Audit reform back on the agenda, but ‘the devil will be in the detail'
Audit reform back on the agenda, but ‘the devil will be in the detail'
When King Charles delivered the first King’s speech for more than 70 years last November, there was palpable frustration across the accounting profession that audit and corporate governance reforms had once again been omitted from the legislative agenda. But less than a year later, and almost seven years after the collapse of Carillion, another King’s speech on behalf of His Majesty’s newly elected Labour government finally delivered on this longstanding commitment with the inclusion of a Draft Audit Reform and Corporate Governance Bill.
Primary legislation should therefore be enacted – if not in the current parliamentary session, then certainly within a couple of years – to complete the programme of audit reform that was initially proposed by the Kingman Review (2018), the Brydon Review (2019), and the Competition and Market Authority’s (CMA) statutory audit market review (2019).
In summary, this trio of extensive reports made similar recommendations: the establishment of a re-invigorated regulator, modernising its powers to investigate and impose meaningful sanctions, and strengthening the transparency and integrity of the UK’s corporate governance, financial reporting and audit.
As CMA Chairman Andrew Tyrie noted in his review: “The Government now has three reports to hand. In large part, they come to similar conclusions. Conflicts of interest cannot be allowed to persist; nor can the UK afford to rely on only 4 firms to audit Britain’s biggest companies any longer. Early action will require legislation – hence the CMA’s proposals.”
In the intervening years, a considerable amount of hard work has been undertaken including plans to replace the Financial Reporting Council (FRC) as the UK’s audit regulator with a new body, the Audit, Reporting and Governance Authority (ARGA).
The government initially announced plans for ARGA in 2019 and published detailed proposals in 2021, which were expected to be fully implemented in 2023 before they were dropped form the King’s Speech. As currently envisaged, ARGA would have enhanced powers and responsibilities, including oversight of the big audit firms, creating standards for corporate governance, and enforcing compliance auditing and corporate reporting requirements.
Ostensibly, detailed proposals are ready and waiting, so there should be no practical reason why they cannot be used as a basis for legislation, much like the previous draft bill. In implementing them, progress should therefore be swift. The most obvious impediment is priority in determining the running order of a very crowded legislative timetable: the King’s Speech and accompanying memorandum contained no less than 40 separate bills. In reality, time will not allow all of them to be passed in the current parliamentary session.
Welcoming inclusion of the proposed bill, former chair of the FRC, Keith Skeoch, rightly stated: “What’s really important is that the FRC are given the statutory powers to ensure the transformation into ARGA happens. The devil of course will be in the detail.”
Currently, the wording of the draft bill mirrors the original proposals formulated under the last government. Potentially, we are therefore looking at:
The FRC being put on a statutory footing through the creation of ARGA, which would have expanded powers to investigate and sanction directors. However, most commentators anticipate that it will take another two years before ARGA eventually reaches fruition. Public Interest Entity (PIE) status will be extended to large private companies, subjecting them to much more rigorous audit requirements. Removal of the unnecessary rules on smaller PIEs in order to reduce the regulatory burden. The introduction of a new regime to oversee the audit market, affording protection against conflicts of interest, building resilience in the sector, and aiming to erode the hegemony of the Big Four.
But none of this is yet set in stone. ARGA’s role, and the scope of its designated powers, may evolve further as the new government chooses to make its mark on the work previously done in drafting the bill by the Office of the Parliamentary Counsel.
So, given its much vaunted pro-growth agenda, will the new government maintain a ‘business friendly’ approach in the wording of the new bill?
It appears that a key component of the original proposals was to require all UK company directors to assess and report annually on the effectiveness of their internal controls and financial reporting procedures, echoing the US Sarbanes-Oxley Act of 2002. Following intense lobbying from corporates, these mandatory measures have since been diluted.
Reconciling ‘failure to prevent fraud’ legislation with an obligation on management to ensure that their systems are ‘fraud robust’ is far from straightforward. The potential for legislation disconnect certainly exists. Ultimately, we will have to wait and see what our legislators decide.
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