Overdue audit and corporate governance reforms on the horizon

Just before the Queen’s Speech, rumors had swirled that long-awaited audit and corporate governance reforms had been unceremoniously dropped. Fortunately, it seems that the call from the chairman of the Commons Business Select Committee not to delay these much-needed reforms has been heard by Downing Street.

Serious reform of the UK’s audit and corporate governance regime is widely recognized as being long overdue. However, such reform is finally on the horizon, following a series of major audit disasters, including KPMG with Carillion and Deloitte with Autonomy. These scandals, along with the collapses of BHS and Patisserie Valerie, have highlighted the need for urgent reform in the UK audit industry.

These major corporate bankruptcies gave rise to three major industry reports, namely Sir John Kingman’s Independent Review of the Financial Reporting Council. (FRC), the Market and Competition Authority’s market study and Sir Donald Brydon’s independent review of audit quality and effectiveness. These reports in turn informed a major 2021 consultation document. This consultation included over 150 recommendations, which were drawn from these three reports.

The reforms proposed by the government consultation are not minor adjustments. They constitute a truly significant reform of corporate governance in the United Kingdom. The proposals of the consultation were divided into six main headings, namely the responsibility of the directors, the audit process, the annual accounts, the audit market, the remuneration of the directors and the dividends.

A great deal of work and thought has already gone into preparing these reforms. We now have to wait and see if eventual legalization proves adequate to achieve the government’s stated goals.

In March 2021, the government white paper stated that the fundamental objectives of the reforms were to:

  • Restore public confidence in the way the UK’s biggest companies are run and controlled
  • Ensure that the UK’s most important corporate entities are governed responsibly
  • Empower investors, creditors, workers and other stakeholders by giving them access to reliable and meaningful information about a company’s performance
  • Keeping UK legal frameworks for large companies at the forefront of international best practice

Genuine prioritization of these key objectives is necessary to restore public and market confidence in the UK audit industry. As the UK economy navigates increasingly uncertain economic waters – rocked by the coronavirus pandemic, inflation, Brexit and the war in Ukraine – growing confidence in the UK’s audit regime- Uni will help boost investor confidence.

As things stand, the Financial Reporting Council (FRC) simply does not have the powers to implement effective measures of stricter control that would hold administrators accountable for any lack of transparency. The FRC should either be given these powers or be replaced by a body with increased resources and skills.

We are still awaiting the fine print regarding the proposed new audit regulator in the UK, the Audit, Reporting and Governance Authority (ARGA), which is to replace the FRC. This new body is supposed to be a more powerful regulator, which will have more powerful investigative and regulatory tools than the FRC.

The government has also pledged to break the dominance of the big four audit firms: KPMG, EY, Deloitte and PwC. A 2019 report by the Competition and Markets Authority (CMA) on the UK audit market called for smaller “challenge auditors to shake up the market and end Big Four dominance “.

However, the CMA report also recognized that building the capacity of small businesses would take time.

However, the growing number of recent FRC investigations of mid-tier challenger audit firms has caused some to question this strategy. For example, the FRC is investigating the 2020 audit of French Connection by mid-tier audit firm Mazars – which is just one of several other investigations of mid-tier audit firms. While a market shake-up is welcome, it is clear that a new regulatory approach is needed. This should give companies and audit firms real clarity about what is expected of them, while giving the regulator both the powers and the resources to ensure compliance with these standards.

Of course, a balance must be carefully struck between effective regulatory control and allowing companies sufficient freedom to do business. However, overweighing the balance towards this last consideration can open the door to those who lack accountability and integrity, as we have seen. This can ultimately damage business confidence across the economy as business people and investors need to have confidence in the UK’s audit regime before they can rely on those same audits. when investing in companies.

The audit industry itself is crying out for better regulation. The strength of sentiment in the sector was evidenced by the strident reaction to rumors late last year that the government was set to weaken proposed audit reforms, including scrapping a proposed requirement that directors approve the companies’ internal controls. This proposal was essentially intended to create a UK equivalent of the US Sarbanes-Oxley Act.

In response to these rumours, a joint letter from CFA UK, Corporate Reporting Users’ Forum, UK Shareholders’ Association and ShareSoc asked, “Why water down measures that would reduce the risk of fraud and inaccuracies? As usual, however, the UK seems to have to fall back on the corporate governance code, which the good guys follow and the bad guys neglect”. The chief executive of the Chartered Institute of Internal Auditors said Sarbanes-Oxley Act-like legislation would “highlight its importance” and help improve compliance. We will soon see if such measures are found in the legislation.

UK audit reforms must be robust enough and in line with those proposed in the government’s 2021 consultation papers. Failure to deliver the necessary reforms in a timely manner would leave a lack of confidence in the audit industry. the UK audit. The ball is now in the government’s court to finally deliver meaningful and effective regulation that restores confidence in the UK audit industry. If successful, it will also boost confidence in the UK business sector more broadly.

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