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Exploring FRC Ethical Standard in context of corporate finance

The UK Financial Reporting Council’s Revised Ethical Standard came into effect for accounting periods starting after 15 March. Its aims were to strengthen auditor independence, prevent conflicts of interest and, laudably, improve audit quality. There are further restrictions that significantly affect corporate finance, such as the banning of contingent fee assignments for non-audit services, and on providing certain other non-audit services to audit clients. Experts explore how this is likely to affect Corporate Finance Faculty’s member firms, including Sophie Wales, Jonathan Boyers, Katerina Joannou, Yvette Allen and David Petrie

Sophie Wales
ICAEW's Director for Technical Strategy, Tax, Ethics and Law

Sophie Wales was a pivotal member of the team that led ICAEW’s response to the Financial Reporting Council (FRC) on the drafting of the new Ethical Standard:

“Contingent fees is an area where there’s been a lot of concern from a perception point of view, due to worries that contingent fees create conflicts of interest within a firm. However, we haven’t seen any evidence suggesting that, given the other requirements and safeguards around fees charged to audited entities, there is an actual threat to audit quality from the previous requirements. The pre-existing framework involved an assessment of each engagement on a threats and safeguards basis, including taking perceived threats to independence into account. This was because one had to consider the objective, reasonable and informed third party’s view of what one was doing. We don’t think that introducing wholesale prohibitions and ‘whitelists’ of allowed engagements is what is needed, but I think it was the perception concern that drove it.

“The restrictions on provision of non-audit services to public interest entities will apply to some large private companies too, from 15 December 2020. If you’ve got audit clients who you think could fall within the definition of ‘other entities of public interest’, you need to look at the rules in detail, including some fairly complex provisions about when the rules would come into force for the particular entity.

“In terms of the revised ethical standard, while we raised our concerns on some of the new provisions, the revised standard is now in force and there’s nothing to suggest that the FRC will be changing it again anytime soon. I think there are likely to be queries arising and an ongoing dialogue with the FRC on interpretation.”

Jonathan Boyers 
Head of UK corporate finance at KPMG and member of the corporate finance faculty’s board

Jonathan Boyers says KPMG has already refocused its origination approach in light of changes to regulation:

“The current environment is a classic example of a situation that highlights the benefits of being a multi-disciplinary business, with restructuring and tax advisory service lines and consulting and integration and separation teams. It has so far demonstrated the strength of that model, where clients need assistance with all sorts of things. We’re moving into a time when there’s going to be a lot more special situations-type stuff, drawing on a range of skills to get deals done.

“Obviously the FRC has set out guidance restricting the types of work that firms perform for audit clients. Last year we advised on 76 deals in total and just four involved audit clients being sold. So our origination activity has focused away from the audit client base for a good 12 months or so. I don’t envisage that we’ll be selling audit clients at all going forward. I am, however, confident that we can continue to grow our market share by focusing on the remainder of the market. There’s still a lot to go for.

“Even though we’re one of the market leaders by volume, we are in a fragmented market and there’s still lots of opportunity for us to grow without doing work for audit clients.”

Katerina Joannou
ICAEW’s capital markets lead 

Katerina Joannou explains the impact of new prohibitions applying to firms acting as reporting accountants for IPOs or capital market transactions:

“Reporting accountants are recognised experts, an established part of the UK’s best-in-class capital markets ecosystem. They provide public opinions that are required by capital markets regulation, including public M&A, and private opinions to support issuers’ or other advisers’ confirmations to regulatory authorities and financial due diligence.

“Their opinion, expertise and judgement are trusted such that if the reporting accountant cannot report, or gives a qualified or adverse report, deals do get pulled. Deep knowledge of internal controls and risk analysis, along with training in interrogation and understanding of a business’s financial position and prospects, are relevant skills that make them right for such work. 

“The core training means that chartered accountants can: distil complex measurement, disclosure and reporting requirements; explain complex matters succinctly; manage expectations; work alongside other experts; recognise when other competencies are needed; and stand back from their work and consider it in the context of other knowledge – sense check it, if you will.

“Of course, these rules may mean that it’s still a chartered accountant who provides the services, albeit, in some cases, not the auditor.”

Yvette Allen
Deloitte corporate finance partner and chair of the corporate finance faculty’s technical committee

Yvette Allen says that the new rules will extend the process of selecting an appropriately independent firm to carry out corporate finance work:

“If a company wants or needs to find another firm for reporting accountant work, it will need to be independent to the right standard. It may not be quite as straightforward as one might think if the company has been sharing advisory work around. In addition, it may not be able to use its auditor even if it wants to, because a lot of reporting accountants’ work is not public reporting but private reporting, which is subject to the fee cap. 

“A company might need to work its way through several firms before it finds one that is independent and has the right skills for the work. It might choose to use its auditor for public reporting and another firm for the private reporting elements, but that adds extra complexity at a time when the management team already has a lot to deal with.

“Following the introduction of restriction in services in 2016 and in contemplation of the fee cap being introduced, companies have been moving away from using their audit firm for non-audit services, and that includes corporate finance. However, the new ‘whitelist’ has taken this much further for PIEs and OEPIs and is seen as being more restrictive than many other major economies.”

David Petrie 
ICAEW head of corporate finance

David Petrie argues that the FRC should look at relaxing the new regulation in the context of the COVID-19 crisis:

“Almost unbelievably, on 23 March, the day the UK went into official lockdown and business as we knew it was very largely suspended, the FRC published a strategy document entitled Strategy 2020/21. Many of the more obvious problems arising from the application of financial regulation are now being addressed. The new regulations were of course predicated on ‘normality’, not on a global crisis. 

“However, getting to that point is hard work and ICAEW, our member firms and other business groups and professional bodies are in constant dialogue with the FRC, Prudential Regulation Authority (PRA), Financial Conduct Authority (FCA) and the Bank of England, as well as HMRC and other government departments.

“While these measures extend way beyond limitations arising from application of a revised Code of Ethics, the FCA, FRC and PRA announced a series of actions and issued a series of statements on 26 March. They intended to ensure that information continued to flow to investors in support of the continued functioning of the UK’s capital markets. 

“I anticipate that further measures will become necessary.”

About the article

Read the full article in the Corporate Financier May 2020 edition. Access this magazine as well as our extensive archive brought to you by the ICAEW Corporate Finance Faculty.