Plans to create a new audit regulator, the Audit, Reporting and Governance Authority (ARGA) to replace the Financial Reporting Council (FRC), putting the new body on a statutory basis with a range of new powers, have been clarified in the audit white paper
The proposals would give the new audit regulator, the ARGA 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 consultation document sets out the steps that the government proposes to give ARGA the formal duties, functions and powers it needs to be fully effective. They include new statutory objectives and functions along with a new statutory levy to replace the existing voluntary levy.
ARGA will be established as a company limited by guarantee. Its general objective will be to protect and promote the interests of investors, other users of corporate reporting, and the wider public interest. It will also have two operational objectives, on quality and competition, and several regulatory principles set out in legislation.
It will be governed by a simplified board with strengthened oversight, and non-executive members including the chair will be public appointments. The regulator will be accountable to parliament, with strategic direction from the government.
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. It also sets out proposals for the regulator to have responsibility for deciding which individuals and firms should be approved to audit PIEs.
The government plans to legislate to provide ARGA with the necessary powers to investigate and sanction breaches of corporate reporting and audit-related responsibilities by PIE directors. All directors of companies which are public interest entities will be in scope, which is a broader approach than initially proposed, when only the CEO, chief financial officer, chair and chair of the audit committee would be covered by the new rules.
The Government’s intention is that the regulator’s new enforcement powers will apply to breaches by directors of the existing statutory duties relating to corporate reporting and company audits. Those include: • the duty to keep adequate accounting records; • the duty to approve accounts only if they give a true and fair view; • the duty to approve and sign the annual accounts; • the duty to approve the directors’ report; and • the duty to provide a statement as to disclosure to auditors and to provide information or explanations at the request of the auditor.
New investigation and enforcement powers
The government proposes to give the regulator powers to gather information and carry out investigations to establish whether a director has breached a relevant requirement, and to impose sanctions in cases where a breach is found to have occurred.
The regime would provide a graduated range of civil sanctions that could be applied by the regulator where a breach was proven. The civil standard of proof ‘on the balance of probabilities’ would apply when deciding disputed facts.
Proposed sanctions include reprimands, fines, orders to take action to mitigate the effect of a breach (or the recurrence of a breach,) or to make declarations as to non-compliance and in the most serious of cases, temporary prohibition from acting as a director of a public interest entity.
In line with proposals set out in the Competition and Markets Authority (CMA) review, the government believes that ARGA should be given powers to set, monitor and enforce compliance with additional requirements for audit committees in the appointment and oversight of auditors. ‘This will help to ensure the committee acts effectively as an independent body responsible for safeguarding the interests of shareholders and other users of accounts,’ the consultation stated. As a result, ARGA’s remit will be extended to allow it to enforce the need for audit committees to ‘continuously monitor audit quality, and consistently demand challenge and scepticism from auditors’.
Where the regulator is particularly concerned about an audit committee’s compliance with the requirements it would be able to meet the audit committee chair to discuss any issues arising in the first instance. It would also be able to place an observer on the audit committee, a move which was strongly opposed in responses to the initial consultation on this proposal.
Operational split of firms
The ARGA will also 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.
It will also be given greater regulatory powers and duties to increase choice and competition in the FTSE 350 audit market, initially through a managed shared audit regime and, if needed, taking a reserve power for a managed market share cap; and oversight of operational separation between the audit and non-audit arms of certain firms, as determined by the new regulator. This will include separate governance, financial statements prepared on an arm’s length basis, and regulatory oversight of audit partner remuneration and audit practice governance.
There will be new statutory powers for the regulator to proactively monitor the resilience of the audit market and audit firms, including powers to require audit firms to address any viability concerns that are identified. The regulator will also have the power to take enforcement action to address anti-competitive practices and an abuse of dominant position within the statutory audit market.
There are also plans to strengthen the regulator’s powers relating to its corporate reporting review work. The proposals respond primarily to recommendations made in the FRC Review.
The key measures proposed are:
- ARGA to have powers to direct changes to company reports and accounts, rather than having to seek a court order which is the position at the moment;
- increased transparency for the existing Corporate Reporting Review process, by enabling ARGA to publish summary findings following a review and, if necessary, full correspondence;
- the extension of the Corporate Reporting Review process to the whole of the annual report and accounts. This will ensure that ARGA can review areas that are not currently within the scope of its powers such as corporate governance statements, directors’ remuneration and audit committee reports as well as voluntary elements such as the CEO and chairman’s reports.
Sir Jon Thompson, CEO of the FRC said: ‘I welcome today’s publication as a significant milestone towards setting up a new, robust and independent regulator, which has the necessary powers to deliver its objectives, and on the ambitions set out in the three independent reviews.
‘The FRC is already delivering on its commitment to transform, implementing reform across a variety of areas, where we are able to do so. This includes the operational separation of the Big Four audit practices, stronger and more timely enforcement, and revisions to standards to drive higher quality work.
‘We will now work with colleagues in government and other regulators to ensure that the UK has an effective and clear regulatory framework, well understood by those we regulate and which supports high standards of audit, corporate reporting and corporate governance; helping to reinforce the United Kingdom’s position as a key global centre for investors and businesses.’
John Wood, chief executive officer of the Chartered Institute of Internal Auditors, said: ‘The Chartered IIA particularly welcomes plans for a new audit regulator funded by a mandatory levy, a measure we have long been calling on the government to implement. At the heart of effective reform must sit a regulator with teeth, with sufficient powers to do its job properly.’
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.
The consultation closes for comment on 8 July 2021.