The Institute agrees with Secretary of State for Business Kwasi Kwarteng’s declaration of the need to ‘reinforce’ UK audit and corporate governance, which suggests an approach that strengthens and underpins existing advantages while addressing weaknesses.
‘Reinforcing’ is the approach favoured by ICAEW. It has welcomed those measures in the consultation that follow that approach while voicing concerns where it suggests ripping up existing rules for no good reason or putting excessive pressure on the capacity of the corporate governance ecosystem.
The response recognises the value of investment to deliver against well-targeted regulatory requirements but stresses this has to be carefully focused on BEIS’ key objective, namely avoiding the surprise failure of those entities most in the public interest and reducing the risk that their accounts are undermined by fraud.
ICAEW’s response highlights five steps it believes should be the focus for reform:
1) Set up ARGA quickly and focus its remit on improvement
“Throughout its work, ARGA should emphasise its role as an improvement regulator,” says Iain Wright, ICAEW’s Managing Director, Reputation and Influence. ARGA should follow the BEIS Regulators’ Code in supporting those it regulates to work to improve quality and build capacity while remaining compliant.
2) Make directors more accountable for internal controls
The government should bring into force a more robust UK regime for accountability over internal control, similar to the United States’ Sarbanes-Oxley (SOX) regime. SOX requires the CEO and CFO to certify that the internal control system provides them with the information needed to monitor and manage the company. They must state that they have evaluated the internal control system and found it either sufficient or identified key weaknesses. This measure, in conjunction with a focused and stronger regulator, could be a game-changer when it comes to improving the governance over corporate reporting and reducing the risk of fraud and unexpected failure.
3) Take targeted action on fraud and resilience
The public and Parliament rightly expect auditors to do more to tackle fraud. No audit firm wants to miss a material fraud, and many are already taking steps to increase rigour when it comes to spotting fraud. Crucially, requiring a stronger statement on fraud will focus directors’ attention on the steps they have taken to guard against it.
ICAEW’s response states that what investors want is to see the quality of directors’ actions. Directors should focus on the processes, controls and behaviours that can cultivate or conceal fraud and take action to mitigate them.
A renewed focus on disclosure around resilience is also essential. Viability Statements have not made an effective difference. Resilience Statements need to avoid a similar boilerplate approach to reporting. ARGA should emphasise directors’ accountability for quality reporting in this area.
4) Use the Audit and Assurance Policy to enhance assurance
The Audit and Assurance Policy can work as a means of strengthening against risks of fraud and failure by enhancing the financial statements audit with targeted assurance over other areas and improving stewardship by making investors central to the process. It will take work to ensure that the Policy reaches its potential, however, as UK corporations need to be fully engaged in developing the Policy. The nine recommendations outlined in Developing a meaningful Audit and Assurance Policy provide a place to start. ICAEW has offered to work with BEIS and the FRC to implement the Policy.
5) Equip ARGA to deliver high-quality corporate reporting
The white paper proposes that the FRC’s current power to seek a court order to address non-compliance should be replaced with the ability to direct changes to reports and accounts. ICAEW backs this move and recommends that checks and balances and an appeals mechanism be included as part of this. An independent arbiter should be considered to assist in decision making.
ARGA should also have powers to publish correspondence that takes place during a Corporate Reporting Review and its summary findings. This should extend to the entire annual report.
ICAEW also highlighted areas of the consultation that were “distractions that undermine successful reform”:
Extending the Public Interest Entity (PIE) regime
The proposal to classify many more entities as PIEs threatens to overwhelm the system. It could result in more firms leaving the PIE market, undermining the choice and resilience of the audit market in turn.
“It is right that the government wants increased scrutiny for public interest entities, but the consultation includes far too many entities for which a reasonable public case cannot be made,” says Wright. “It would frustrate any efforts to increase competition, choice and audit quality.”
A lack of focus to ARGA’s powers
“There is no need to extend its remit into statutory regulation of chartered accountants or setting up an independent code of ethics,” says Wright. “Focus ARGA’s objectives to avoid failure through insufficient capacity and regulatory overreach.”
Establishing a separate professional body for corporate audit is unnecessary
The recognised qualifying and supervisory bodies support a quality audit profession. Creating a new professional body for corporate audit risks complicating the qualification process and reducing the appeal of entering the profession. This is critical to the UK’s world-leading professional services market. Instead, ICAEW has proposed developing its qualifications and training to help support government objectives.
More thought on market opening measures is needed
ICAEW supports more competition in the large audit market. However, the white paper’s proposal for an incremental introduction of managed shared audit will take years to make a difference. A market share cap might be a quicker and easier solution, but greater intervention may be required to make a significant difference, for example, in the area of auditor liability – a large barrier to entry for challenger firms.
Audit reform is a global issue, and the UK profession must be globally competitive
The issues addressed in the BEIS white paper are not new or unique to the UK. Jurisdictions across the world are looking at restoring corporate trust, improving audit quality and increasing the competitiveness and resilience of the audit market. They will look to the white paper as a blueprint for reform.
It is essential to reinforce a world-class regime that acknowledges the fact that chartered accountants are a force for good. The government recognises the world-class status of the UK accountancy profession and the wider professional and business services sector. That should remain at the centre of any measures that are taken forward.
Read the response in full
Restoring trust in audit and corporate governance
‘Restoring trust in audit and corporate governance’ is the BEIS white paper that sets out proposals on strengthening the UK’s corporate governance framework and the way companies are audited. Read ICAEW’s views on the consultation, explore what restoring trust means, and share information on the reform agenda.