White Paper audit reform

There was relief at ICAEW when the BEIS consultation on corporate governance and audit reform was finally issued back in March. ICAEW has been a strong supporter of reform and there were concerns that it might never see the light of day. But among the first reactions to the White Paper were concerns expressed by the Institute of Directors and the Confederation of British Industry about the “unnecessary burden” on directors that the proposals represent, and about the risk that they will discourage entrepreneurship and drive investment away from the UK. 

Kwasi Kwarteng, Secretary of State for BEIS, responded. He emphasised the focus of the consultation on large, publicly traded companies whose collapse sometimes requires huge taxpayer-funded bailouts, and his belief that the proposals will not stifle entrepreneurship.<

Both viewpoints, and many others in between, are no doubt genuinely and deeply held. ICAEW has its work cut out in charting a course through them. 

What has been proposed?

Eleven chapters, 220 pages and 98 questions are supplemented by another 210 pages of impact assessment. The media focused on:

• clawbacks of directors’ bonuses and the prevention of their payment – with a minimum two-year application period in cases of ‘serious misconduct’, a ‘material misstatement of results’ or ‘an error in performance calculations and failures of internal controls and risk management’ – all under a similar regime to that currently applying to banks;
• a requirement for directors to make statements regarding dividend policy, affordability and legality;
• fines or suspensions of directors for withholding information from auditors or failing to keep proper accounting records; and
• enhanced (but not radically revised) requirements for directors and auditors relating to fraud.

The Guardian referred to a “sweeping series of reforms designed to break the dominance of the Big Four” and the “biggest shake-up of the UK’s corporate governance rules in decades”. It noted a proposed cap on the Big Four audit firm market share of the FTSE 350 if competition does not, in fact, improve. 

Less media focus was directed at proposals for:

• the new regulator – the Audit, Reporting and Governance Authority (ARGA) – to replace the existing FRC, with considerably more powers;
• a new corporate auditing profession – possibly the single most difficult aspect of the proposals;
• mandatory company reporting on internal controls over financial reporting;
• the publication of a new corporate ‘resilience statement’; and
• an audit and assurance policy on which shareholders will have an advisory vote, covering assurance over non-financial matters, such as key climate targets.

Which companies are affected?

The proposals cover public interest entities (PIEs), the definition of which would be widened to include, for the first time, large AIM companies and many large private entities, and possibly some public sector entities, with possible temporary exemptions for newly listed companies. The proposed expansion of the definition of PIEs roughly doubles the number of companies in scope, and there are some serious concerns about the implications.

The following are three issues that featured strongly in preliminary discussions with members.

ARGA and the timing of legislation

Some reforms can be taken forward without the new regulator, but many cannot. The establishment of ARGA – funded by a mandatory levy on industry – requires primary legislation.

ICAEW has stressed the need for the timely establishment of ARGA. CEO Michael Izza has called for the whole reform agenda to be taken forward at pace, in particular to ensure that the new regulator is up and running by April 2023. Government has committed to bringing forward legislation, but only “when parliamentary time allows”. 

Among additional powers proposed for ARGA are powers relating to:

• forcing the revision of defective accounts without resort to the courts;
• publishing regulatory reports on auditors without the consent of the firm or company;
• appointing FTSE 350 auditors and audit committees; and
• defining distributable profits and embedding the definition in legislation. 

Expectations need to be managed regarding what the new regulator can achieve in practice, even with increased funding and powers. There may also be a need for greater acknowledgment that recent corporate failures have not arisen as a result of a failure in the remaining limited self-regulation exercised by the professional bodies – quite the contrary. The highly complex technical area of distributable profits is a good example. Alongside ICAS, ICAEW is the only body currently providing comprehensive guidance in this area and has repeatedly called for authoritative regulatory or legislative guidance.

Reporting on resilience

The pervasive view of viability statements is that they don’t work. In his review of financial reporting regulation, John Kingman recommended that they either be scrapped or amended to make them more effective. BEIS has decided to attempt the latter, proposing a new annual resilience statement that expands on viability statements to create something more detailed and comprehensive. The new statement would set out how directors are assessing the company’s prospects and addressing challenges to its business model over the short, medium and long term. 

The short-term section of the statement would incorporate the existing going concern statement, including the disclosure of any material uncertainties considered by management during their going concern assessment. 

Existing viability statement requirements would be incorporated in the medium-term section of the resilience statement. The mandatory assessment period would, however, be five years, rather than three. The section of the statement covering reporting over the medium term would also need to evidence scenario planning. The government plans to require companies to include at least two reverse stress testing scenarios. 

The proposed statement would also require further disclosures in both the short- and medium-term sections. Common resilience issues, such as supply chain resilience, digital security risks and major disruptive events, may be mandatory inclusions. 

The long-term section would set out what the directors of the company consider to be the major long-term challenges to the company and its business model and how these are being addressed. 

The risk in all of this is a rush to boilerplate. We plan to explain to government how these proposals, if improved, might achieve their goals. 

Reporting on internal controls over financial reporting

ICAEW is a strong supporter of the development of a high-quality UK framework for reporting on internal controls over financial reporting. The proposals have been praised for avoiding the more burdensome aspects of the Sarbanes-Oxley regime in the US and criticised on more or less the same basis because they lack the teeth – ie, jail terms for directors – of the US system. 

Many believe the Sarbanes-Oxley regime has contributed significantly to the reduction in corporate and audit failure in the US over the past 20 years, but others believe better analysis of UK corporate failure is needed. It has also been noted that this will not be a quick fix. The Public Company Accounting Oversight Board in the US has had 20 years to develop the regime there, including relationships with overseas regulators, and we should not expect the UK regulator to do the same in half the time.

Moving ahead

The White Paper is a rare opportunity to encourage genuine and long-lasting changes to the profession, audit and the wider corporate governance system. As is often the case, developments here are being followed closely in the EU and beyond. The trajectory of reform in the UK will have global repercussions. 

Your views on this reform agenda are important. The debate about the proposals and their effective implementation will continue for some considerable time after 8 July 2021, which is the deadline for comments on the White Paper. You can contact us at frf@icaew.com

About the author
Nigel Sleigh-Johnson, Director, Technical Strategy Accountability Group, ICAEW