Active investment commentary & analysis

FRC has proved ineffective

Investors might care little for the workings of the Financial Reporting Council (FRC). But, the news that the FRC is to be abolished could mean a step change in regulating company reporting. All investors should benefit – it heralds tougher scrutiny of corporate behaviour.

The proposed new accounting regulator will raise the bar for audit and reporting, recognising that the FRC has proved ineffective. Recent high profile corporate failures seem linked to unreliable reporting and poor audit quality. Not all reporting problems can be blamed on auditors – some companies not at risk of failure, are making use of earnings adjustments to flatter headline numbers. Shareholders demand candour from management and boards, combined with audit rigour. And, many other stakeholders have an interest in avoiding nasty surprises – taxpayers usually end up paying for company failure alongside employees, landlords and others.

The need for a new accounting regulator, and recognition of the problems with company reporting, highlights the risk in passive investing. There are risks in blindly hoping that other investors have analysed the numbers to price shares. In contrast, active investors can examine reported information and set it against industry patterns in a process to reduce the risk. It highlights the value of examining company governance, too, as part of an environmental, social and governance (ESG) approach. Delayed, or less than candid, reporting of company problems, often runs alongside poor governance. Boards that lack challenge often do not give good transparency on company performance.

The prospect of tougher regulation alongside greater focus by investors on stewardship should reduce some investment risks. Meanwhile, investors should be mindful of the need to question companies closely and look beyond the headline numbers.