What the FRC’s risk-based supervision overhaul means for auditors

The Financial Reporting Council’s latest overhaul of audit supervision marks one of the clearest signals yet that the regulator believes the profession has entered a new phase: one in which traditional inspection-led oversight is no longer sufficient for the complexity, scale and commercial realities of the modern audit market.

Following a consultation with industry stakeholders, the FRC has unveiled a revised supervisory framework that shifts towards a more risk-based approach centred on firms’ Systems of Quality Management (SoQM), rather than relying predominantly on retrospective inspections and Audit Quality Review (AQR) gradings. The framework has begun its roll-out this April, with further pilot developments planned through 2026/27.

For the regulator, the move reflects a broader evolution in how audit quality should be monitored. Richard Moriarty, chief executive of the FRC, described the new framework as “the next evolution of our regulatory model – one that is more modern, proportionate and firmly grounded in risk”.

Anthony Barrett, executive director of supervision at the FRC, similarly argued that “a system designed in a 2018 world is less relevant to a 2026 world”, adding that the revised approach would allow the regulator to scale supervisory attention according to risk while preserving confidence in the UK’s capital markets.

From inspection-led oversight to systems-based supervision

The reforms build on years of post-Carillion scrutiny of audit quality and the wider effectiveness of regulation. Since 2018, the FRC has increased pressure on firms to improve standards, while simultaneously facing criticism that existing inspection processes are resource-intensive, retrospective and sometimes limited in their ability to drive long-term behavioural change.

Andrew Howell, partner in the disputes and investigations team at Taylor Wessing, says the regulator’s shift towards a more proportionate model is a “welcome development”. While inspections have played an important role in raising standards, he notes that they often consume “very significant time and costs” without necessarily delivering meaningful forward-looking improvements in audit quality.

Instead, the FRC’s revised framework places greater emphasis on whether firms can demonstrate that quality controls are embedded throughout the organisation in real time. Thematic reviews, targeted follow-up work and ongoing assessment of governance systems will all play a larger role in how firms are supervised going forward.

For firms themselves, this marks a significant operational shift. The emphasis is no longer simply on performing well in periodic inspections, but on providing evidence that robust systems, governance structures and quality controls are continuously functioning across the business.

Syed Hussain Murtaza, managing director of Naail and Co Chartered Certified Accountants, says the regulator has been moving steadily towards a more systems-led approach for several years through the introduction of ISQM (UK) 1. However, he believes the new framework formalises that direction by explicitly prioritising firm-level risk assessment and internal controls over routine inspection cycles.

“What changes most is the emphasis,” he says. “Instead of relying primarily on retrospective file reviews, the FRC is placing greater weight on whether a firm’s internal controls are designed and operating effectively in real time.”

According to Murtaza, the model should allow the regulator to focus resources more effectively on higher-risk firms and engagements, though it will also increase the importance of judgement from both regulators and firms themselves.

That increased reliance on internal systems means firms will face growing pressure to ensure their SoQM frameworks are not merely compliant on paper, but deeply embedded within day-to-day operations and culture.

Nick Leale, partner at CM Murray, argues that strong quality management systems will need to be “vividly clear” in terms of proactive review and senior oversight. Systems will need to evolve alongside firms’ client portfolios and changing risk profiles, while senior leadership must be visibly accountable for maintaining quality standards.

Importantly, he says, firms will need to demonstrate that quality takes precedence over short-term profitability and client retention. “The firm’s systems will need to be continuously monitored for effectiveness in identifying and mitigating threats to the firm’s independence and professional ethics,” he explains.

Who stands to gain under the new regime?

The implications of the new framework are unlikely to be felt evenly across the market. Larger firms, many of which have already invested heavily in governance, compliance infrastructure and internal monitoring over recent years, may be particularly well positioned to benefit from a more proportionate supervisory model.

Leale suggests the largest firms are likely to gain the most from the reforms because they already possess the resources needed to maintain sophisticated quality management systems that can keep regulatory intervention at arm’s length.

Mid-tier firms could also emerge as beneficiaries. Under the revised approach, firms capable of investing in stronger governance systems may find it easier to compete for Public Interest Entity (PIE) audit work, particularly if the removal of more rigid supervisory tiers reduces perceptions of hierarchy within the market.

