Stewardship News

Kingman Report analyzes UK regulator

In response to a request made by the Department of State in April 2018, the UK government prepared and published the “Independent Review of the Financial Reporting Council,” an independent report about the strengths and weaknesses of the Financial Reporting Council (FRC), the regulator responsible for transparency (including audit), governance and stewardship in the UK market. Published at the end of 2018, the document sets out 83 recommendations, among which an extensive review of the FRC itself.

The report is the result of the political pressure associated with the collapse of important companies in the United Kingdom, such as Carrilion, involving what some people believe to be audit failures and inefficiency in taking prompt action to punish them. The review was led by Sir John Kingman, former Treasury official and chair of the Board of Directors of Legal & General PLC, British multinational financial services company and one of the United Kingdom’s largest asset managers.

The review recommends that the FRC be replaced with an independent statutory regulator, accountable to Parliament, with a new mandate, new clarity of mission, new leadership and new powers. The new regulator would be called the Audit, Reporting and Governance Authority. The context of the changes suggested is explained right in the report’s summary. According to Kingman, the FRC is “an institution constructed in a different era – a rather ramshackle house, cobbled together with all sorts of extensions over time. The house is – just – serviceable, up to a point, but it leaks and creaks, sometimes badly. The inhabitants of the house have sought to patch and mend. But in the end, the house is built on weak foundations. It is time to build a new house,” he states.

Sir Kingman also defends the end of self-regulatory models for external audit firms to increase the transparency demanded from these firms and also from auditors, as well as more severe sanctions when necessary. He believes that the regulator should be given new power to order the removal of the auditor and even recommend to shareholders a change of CEO, CFO, chair or audit committee chair.

The report also makes recommendations on the stewardship area. Kingman observes that the FRC launched the Stewardship Code without an original mandate. And that, whilst a major and well-intentioned intervention, it needs changes to be effective in practice.  The report recommends a shift in approach to ensure that the revised Stewardship Code more clearly differentiates excellence in stewardship.

In the author’s opinion, the Government should consider whether any further powers are needed to promote compliance with the Code. If the Code remains simply a driver of boilerplate reporting, serious consideration should be given to its abolition (recommendation 42). The report also states that the FRC needs to engage at more senior level in a much wider and deeper dialogue with UK investors, including both fund managers and representatives of end-investors (recommendation 43).

The full report is available here.