Well over two years since Sir John Kingman’s Independent Review of the Financial Reporting Council appeared, the UK government has published proposals for the reform of audit and corporate governance.
The 232 pages (mostly) apply Kingman’s call for the regulator to be ‘firmly focused on the interests of consumers of financial information, not producers’. Sir Donald Brydon’s review of the quality and effectiveness of audit has also helped craft the sections on directors.
With so many public interest entities remaining private, the case for extending the net is clear
It is taken as read that the Financial Reporting Council (FRC) will become the Audit, Reporting and Governance Authority (Arga). The last word embodies new powers to supervise and enforce, from the boardroom to audit firms.
A statutory levy will cover annual costs, which are set to rise from less than £29m in 2018/19 to £52.2m in 2021/22. Headcount will have doubled to well over 400 by March 2022.
Talking points are more likely to revolve around Arga’s objectives. Protecting and promoting the interests of investors and the public interest (in reliable information and decently run companies) is fine. But how big is the audience described as ‘other users of corporate reporting’? For instance, to what extent should Arga be used as a vehicle for climate-related government policies?
Turning to the objective of promoting competition, it is not obvious that this should be given the same weight as the quality of corporate reporting, governance and auditing. How many agree that ‘the regulator may…need to promote effective competition where the importance of doing so may outweigh the need to promote quality’?
Held to account
Moving to the most controversial areas, the first concerns holding directors to account for breaches of their corporate reporting and audit-related responsibilities. Arga would potentially employ a range of civil sanctions including fines and temporary bans.
Remember that directors already face criminal prosecution under the Companies Act 2006, which sets out their duties, and the Financial Conduct Authority is supposed to enforce listing, transparency and market abuse rules.
The potential requirements read like a US management discussion and analysis checklist for audit committees
Both the proposed dividend and resilience disclosures require crystal balls, looking ahead two and five years respectively. There is a conflict here between the gathering view that corporate information is all about the company’s long-term survival and the classic one: that it helps the providers of capital and credit decide how best to allocate their resources. More rigorous obligations on both directors and auditors to watch out for fraud should help with both.
Turning to the audit market, the operational separation of audit from consultancy is under way. It is a key step towards changing auditors’ mindset. Other proposals include requiring them to pay attention to directors’ conduct and external signals, such as short selling. Whether the complicated business of creating a new corporate auditing profession is essential to this is another matter.
And, finally, competition. The government has shied away from the Competition and Markets Authority’s recommended joint audits and instead plumped for shared ones. Crucially, the lead auditor for the biggest companies – still likely to be from the Big Four – retains overall responsibility and liability. Smaller firms will increasingly be hired to carry out audits of UK subsidiaries.
Challengers would gain introductions to bigger audits, but the overlap between providers will increase costs. It may encourage boards to skip that and hire a non-Big Four firm for the whole audit. If the market remains concentrated, Arga will have the power to impose a market share cap.
With audit committees coming under Arga supervision, what about the other dog that has not barked enough: shareholders? The proposals are threaded with references to the need for them to engage, from audit planning to a vote on audit policy. Since the reforms are cast as protecting their interests, it is to be hoped the call to action will be heeded.