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We need audit reform from our next government

Author: ICAEW Insights

Published: 28 Mar 2024

ICAEW has given evidence to the Business and Trade Committee on the challenges of audit and corporate governance reform. Iain Wright, ICAEW’s Managing Director, Reputation and Influence, explains what’s needed.

We are in a very different place than we were in 2018/19, when the UK government first started looking at audit and corporate governance reform. We’ve seen the impacts of a global pandemic, a war in Europe and the acceleration of AI. 

Still, that reform is essential if the UK is to become the world’s first net zero financial centre. We need legislation and regulation on audit and corporate governance reform to reduce the risk of disorderly corporate failure. We want to enhance the governance of major UK corporates.

Without this reform, the threat of the chaotic failure of a major British institution will continue to loom large.

Within its first 100 days, the next government should hold a consultation on new primary legislation. We believe the core of this legislation should be a strong statutory regulator, greater director accountability, and enhanced assessment of resilience and fraud risk.

When I was asked to give evidence at the recent Business and Trade Committee evidence session on Tuesday this week, it was an opportunity to outline the action that ICAEW believes must be taken to shore up trust and confidence in UK plc. The Institute issued a joint letter with ICAS urging the government to do more in this space.

We need ARGA

The introduction of the Auditing, Reporting and Governance Authority (ARGA) seems to have stalled, but its relevance has not diminished.

ARGA should have the power to take enforcement action against directors of public interest entities (PIEs) found to be in breach of their duties for reports, accounts and audit, including the failure to provide information or explanations to auditors. Under the current regime, these duties are difficult to enforce. Giving ARGA these oversight powers for all PIE directors will drive up standards and increase confidence and resilience in the marketplace. 

A strengthened regulator will also support financial reporting and audit reform at English local authorities to help them recover from the local audit crisis.

The Financial Reporting Council (FRC) has acted to strengthen regulation to improve audit oversight over the last six years. The largest audit firms have invested significantly in people, methodology and technology to improve capability and performance.

Within firms, this has included greater use of internal technical consultations, the voluntary adoption of operational separation and other governance enhancements. 

We all want a regulatory environment that protects the public interest and investors. It should make sure that the UK is an attractive and competitive place to do business. That means a regulatory environment that is fair, proportionate and respected. 

Reform is essential to maintain confidence in the UK’s largest businesses and the markets in their securities. We need to keep pace with international developments in sustainability reporting and assurance to help deliver a market-led solution to greenwashing risks.

The PIE market, and challenger firms

Some large firms have made a conscious decision not to compete at the top of the PIE audit market. Others have had to put the ‘horse before the cart’, investing in staff and technical resources to reach the required capacity and competence to compete for those audits.

ICAEW research in 2023, based on anonymised interviews with 18 non-Big Four firms, indicated an unprecedented abundance of non-PIE audits at attractive fees; firms are having to turn away tenders. 

For many challenger firms, this doesn’t create the requisite risk-reward balance to embrace the largest FTSE audits. The higher fees on offer in those markets don’t always overcome the regulatory regime, the related reputational and sanction risks to firms and responsible individuals (RIs), and the investment required to take on those larger, riskier audits.

Firms may be reluctant to take the leap of investment as, even after doing so, other factors may prevent them winning the most lucrative audits. For instance, the FRC may reject their RIs for PIE audit registration.

Additionally, the definitions of PIE haven’t been pinned down. Auditing a large private company for a reasonable fee may suddenly become unattractive if it falls within new PIE criteria, as the amount of regulatory scrutiny increases.

PIE audits also require staff and RIs with the relevant training and experience. Challenger firms need to be able to attract and retain these staff to enter the market. Our interviews last year indicated that RIs and other staff were relatively mobile between firms, but the attractiveness of audit as a profession needs to be an area of focus. Some commented that very public sanctions negatively impact the attractiveness of carrying out the largest audits for individual auditors.

Improvements in the profession

Since the collapse of Carillion, professional bodies have collaborated with the FRC and individuals such as Professor Sir Andrew Likierman on improving professional judgement. We have created a more rigorous CPD environment that is more tailored to individual needs. 

We have worked to improve ethics and deliver thought leadership on internal controls. For instance, ICAEW’s Audit and Assurance faculty produced two reports: Internal Control Effectiveness: Who Needs to Know (2019) and Internal Controls Reporting: Sketching Out the Options (2020).

In turn, the FRC released a framework on professional judgement and made changes to ISA 240 (UK) on fraud. That included clarification of the auditor’s responsibilities, linked with requirements in ISA 700 (UK), to report to the extent to which the audit was designed to identify irregularities including fraud.

Revisions made to other standards, like ISA 500 on audit evidence and ISA 505 on external confirmations, tie into real-world instances that reflect poorly on auditor bank confirmation procedures.

The FRC has also been involved in implementing UK versions of the IAASB’s quality management standards. This is a major change that firms are taking very seriously. We expect it to deliver significant improvements in audit quality over the next few years.

Firms have also not remained complacent, undertaking more internal technical consultations. Some major firms are voluntarily separating their audit and non-audit operations. Some others have established independent audit boards comprising audit non-executives.

The profession can see the benefits of audit and corporate governance reform. Now the government needs to follow through with its plans, before another major failure dominates the headlines.

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