Essential Corporate News – Week ending December 9, 2022

FRC: Firm level Audit Quality Indicators Consultation – Feedback Statement

On December 6, 2022 the Financial Reporting Council (FRC) published a Feedback Statement which provides an analysis and explanation of the responses received to a consultation the FRC launched in June 2022 on the public reporting of firm-level Audit Quality Indicators (AQIs). It explains how the FRC has considered and addressed the feedback and how firms will report on the AQIs.

AQIs are quantitative and qualitative measures of external audit quality, including input, output, and outcome measures. They indicate a firm’s historical, present or future ability to perform quality audits, as well as providing insights into audit quality when read with other AQIs and relevant context. Unlike Key Performance Indicators (KPIs), the FRC notes that AQIs are viewed through a quality lens to either assess audit quality or determine actions that will improve audit quality. The FRC believes that reporting firm-level AQIs will lead to an improvement in the information available to stakeholders regarding factors that contribute to audit quality. Users of audit services will be provided with an additional source of information related to audit quality, which should facilitate detailed and robust conversations about audit quality with firms.

In relation to AQIs, the FRC has decided as follows:

• The scope of audit firms to be included for reporting of firm-level AQIs should be aligned to the scope of the revised Audit Firm Governance Code (AFGC) issued in April 2022. The AFGC's scope is firms that audit 20 or more public interest entities (PIEs) or firms that audit one or more FTSE350 companies. 
• All audit engagements will be in scope of the AQIs but some AQIs will be segmented and only apply to PIE audits rather than to non-PIE audits as well.
• Firms will have to produce the AQI data covering any 12-month period that they choose. However, all firms within scope should provide the FRC with their data by mid-June each year for publication shortly thereafter and should indicate to the FRC the coverage period applicable to their AQIs, which the FRC will also publish. 
• Firms will be able to provide narrative supporting the AQIs and provide links to relevant FRC publications and webpages (but not to the firm’s own website). The FRC will include guidance on what is expected to be included in the supporting narrative in the definitions note that it will issue.
• There are 11 AQIs. One on audit planning milestones, originally proposed, has been removed from the list consulted on but one of the alternative AQIs consulted on has been included with some modifications – this is one which measures the ratio of each firm’s staff to partners or “Responsible Individuals” (the FRC had previously only referred to partners in the consultation document).
• Implementation will be phased.  In the first year of implementation, all firms in scope will participate in a pilot to collect the AQI data for private reporting in Summer 2024. In Summer 2025, firms will be asked to provide the FRC with AQI data, segmented between all audits, PIE audits, and non-PIE audits where possible (for consistency checking). The FRC will then publish the AQI data segmented between “all” and PIE audits. From Summer of 2025 (first year of public reporting), the previous year’s data will be published for each AQI and the FRC propose that a senior partner (generally the Head of Audit Quality or similar) in each firm provides attestation confirming the accuracy of the information, including the comparative data, in the second year of implementation for public reporting in Summer 2025.

FRC: New support measures for smaller audit firms being introduced as their market share grows

On December 7, 2022 the Financial Reporting Council (FRC) published an Audit Quality Inspection and Supervision Report into Tier 2 and Tier 3 audit firms, and at the same time announced new supervision measures to support smaller audit firms seeking to grow their share of the audit market without compromising audit quality.

The FRC allocates audit firms into one of three tiers (Tier 1, Tier 2 and Tier 3), based on the number of audits of Public Interest Entities (PIEs) that a firm conducts and other risk factors. The FRC varies the intensity of its inspection and supervision work at each tier proportionately to the risk to the public interest. Tier 2 and Tier 3 firms together currently audit a minority of entities within the FRC’s scope with a significant majority being audited by the seven Tier 1 firms. 

This is the first report on Tier 2 and Tier 3 firms collectively that the FRC has issued since it became the UK Competent Authority for Statutory Audit in 2016. It has done so because of the increased focus on promoting audit quality, resilience and competition throughout the audit market and the FRC now intends to publish a report on its work at Tier 2 and Tier 3 firms annually. 

With the report, the FRC has also announced that it will be increasing its support to Tier 2 and Tier 3 firms, as well as firms planning to enter the PIE audit market, through:

• Increasing its supervisory resources dedicated to Tier 2 and Tier 3 firms. 
• Sharing more about ‘what good looks like’ and the FRC’s expectations through: increasing its face-to-face engagement with firms; holding more events such as roundtables and briefings; and, developing new publications, in particular a guide to what makes a good audit firm operating at or planning to enter the smaller end of the PIE audit market, which the FRC plans to publish in early 2023. 
• The intention to create an ‘Audit Firm Scalebox’ to provide bespoke input, outside of the formal inspection process, to Tier 2 and Tier 3 firms and firms considering entering the PIE audit market, so as to improve their ability to meet the standards the FRC expects of them as they enter the market and grow. 
• Creating an ‘Audit Sandbox’ to explore audit policy and innovative ways to drive improvements in audit quality, including through technology.
• Conducting research to better understand the challenges faced by smaller firms in entering the PIE audit market and performing high-quality audits. 

The FRC will publish further details of its new initiatives in due course.

(FRC, FRC to introduce new support measures for smaller audit firms as their market share grows, 07.12.2022)

FCA: Introducing a gateway for firms who approve financial promotions – CP22/27

On December 6, 2022 the Financial Conduct Authority (FCA) published Consultation Paper CP22/27 which sets out how the FCA plans to operate a new gateway so that all firms wanting to continue approving financial promotions for unauthorised persons will need to apply for permission.

For further information, please see our Regulation Tomorrow blog post here.