“The changes are likely to increase the interest of private equity in the audit sector given their ability to invest in the processes that will keep the regulatory burden light for them in the long term and really ‘go’ for growth.” – Nick Leale, partner at CM Murray

At the same time, the reforms may create new pressures for smaller firms. While the FRC has stated that the revised framework is intended to support capacity building within the SME audit market, the practical demands of implementing and evidencing robust SoQM structures could prove challenging for practices with limited resources.

Murtaza notes that smaller and mid-tier firms face both opportunity and pressure under the new system. A risk-based approach may reduce the burden associated with routine inspections, but it also raises expectations around documentation, monitoring and governance. “Firms that lack scale may find it more challenging to build and maintain the level of formalised governance expected under ISQM UK requirements,” he says, warning that compliance costs could accelerate further consolidation in the mid-market.

A lighter-touch regulator or higher stakes for firms?

One of the most closely watched aspects of the reforms is what they could mean for private equity investment in the accountancy sector, which has intensified significantly in recent years as investors seek exposure to resilient, recurring revenue streams.

For some industry observers, the FRC’s move towards a more principles-based supervisory regime could make the sector increasingly attractive to external investors, particularly firms capable of funding large-scale investment in governance and operational systems.

Leale argues that the changes align closely with the UK government’s broader “growth agenda” and could help reduce administrative burdens for firms willing to invest heavily in internal controls. “The changes are likely to increase the interest of private equity in the audit sector given their ability to invest in the processes that will keep the regulatory burden light for them in the long term and really ‘go’ for growth,” he says.

Mid-sized firms, which are often viewed as the most attractive acquisition targets for private equity, could stand to benefit particularly strongly from this dynamic.

However, experts caution against interpreting the reforms as a broader relaxation of standards. While the supervisory methodology may be evolving, the FRC’s focus on audit quality, independence and governance remains firmly intact.

Murtaza believes any impact on private equity appetite is likely to be incremental rather than transformative. A reduction in headline inspection gradings may create a more predictable regulatory environment, he says, but the core constraints around ownership structures, partner accountability and reputational risk remain unchanged.

“Audit is still a highly regulated, trust-based service line where regulatory scrutiny can intensify quickly if quality concerns emerge,” he notes.

Experts suggest that the revised framework may simply redistribute regulatory risk rather than reduce it altogether. Firms with mature governance systems and strong internal controls may benefit from lighter-touch supervision, but weaknesses in those systems could attract sharper regulatory attention than under the previous model.

Leale warns that firms unable to demonstrate effective supervisory systems could face enhanced oversight from the FRC, with potentially significant financial and reputational consequences. The danger for PE-backed firms in particular, he says, is that rapid growth ambitions or commercial pressures begin to outpace investment in quality assurance and governance.

“The risk to PE-accountancy firms is that they prioritise the expected rapid growth in turnover and profitability ahead of ensuring that their quality assurance oversight is based on robust and effective systems that are embedded in the firm’s culture,” he says.

Questions also remain around how effectively the new supervisory model will interact with the FRC’s enforcement powers. Alongside its supervisory reforms, the regulator is separately reviewing aspects of its enforcement regime, raising broader questions about where accountability will sit in practice if internal systems fail.

Howell says it will be important for the regulator to clarify how supervision and enforcement are intended to work together under the revised framework. In his view, the interaction between the two “has not always worked well in the past”.

“Instead of relying primarily on retrospective file reviews, the FRC is placing greater weight on whether a firm’s internal controls are designed and operating effectively in real time.” – Syed Hussain Murtaza, managing director of Naail and Co

Nevertheless, he believes the overall direction of travel is sensible. Greater emphasis on robust systems, thematic reviews and proportionate intervention could ultimately prove a more effective use of resources for both regulators and firms than heavily inspection-led models.

For the profession more broadly, the reforms underline how significantly expectations around governance and accountability have evolved over recent years. Audit quality is increasingly being judged not simply by the outcome of individual engagements, but by whether firms can demonstrate that quality management is embedded throughout their structures, incentives and culture.

The success of the FRC’s new framework will therefore depend less on the reduction of inspections themselves and more on whether firms can convincingly prove that their systems are capable of identifying and managing risk before failures occur.

In that sense, the regulator’s latest reforms may represent not a loosening of oversight, but a transfer of responsibility: one that places greater accountability directly onto firms to regulate themselves effectively while continuing to maintain public trust in the profession.