The government is proposing a major overhaul of the UK’s audit sector, with plans to break up the dominance of the Big Four, hold company directors of big businesses to account with the threat of fines or suspensions in the most serious cases, and create a new statutory regulator
In recent years, investor and public confidence in how businesses are governed has been undermined by large-scale company failures, such as Carillion, Thomas Cook and BHS, leading to severe job losses and the British taxpayer picking up the bill, resulting in ongoing audit investigations.
To improve corporate transparency, the government is launching a four-month consultation on extensive reforms to modernise the country’s audit and corporate governance regime, targeting the UK’s biggest businesses and ensuring markets work effectively.
Robust and rigorous scrutiny of large firms provided by auditors, as well as greater transparency and trustworthy information, is essential to ensuring that investors, employees and consumers have an accurate picture of the health of the company. The measures are wide ranging including the creation of a new more powerful regulator, the introduction of new reporting obligations to detect and prevent fraud, and measures to make directors more accountable.
Directors could face fines or suspensions in the most serious cases failings such as significant errors with accounts, hiding crucial information from auditors, or instances of fraud.
There are also plans to curb payouts of dividends and bonuses if the business is facing potential insolvency, with clawbacks of bonuses written into law, with payback up to two years after the pay award is made.
Directors would also have to publish annual ‘resilience statements’ that set out how their organisation is mitigating short and long-term risks, encouraging their directors to focus on the long-term success of the company and considering key issues like the impact of climate change.
There may also be new directors’ duties relating to internal controls and risk management that builds upon the UK’s existing framework, with the government’s initial suggested option less burdensome than the US Sarbanes-Oxley system and providing companies and shareholders greater flexibility. This will be reflected in amendments to the UK Corporate Governance Code.
The consultation is also calling for new reporting requirements for larger companies on anti-fraud measures and the level of independent scrutiny given to their published reports.
The government proposes to legislate to require directors of public interest entities to report on the steps they have taken to prevent and detect material fraud. In addition, auditing standards will be updated to clarify that fraud detection is an integral part of the audit, with the audit regulator working on revisions to standards.
The proposals would see the creation of a new audit regulator, the Audit, Reporting and Governance Authority (ARGA) which would replace the Financial Reporting Council (FRC), giving it greater oversight and stronger powers to enforce standards and break up the dominance of the Big Four audit firms – PwC, Deloitte, EY and KPMG – which audit the overwhelming majority of FTSE 350 listed businesses, currently handling 97% of these listed audits.
The ARGA will have the power to impose an operational split between the audit and non-audit functions of accountancy firms to reduce the risks of conflicts of interest. This is already underway with the Big Four working on plans to split their audit businesses from the main firm activities, which has seen Deloitte and KPMG selling off their restructuring divisions. The current deadline for operational splits is 2023.
The new regulator’s remit would also be extended to give the newly formed ARGA the powers to oversee the audits of some of the largest privately held companies. The government plans to extend the definition of public interest entities (PIEs) to bring these companies into scope, regardless of whether they are admitted to trading on a regulated market.
Legislation will be introduced to put the ARGA on a statutory basis and it will be part funded by a mandatory levy on the industry.
Although the government has held back from proposing joint audits, the consultation proposes that large companies would be required to use a smaller ‘challenger’ firm to conduct a meaningful proportion of their annual audit, watering down the dominance of the Big Four auditors. Under proposals for a managed shared audit regime, where a Big Four auditor would have responsibility for the bulk of the company audit, challenger audit firms would have to audit a subsidiary company.
However, the government ruled out any intention to give the FRC the powers to appoint an auditor, stating ‘the Government is not persuaded that it is appropriate to give ARGA independent powers of appointment at this time’.
There could also be a market share cap on how many FTSE 350 audits Big Four firms could handle if ‘competition in the sector does not improve’, the consultation states.
Another area of proposed reform is to create a new professional body for auditors, outside of the current professional accountancy institutes. There a number of suggestions of how this could operate with the government setting some very open questions about this proposal, including whether there should be a single body, its training obligations and disruption to the current professional bodies.
The government also wants to strengthen the role of investors and 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.
Business secretary Kwasi Kwarteng said: ‘Restoring business confidence, but also people’s confidence in business, is crucial to repairing our economy and building back better from the pandemic.
‘When big companies go bust, the effects are felt far and wide with job losses and the British taxpayer picking up the tab. It’s clear from large-scale collapses like Thomas Cook, Carillion and BHS that Britain’s audit regime needs to be modernised with a package of sensible, proportionate reforms.
‘By restoring trust in our corporate governance regime and encouraging greater transparency, we will provide investors with clarity and certainty, cement the UK’s position as the best place in the world to do business, and protect jobs across the country.’
The consultation is open for four months and will then require primary legislation, which the business secretary said will be brought forward during this parliament. There is no fixed timetable for the introduction of new audit framework and some measures will be given a transition period.
Kwarteng said: ‘Looking to the future, the timetable for these changes is clearly of key importance to affected businesses. The government understands the serious challenges that businesses are facing because of the pandemic and we will not add to those: reforms will be introduced over an appropriate timetable.
‘However, I am committed to our stated aim of reforming the corporate governance and audit regime and we intend to bring forward these reforms later in the parliament, once we have taken account of your responses.’
The reform proposals follow three major reports into the state of the UK audit market in 2018, Sir John Kingman’s Independent Review of the Financial Reporting Council (FRC), the Competition and Market Authority (CMA)’s Statutory Audit Services Market Study and Sir Donald Brydon’s Independent Review of the Quality and Effectiveness of Audit.
The consultation closes for comment on 8 July 2021.