On 18 March, the Government published its long awaited consultation on the future of audit – ‘Restoring trust in audit and corporate governance’.
A 232 page document, containing 98 questions, supported by a 210 page impact assessment and a 30 page supplementary publication on review recommendations, this is one of the most significant consultations in the governance arena for some time. It brings together the Government’s response to the more than 150 recommendations from three separate reviews of audit and the audit market in recent years: the independent review of the Financial Reporting Council (FRC) by Sir John Kingman in December 2018; the independent review of the quality and effectiveness of audit by Sir Donald Brydon in December 2019; and the Competition and Markets Authority’s statutory audit services market study published in April 2019.
The Government’s proposals include new measures in relation to directors, auditors and audit firms, shareholders and the audit regulator, and ‘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’.
For Directors, the Government proposes increased accountability with the Audit, Reporting and Governance Authority (ARGA), the successor regulator to the FRC, having power to sanction all directors of large companies on those rare occasions when they neglect their duties, rather than just those directors who happen to be members of professional accountancy bodies as at present. There will also be increased internal controls over financial reporting, dividend and capital maintenance decisions, and the steps that directors are taking to consider and strengthen a company’s future resilience. This is likely to include a UK version of the Sarbanes-Oxley regime used to strengthen auditor assurance and internal controls. Measures will also be developed to strengthen malus and clawback provisions within executive directors’ remuneration arrangements.
Auditors and audit firms will have greater accountability for the quality of the work that they do through 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. The Government is also proposing new regulatory measures to increase competition and reduce the potential for conflicts of interest, by providing new opportunities for challenger audit firms to take part in a significant element of the audit of FTSE 350 companies through a ‘managed shared audit regime’ and new requirements for audit firms to separate their audit and non-audit practices. The Government’s proposals for shared audit will need to be carefully balanced if they are to improve quality rather than duplicate effort, but if they can achieve the aim of broadening the market without reducing quality, this will be a major step forward.
Shareholders will be given ‘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.’
ARGA, as the new audit regulator, will be placed on a statutory basis with statutory funding and new and increased 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.
All this is encouraging, as it addresses many of the Institute’s core concerns, repeated in our responses to each of the previous reviews, on the role of audit, the degree of professional scepticism exercised by auditors and the lack of trust in the ability of auditors outside the Big Four.
Having a robust audit market is essential to building trust and maintaining the UK’s reputation as a good place to do business.
The consultation will close on 8 July. The Institute will be responding and will, as usual, be forming working groups to develop our response. Any members wishing to help us with this are asked to contact firstname.lastname@example.org. Subject to the outcome of the consultation, the Government will bring forward primary legislation to implement the proposed reforms when parliamentary time allows.