Building trust by briefing members

Audit: Restoring Trust In Audit And Corporate Governance

“The rise of the Audit, Reporting and Governance Authority (ARGA)”.

Presented to Parliament by the Secretary of State for Business, Energy and Industrial Strategy, this consultation states it is part of the “Build Back” post Covid-19 government strategy for Britain to have open and competitive markets with companies publishing information investors trust.

The consultation lasts until 8 July 2021.

Kwasi Kwarteng, the Secretary of State for Business, Energy & Industrial Strategy, states in his foreword to the consultation “I want to ensure investors can get high quality, focused and reliable information on UK companies so they can invest here with even greater confidence. So I am pleased to publish the Government’s ambitious plans to strengthen the UK’s audit and corporate governance framework and empower shareholders, which will help companies to build back stronger and better equipped to face tomorrow’s challenges and enable the UK to remain a premier global centre for investment”.

The consultation can be read in full here: Restoring trust in audit and corporate governance (publishing.service.gov.uk)

Executive Summary

The executive summary refers to stakeholder and wider public trust in the credibility of directors’ reporting and the statutory audit being “shaken by a succession of sudden and major corporate collapses which have caused serious economic and social damage, including the insolvencies of BHS in 2016 and of Carillion in 2018.” It also refers to the Financial Reporting Council’s (FRC) report “Developments in Audit 2020” and states “Alongside this, the audit regulator has in recent years found up to a third of audits carried out by the seven largest audit firms to be in need of improvement or significant improvement. There are also more long-standing concerns about a lack of competition and resilience in the statutory audit market covering the UK’s largest companies, and a perceived failure of the audit product to meet the growing expectations of its users”.

The government commissioned three reviews in 2018 and one of these related to the FRC. The executive summary refers to this review and states “The FRC Review found that the existing regulator lacked the necessary powers and clarity of purpose to hold auditors and directors sufficiently to account and recommended that it be replaced”.

The 2018 review entitled “Report of the independent review into the quality and effectiveness of audit” and the executive summary comments “…concluded that statutory audit needs to become more informative, and that higher expectations should be placed on both directors and auditors to deliver more useful information to the users of reports”.

The Competition & Markets Authority (CMA) 2018 review entitled “Statutory audit services market survey” is also referred to and the summary states “The CMA Market Study showed an unhealthy dominance of the statutory audit market for larger companies by a small number of audit firms and called for new measures to increase quality, competition and resilience in the delivery of audit”.

The summary then details the proposals outlined in the consultation are designed to address the weaknesses and lack of accountability that the three reviews highlighted and that it is the intention of the government to strengthen and enhance the standards for corporate governance.

Summary of proposals

The proposed reforms in the consultation address the findings of each review and include new measures in relation to directors, auditors and audit firms, shareholders and the audit regulator. The report states “They are focused on the largest companies because that is where there is greatest public interest in ensuring that audit and corporate reporting are functioning effectively. The proposals take full account of the roles of the Financial Conduct Authority, the Prudential Regulation Authority and the Insolvency Service where they have related responsibilities. A holistic approach is essential to drive meaningful and lasting change and the Government is clear that directors, auditors, shareholders and the audit regulator must all play their part”.

The reforms proposed in relation to all four are summarised below.

Directors

The consultation proposes new reporting and attestation requirements covering internal controls, dividend and capital maintenance decisions, resilience planning which are designed to “sharpen” directors’ accountability in these key management areas within the largest companies. There are also proposals to ensure that the regulator has effective investigation and civil enforcement powers to hold to account directors of large businesses which are of public importance for breaches of their duties in relation to corporate reporting and audit.

Audit, auditors and audit firms

The government states that reform is needed to drive a new auditor mindset and to strengthen the resilience and integrity of the audit market. Central to achieving this is the proposed creation of a new, stand-alone audit profession, underpinned by a common purpose and principles – including a clear public interest focus – and with a reach across all forms of corporate reporting, not just the financial statements. Alongside this the Government is proposing new regulatory measures to increase competition and reduce the potential for conflicts of interest, by providing new opportunities for challenger audit firms and new requirements for audit firms to separate their audit and non-audit practices.

Shareholders

This consultation document proposes further measures to improve stewardship by giving investors stronger and better opportunities to engage with companies, particularly on audit matters. These include a proposal for companies to be required to set out their approach to audit through publication of an audit and assurance policy on which there would be an advisory shareholder vote. Shareholders would also have a formal opportunity to propose to the audit committee areas of emphasis to be considered within the auditor’s annual audit plan.

The audit regulator

Following the Reviews outlined above in 2018, the consultation papers comment that the FRC, under new leadership, has taken significant steps to strengthen its capabilities.

The proposals are that legislation is needed in many areas to complete the task of remodelling the regulator and to establish the FRC’s successor body, the Audit, Reporting and Governance Authority (ARGA). The consultation document sets out the steps that the Government proposes to take to give ARGA the formal duties, functions and powers.

They include new statutory objectives and functions along with a new statutory levy to replace the existing voluntary levy. The government is also proposing to give the regulator competition powers and new powers to strengthen its corporate reporting review function, its oversight of audit committees and to enforce the corporate reporting duties of directors. The consultation document additionally sets out proposals for the regulator to have responsibility for deciding which individuals and firms should be approved to audit Public Interest Entities.

Conclusion

This consultation paper has some far reaching implications for the future of corporate reporting and responsibilities. For example, if you read the chapter on internal controls it asks whether directors should be required to carry out a review of the effectiveness of their company’s internal controls each year and make a statement, as part of the annual report, as to whether they consider them to have operated effectively.

They also seek opinions on whether auditors should describe their internal controls work and whether or not a formal opinion should be given on internal controls effectiveness.

All auditors and their team should read this consultation paper and perhaps comment directly to the government on its proposals. We will keep you up to date with developments and proposed legislation after the consultation period ends.

Ends.

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