FRC reform: more red tape or improving professional standards?

Key points

• The Labour government plans to replace the FRC with a stronger auditing watchdog, ARGA
• The move will likely lead to market realignment and higher professional standards across the accounting sector
• The reforms aim to rebuild trust, with the bill expected by 2025 or 2026

Designed to improve auditing and financial standards, the legislation would see the replacement of the Financial Reporting Council (FRC) with a more powerful watchdog: the Audit, Reporting and Governance Authority (ARGA).

Initially introduced in 2020, the shift to ARGA was delayed by the previous government in favour of focusing on “growth and the UK’s competitiveness”.

Public and professional support for the reform has been overwhelmingly positive, with many in finance welcoming the move, but there are likely to be wider market implications. Might we see an influx of cumbersome red tape, or could professional standards be raised across the board?

Replacing FRC with ARGA

First, let’s remind ourselves of how the auditing and corporate governance regulator found itself facing calls for structural reform.

Following a decade of high-profile corporate failures including the collapse of Thomas Cook and Carillion, which triggered a 20% spike in the number of UK building firms becoming insolvent, the scrutiny of large companies was thrust into the spotlight in 2018.

Multiple government-commissioned independent reviews found issues with the quality and transparency of the UK’s audit market. Two major Select Committees accused the FRC of being timid, slow to act and too close to the organisations it is responsible for regulating.

Recommendations included replacing the regulator with a body accountable to parliament, driven by a clear purpose and mission. Subsequently, progress was made towards replacing the FRC with ARGA before it was delayed in 2023.

Following the King’s Speech, ARGA is expected to replace the FRC, but with enhanced powers.

The regulator will hold the largest auditors accountable under regulatory terms, enforce more rigorous scrutiny of large companies, and sanction company directors if they fail in financial reporting duties. There are additional changes also predicted to come into effect, including:

• The extension of Public Interest Entity (PIE) status to large private companies
• Removal of unnecessary red tape on smaller PIEs
• A new regime to protect against conflicts of interest and build resilience in the audit market.

What does this mean for accountants and auditors?

Chris Moss, Audits & Accounts Partner at JS

The Big Four auditors, Group A and their large company clients will be the most directly impacted by the reforms. But Chris Moss, Audits & Accounts Partner at JS, says there is likely to be some market realignment.

“Some smaller firms may have larger audited clients that aren’t currently regulated directly by the FRC, but will fall into ARGA’s remit. They will be subject to more robust scrutiny … and will have to decide whether they want to continue to act for those clients, given they will likely have to invest in stronger controls and processes to meet ARGA’s standards,” he says.

Mr Moss adds smaller firms that focus on non-auditing work should prepare for change too.

“We’re likely to see a trickle-down effect across the sector. As professional standards rise at the very top, clients of all sizes may expect their professional advisors to adapt and provide the same quality of service. This could encourage greater innovation across the market, particularly around the calibre of staff and the training offered to them.”

Given the draft bill is in the pre-legislative phase, there could be additional impacts that have not yet been made public.

“We don’t yet know if ARGA will apply any direct control over smaller firms, or whether it will require the largest firms to separate audit and non-audit work. If the latter is enforced, this could create opportunities for smaller firms to pick up some good quality work,” Mr Moss says.

By tackling poor financial reporting, it is hoped the new watchdog will help build trust and greater confidence in the sustainability of British firms to encourage greater investment.

The balance many are hoping ARGA will strike is an appropriate level of oversight of corporate conduct and audit reform, without inadvertently slowing processes down with excessive red tape.

The bill is expected in late 2025 or early 2026, with Justin Madders MP leading the Department for Business and Trade on pre-legislative scrutiny.