Half-yearly corporate update – our latest briefing

We have published our half-yearly update briefing which summarises the major developments in UK corporate law and regulation that have occurred over the last six months, that is from July to December 2022, and which are of relevance to UK listed companies.

The briefing is available here.

Julie Farley
Julie Farley
+44 20 7466 2109

Mike Flockhart
Mike Flockhart
+44 20 7466 2507

Sarah Hawes
Sarah Hawes
+44 20 7466 2953

FRC consultation on Audit Committee Standard

The Financial Reporting Council (FRC) has launched a consultation on a draft minimum Standard for audit committees of FTSE 350 companies in relation to external audit.

As part of the reform of audit and corporate governance in the UK, the government announced in May 2022 that it will give the Audit, Reporting and Governance Authority (ARGA) – the new successor regulator to the FRC – power to impose minimum requirements on audit committees of FTSE 350 companies in relation to the appointment and oversight of auditors. For more information on the audit and corporate governance reforms, see our updated briefing.

In anticipation of ARGA being given these powers by legislation, the FRC has published a draft minimum standard for consultation. The standard sets out the responsibilities of the audit committee in relation to the external audit, in particular with regard to the tendering process, the oversight of the external auditors and reporting to investors on these responsibilities in the annual report. The draft draws on existing FRC publications, including its Guidance on Audit Committees and the Governance Code. The consultation on the standard closes on 8 February 2023.

Until the necessary legislation is passed and ARGA is in place, the FRC will encourage FTSE 350 companies to comply with the final form standard on a comply or explain basis. The government confirmed in its May 2022 response paper that the legislation will also give ARGA powers to monitor compliance with the minimum standard, through review of publicly available information, enhanced powers to require information and reports from audit committees on compliance, and powers to take action in the event of a failure to comply with these new requirements.

Isobel Hoyle
Isobel Hoyle
+44 20 7466 2725

Roddy Martin
Roddy Martin
+44 20 7466 2255

Gareth Sykes
Gareth Sykes
+44 20 7466 7631

FRC publishes reviews of reporting in 2021/22

The Financial Reporting Council (FRC) has published its annual review of corporate reporting for 2021/22 and its annual review of corporate governance reporting for 2022.

Review of corporate governance reporting

The FRC’s annual review of corporate governance reporting discusses the quality of reporting against the UK Corporate Governance Code in 2022 and its expectations for companies reporting in 2023.

The FRC reviewed the corporate governance reports of 100 FTSE 350 and Small Cap companies. Of these, only 27 claimed full compliance with the Code, compared with 58 in 2020 and 36 in 2021. The FRC is pleased that more companies are using the flexibility of the ‘comply or explain’ nature of the Code, and are offering greater detail when reporting departures from the Code. It says companies should be transparent in their reports by naming the specific Code provision(s) that have not been complied with.

Other key messages from the report include:

  • Risk management and internal controls – Over half of the companies provided a statement to confirm that their risk management and internal control systems are effective or that no weaknesses or inefficiencies have been identified. However, many of those companies do not explain the steps taken to assess these systems.
  • Workforce engagement – The FRC notes that disclosures on outcomes of workforce engagement are almost exclusively in relation to flexible working matters. The most common engagement mechanism was having a designated non-executive director. The FRC says that companies should explain why they have chosen their engagement mechanism and how they monitor it to ensure that it is effective.
  • Shareholder and wider stakeholder engagement – Wider stakeholder engagement is generally of a good standard but there is minimal disclosure of specific board members’ engagement with major shareholders. The FRC states that good reporting should include details of how the board engaged with the shareholders and stakeholders (methods of engagement, those involved, the frequency of engagement and topics discussed), what the feedback was and the impact it had on board discussions and decision-making.

Other areas covered by the report include modern slavery and climate change reporting, chair independence and tenure, board diversity and remuneration.

The FRC says that it will consult on amendments to the Code next year – to reflect the FRC’s transition to ARGA – but that it doesn’t intend to effect a wholesale revision of the Code. It plans to focus on those areas identified in its July 2022 position paper (see our blog post here).

Annual review of corporate reporting

The broader review of corporate reporting provides an overview of the work of the FRC’s corporate reporting review (CRR) team and sets out the FRC’s view on the current state of corporate reporting in the UK.

Despite the challenging environment caused by economic and geopolitical uncertainty, the FRC notes that the quality of corporate reporting by FTSE 350 companies has not declined. Improvements have been seen in the reporting of areas such as judgement and estimation uncertainty, revenue and alternative performance measures (APMs).

The FRC’s review discloses that:

  • around 250 companies were reviewed by the CRR team during this review cycle, resulting in just over 100 companies being contacted for further information or explanation. These numbers are similar to those seen in the 2020/21 review cycle;
  • the number of companies required to refer to these CRR enquiries in their next annual report (Required References) almost doubled compared to during the previous review cycle, with the majority of these Required References relating to cash flow statements; and
  • other topics frequently raised with companies include income taxes, APMs, financial instruments, impairment of assets and strategic report and other Companies Act 2006 matters.

