The Department of Business, Energy and Industrial Strategy has today published its long awaited consultation paper on audit and governance reform, Restoring trust in audit and corporate governance.
The consultation paper follows three separate reviews into audit and the audit market over the last few years:
- the Kingman Review on the operation of the Financial Reporting Council (FRC), in December 2018 (see our corporate update 2019/1);
- the Competition and Markets Authority’s update to its statutory audit paper on competition in the audit sector, in April 2019 (see our corporate update 2019/8); and
- the Brydon Review on the quality and effectiveness of the audit process and product, in December 2019 (see our corporate update 2020/1).
Together, these reviews made over 150 recommendations for reform. The consultation paper states that the government is planning to takes forward the vast majority of the recommendations.
Under the government’s proposals:
- Director accountability – The Audit, Reporting and Governance Authority (ARGA), the successor regulator to the FRC, will have power to sanction directors of all large companies for breach of their duties under the Companies Act 2006 in respect of reports and accounts, including the duty to approve accounts only if they give a true and fair view, and the duty to provide information to auditors.
- Audit process – There will be new reporting obligations on both auditors and directors around internal controls and detecting/preventing fraud. It is consulting on different options, including a regime similar in scope to the US’s Sarbanes-Oxley Act on auditor assurance on internal controls.
- Annual accounts – The current mandatory going concern statement and viability statement will be replaced with a ‘resilience statement’, requiring directors to focus their minds on short term survival, medium term reliance and long term threats to resilience.
- Audit market – In order to increase the number of firms participating in the audit market, FTSE 350 companies will be required to use a smaller “challenger” firm to conduct a meaningful portion of their annual audit (e.g. one or more subsidiaries would be audited solely by a challenger firm), referred to as a managed shared audit.
Corporate governance proposals
The consultation paper also proposes a wider range of governance reforms, including in relation to:
- Executive pay – Under the UK Corporate Governance Code, listed companies will be expected to be able to recover bonuses or share awards from executive directors if they have failed to protect customers’ and employees’ interests; and
- Dividends – Directors will be required to make a formal statement about the legality and affordability of any proposed dividend.
The consultation period will close on 8 July 2021. Subject to the outcome of the consultation, the government will bring forward primary legislation to implement the proposed reforms when parliamentary time allows.
We will publish a fuller briefing on the detailed proposals in due course.