Audit and Corporate Governance Reform

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In May 2022, the Department for Business, Energy and Industrial Strategy (BEIS) published their response to 2021 White Paper on audit and corporate governance reform. The changes will not be introduced fully for as long as two years with amendments required to the UK Corporate Governance Code and primary and secondary legislation.

Have the measures to restore trust in audit and corporate governance gone far enough?

Some of the corporate failures and scandals both in the UK and US have been caused by audit failings by not carrying out the audits as you would expect a professional firm to do. If they had audited the firms correctly, they may still be in operation today. The reforms could have gone much further but instead the initial proposals have been watered down.

Although there will be additional legislation to hold directors to account and auditors to be held to a higher standard, the reforms are just tightening up what was already in place and the measures only cover companies with a turnover of £750 million or more.

Shouldn’t the reforms have covered all listed entities as the measures are supposed to improve confidence in the investment markets? BEIS are reportedly considering reporting requirements for smaller public interest entities.

Some of the proposals will be included in the UK Corporate Governance Code, which is not mandatory, therefore, they are not likely to improve listed company reporting for those companies that do not have the same regard for corporate governance than others and may just create further boilerplate reporting.

Giving the Audit, Reporting and Governance Authority (ARGA) some teeth may be a good thing which the Financial Reporting Council (FRC) lacked. The ARGA may also hold the key to improved corporate reporting in the long term but ARGA will not be in full force until 2024 so we have some waiting to do.

Details of the reforms are listed below.

Who is in scope?

All companies (referred to as PIEs – Public Interest Entities) that have 750 employees and at least £750 million annual turnover, this includes subsidiaries and AIM listed companies too.

What are the reforms?

Director accountability – a new regulator will be created, ARGA who will have power to investigate and sanction directors for breaches of their duties and responsibilities under the Companies Act 2006 in respect of corporate reporting and audit. The new regulator will be funded by a levy on companies.

Audit process and internal controls – an explicit statement will be required in the annual report and accounts setting out the board’s views on the effectiveness of the company’s’ internal controls and the basis for the assessment. These companies will also be required to report on measures to prevent and detect material fraud. Audit committees will need to engage with shareholders on the audit plan and the regulator will have powers to impose additional requirements on audit committees with regards their appointment and oversight.

Audit and Assurance Policy – PIEs will need to publish a policy every three years and state in the policy how assurance will be obtained including on the internal controls statement.

Resilience statement – the going concern and viability statements will be replaced by a resilience statement where PIEs will need to consider short- and long-term threats to company resilience.

Review of annual reports – the regulator will be able to review the entire annual reports and accounts of PIEs and will not require a court order to direct company’s to change, rectify or restate its annual report and accounts.

Dividends – PIEs will be required to disclose their distributable reserves and to explain their approach to the return of value to their shareholders and a formal statement on the legality of any proposed dividend.

Audit market – FTSE 350 companies will be required to either use a challenger firm to conduct their annual audit as sole auditor or a challenger firm to conduct a meaningful portion of the annual audit as a managed shared audit. A challenger firm is a non-Big 4 audit firm i.e. not PwC, KPMG, EY and Deloitte.

Executive pay – companies will be required to be more transparent in relation to withholding or recovering remuneration for directors.

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