The review also highlights the thematic reviews carried out by the FRC Lab and the CRR team on various issues, including business combinations, earnings per share and TCFD disclosures in financial statements (see our corporate updates 2022/15 and 2022/17 for more details on these reviews).

Mike Flockhart
Mike Flockhart
+44 20 7466 2507

Heidi Gallagher
Heidi Gallagher
+44 20 7466 2367

Sarah Hawes
Sarah Hawes
+44 20 7466 2953

FRC position paper on audit and corporate governance reform

Following the publication in May this year of the government’s response to its consultation on audit and governance reform (see our blog post here for more details), the FRC has published a position paper setting out the steps it will take to implement the reforms outlined by the government.

In particular, the FRC intends to publish a consultation paper on changes to the UK Corporate Governance Code in the first quarter of 2023, with the expectation that the revised Governance Code will apply to financial reporting periods starting on or after 1 January 2024. The changes to the Governance Code will include enhancing the disclosures that the board is required to make in relation to the effectiveness of the company’s internal control systems and strengthening the provisions of the Governance Code that deal with the conditions for withholding executive pay.

The FRC will also consult on necessary changes to the guidance which supports the Governance Code, including its Guidance on Board Effectiveness and the Guidance for Audit Committees.

A number of the reforms set out in the government’s response will require primary and secondary legislation, the timing for which is not yet known. The FRC intends to implement the reforms through only one set of changes to the Governance Code and each standard and piece of guidance for which it is responsible, and so recognises that the timing for its consultations will ultimately be driven by the government’s legislative timetable.

We have produced a detailed briefing on the government’s response to the audit and governance consultation, which is available here.

Sarah Hawes
Sarah Hawes
+44 20 7466 2953

Isobel Hoyle
Isobel Hoyle
+44 20 7466 2725

Ben Ward
Ben Ward
+44 20 7466 2093

Government response on audit and corporate governance reform consultation

The Department of Business, Energy and Industrial Strategy has published the response to its March 2021 consultation on audit and corporate governance reform, Restoring trust in audit and corporate governance (for further details, see our corporate update from March 2021). Most of the proposals contained in the consultation will be implemented, a number in modified form following feedback received.

The reforms will see the creation of the Audit, Reporting and Governance Authority (ARGA) as the successor regulator to the Financial Reporting Council (FRC). The ARGA will have a broader remit and significantly expanded powers as compared to the FRC.

The majority of the changes will impact public interest entities (PIEs), a concept derived from the EU Audit Directive (as implemented into UK law). The reforms expand the current UK definition of PIEs to include all UK incorporated companies (and groups) with both 750 or more employees and an annual turnover of £750 million or more (the 750:750 threshold). AIM companies and LLPs which meet the 750:750 threshold will also be PIEs under the reforms.

The wide-ranging reforms will introduce a number of fundamental changes to the corporate governance and reporting landscape. These include:

  • Directors’ duties – The ARGA will be given the power to enforce breaches by directors of their duties in relation to audit and corporate reporting. All directors of PIEs (and in exceptional cases, directors of their subsidiaries) will be within the scope of this new enforcement power.
  • Internal controls – The FRC will amend the UK Corporate Governance Code to require an explicit board statement on the effectiveness of the company’s internal control systems and the basis for that statement. This was one of the three options the Government consulted on to strengthen the requirements in relation to internal control systems – another of the options that is not being taken forward was a statutory reporting and assurance regime similar to the US Sarbanes Oxley regime.
  • Dividends – PIEs meeting the 750:750 threshold will be required to explain their long-term approach to the return of value to shareholders and how that policy has been applied in the reporting year. Directors of these PIEs will also need to confirm the legality of any dividend proposed or paid in year. They will not need to provide a two year solvency statement prior to payment of any dividend, as had been proposed.
  • Reporting – A number of changes are being introduced in relation to corporate reporting. These new reporting requirements will apply to PIEs meeting the 750:750 threshold.  They include:
    • replacing the existing UK Corporate Governance Code viability and going concern statements with a new statutory resilience statement, which will form part of the strategic report;
    • requiring the publication every three years of an audit and assurance policy (AAP), and an annual report on the implementation of the AAP; and
    • requiring directors to report on the steps taken to detect and protect against material fraud.

The Government has also confirmed a number of measures to reform the audit market and to amend the regulation of auditors.

The reforms will be implemented through primary and secondary legislation and amendments to the UK Corporate Governance Code. As a result, and in order to give companies time to prepare for the new regime, the reforms will be implemented over a number of years.

An easy snapshot of the reforms can be found here. We have also produced a more detailed briefing on the reforms, which can be found here.

Sarah Hawes
Sarah Hawes
+44 20 7466 2953

Isobel Hoyle
Isobel Hoyle
+44 20 7466 2725

Gareth Sykes
Gareth Sykes
+44 20 7466 7631

Audit reform and corporate governance – consultation paper on audit and corporate governance reform

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:

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.

Audit reform

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.

Sarah Hawes
Sarah Hawes
+44 20 7466 2953

Gareth Sykes
Gareth Sykes
+44 20 7466 7631

Ben Ward
Ben Ward
+44 20 7466 2093