The Department of Business, Energy and Industrial Strategy (“BEIS”) published its consultation paper ‘Restoring trust in audit and corporate governance’ in March 2021. This followed three separate reviews into audit and the audit market over the last few years:
1. Kingman Review, December 2018 – an independent review of the Financial Reporting Council (“FRC”) by John Kingman which called for the FRC to transition into ARGA (Audit, Reporting and Governance Authority) from 2023. It was argued that this was in the best interests of consumers of financial statements, as opposed to the producers of financial statements. ARGA would have greater powers than the current FRC and would have greater accountability to government.
2. Competition and Markets Authority’s (“CMA”) update paper, April 2019 – the paper outlined ‘serious competition concerns’ with the UK audit market and proposed legislative changes including separating audit from consulting services; introducing measures to increase the accountability of those chairing audit committees and imposing a ‘joint audit’ regime giving firms outside the Big Four a role in auditing the UK’s biggest companies.
3. Brydon Report, December 2019 – an independent review, by Donald Brydon, into the quality and effectiveness of audit, new proposed definition of an audit (to help establish and maintain deserved confidence in a company, in its directors, and in the information for which they have a responsibility to report, including the financial statements).
Together, these reviews made over 150 recommendations for reform. The consultation paper states that the government is planning to take forward the vast majority of the recommendations in one form or another.
The consultation will come as no surprise to company secretaries who have long witnessed the cycle of large corporate failures followed by onerous governance reforms, and the audit and governance reforms are no different since they followed the audit failures of BHS and Carillion. So what makes this consultation and the proposed reforms different?
Audit reform and the current proposals
Increased Director Accountability
• ARGA will have the power to sanction directors of all large companies for breach of their duties under the Companies Act 2006 in respect of the company’s reports and accounts, including the duty to approve accounts only if they give a true and fair view.
• Directors will also be more accountable for negligence in their duties, for example, a director may be required to repay their bonus for breaching their duties.
• Directors will be asked for prepare ‘resilience statements’ about how the company is managing its risks, which consolidates and builds upon the current going concern and viability statements.
Rigorous Audit process
• There will be new reporting obligations on both auditors and directors around internal controls and detecting/preventing fraud. It is consulting on different options, including a regime similar in scope to the US’s Sarbanes-Oxley Act (“SOX”) on auditor assurance on internal controls. As part of the BEIS consultation firms have been asked for their views on whether to adopt SOX in the UK and whether directors’ self-certification would be sufficient to restore public trust in audit and corporate governance.
• The current compulsory going concern statement and viability statement will be replaced with a resilience statement, as mentioned above; this requires directors to focus their objectives on short term survival, medium term resilience and long term threats to resilience.
• In order to increase the number of firms participating in the audit market, FTSE 350 companies may be capped to using smaller challenger firms on part of the audit, e.g. one or more subsidiaries would be audited solely by a challenger firm, referred to as a managed shared audit. This would replace the aforementioned ‘joint-audit.’
• There will be greater obligations on auditors around fraud detection.
• A three year rolling Audit and Assurance Policy which would document the company’s approach to auditor selection and rotation.
• Companies will be asked to include Non-financial metrics and measures on things like climate change targets. The scope of audit will expand to include additional disclosures on sustainability and climate change metrics.
Corporate governance proposals
The consultation paper also proposes a range of governance reforms with regards to:
• Under the UK Corporate Governance Code (“UK Code”), listed companies will be expected to be able to recover bonuses or share awards from executive directors if they have failed to protect customers’ and employees’ interests.
• New dividend disclosures whereby directors will be required to make a formal directors’ dividend statement about the legality and affordability of any proposed dividend. One could argue this is as a direct response to BHS being criticised for paying dividends prior to its collapse.
• ARGA would be made responsible for approving the auditors of Public Interest Entities (“PIEs”) (i.e. those entities with publicly listed securities in the UK, credit institutions or insurance undertakings).
• Expansion of definition of PIEs to include AIM listed clients with a market capitalisation above £200m and certain large private companies that would either:
- Have 2,000 employees; or, a turnover of more than £200m; and a balance sheet of more than £2bn; or
- Have over 500 employees, and a turnover of more than £500m.
• Requiring directors of PIEs to report on steps taken to prevent/detect fraud.
• Whether newly listed companies should have a temporary exemption from some of the new reporting requirements to encourage private companies to list.
• Greater shareholder engagement with audit where shareholders can ask auditors to review any areas of their concern.
• Directors attest to how they have prevented fraud.
The consultation period closed officially on 8th July 2021. We await further clarity on reforms once the responses to the consultation have been analysed.
For further information on these reforms or consultation contact Shaun Zulafqar or another member of the company secretarial team.
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