, it says, they have replaced it with one “based on the idea that the primary purpose of accounts is to present information that is ‘useful to users.’” The process, says the FT report, “allows managers to pull forward anticipated profits and unrealised gains, and write them up as today’s surpluses. Read the piece in its entirety for context.

Today, with plenty of evidence in the UK to highlight concerns about the role of the Big Four accountancy firms in audits that have not proved to be fit for purpose there is renewed talk of breaking up them up. While investigating the KPMG audit of Carillion, the FRC published its first thematic review of audit culture in May, in which it called on audit firms to “do the right thing in the public interest.” This seems an unlikely way forward when it comes to connecting the dots between the use of accountancy standards and best practice in corporate governance. 

The FT piece suggests the real issue that needs to be addressed is the gap that has developed between accounting standards and UK company law, which says the accounts of a company should present a “true and fair” picture of the its financial position and earnings.

Concern about accounting standards and about the way in which they are used and abused has been expressed loudly across media and in public forums for debate –with voices ranging from corporate governance practitioners to academics to investors. Natasha Landell-Mills, head of stewardship at asset manager Sarasin & Partners, has often highlighted the link between audit, the protection of capital and the role of stewardship. 

In a letter written in May to Greg Clark, UK Business Secretary around the Kingman Review, Sarasin joins other investors to ask for a “full, transparent review of the true and fair legal standard as well as the enforcement of the capital regime”, describing this is an “urgent” need. It also says that the FRC would be in the strongest position to participate in such a review if it is split into two independent bodies – one responsible for standard setting and the other responsible for enforcement – “to avoid conflicts that arise where the regulator feels that it cannot critique weaknesses in the standards it is responsible for setting.”

The FRC’s dual responsibility for being the regulator for the accountancy profession as well as the overall watchdog of UK corporate governance has always seemed a little odd. 

Earlier this week this dual responsibility was called out by the Institute of Directors (IOD) in its submission to the Kingman Review, in which it asks for the hiving off of the FRC’s responsibility for the corporate governance code, leaving it to focus on its core task of improving company audits. This chimes with my own experience of the current thinking among senior business figures, as covered in my blog Board Talk. 

Bringing together the suggestions made by the coalition of investors headed by Sarasin and by the IOD would be a powerful combination for regulation fit for the future. The Kingman review is due to be completed by the end of the year, with the potential to transform the workings of both the accountancy profession and the very ethos of the UK’s standards of corporate governance. 

Automation and Responsibility

A two-year commission organised by the Fabian Society and the trade union Community was launched this week on Workers and Technology, chaired by Yvette Cooper MP. It aims to identify the immediate actions that government, employers and trade unions need to take to support workers as technology impacts on jobs in the next decade.

A YouGov poll conducted in July found that only 27% of employees agreed that their employer was taking the action needed to help them feel prepared for changes in their jobs resulting from new technologies, and 41% disagreed that any such action was taking place. While there is confidence among a large majority of workers (73%) that they will be able to change and update their skills if new technologies affect their current job, 37% of workers or more than 10 million people (particularly those over 45) are worried about their job changing for the worse. 

There is a great deal that businesses could do here in terms of better communication via its HR function, and the identification of opportunities for re-skilling. Better communication leads to better engagement, and productivity – rather than the corrosive nature of silent anxiety that is caused by fear of the unknown. It’s also part and parcel of better corporate governance.

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