Government publishes consultation on “Restoring trust in audit and corporate governance”

The UK Government’s Department for Business, Energy & Industrial Strategy (BEIS) has launched a consultation on a range of new proposals designed to overhaul how UK companies are governed and audited. This quick guide breaks down those proposals and explains what company directors need to know about the upcoming changes.

Over the course of the last five years, the UK has played host to a flurry of corporate scandals. The catastrophic collapse of major organisations like Carillion, Thomas Cook and British Home Stores (BHS) have had a detrimental impact on UK society — costing jobs, creating monumental pension deficits, creating depressing gaps in high streets and more.

And while some businesses simply aren’t designed to withstand the test of time, these particular insolvencies weren’t simply a result shifting consumer demographics. They were all the product of proven corporate mismanagement and, in many cases, insufficient or blatantly incorrect auditing.

According to the UK Government’s Department for Business, Energy & Industrial Strategy (BEIS), these increasingly frequent corporate failures have shaken public trust in the credibility of UK company directors’ reporting regimens and statutory auditing exercises. As a result, regulators now say that the UK’s wider reputation as a global business hub is now under threat.

That’s why the BEIS released its latest white paper at the end of March — and the proposals included within that white paper could have major implications for company directors and UK limited companies of all shapes and sizes.

At over 200 pages long, the new BEIS white paper is entitled “Restoring trust in audit and corporate governance”. It’s primarily designed to respond to and address the more than 150 recommendations which arose from three earlier independent reviews into this area carried out by Sir John Kingman, the Competition and Markets Authority (CMA) and Sir Donald Brydon.

To help you understand the changes that the BEIS is considering as part of the white paper, we’ll delve into some of the paper’s key proposals and their implications on UK company directors.

What changes are the government proposing?

The BEIS white paper includes a wide range of proposals as part of what it considers a proportionate response to growing concerns over how companies should report on their governance and finance, the report types that need to be audited and, perhaps most importantly, the intent to create a new regulator to oversee auditing changes.

In order to explore these proposals as succinctly as possible, we’ll divide the white paper’s biggest policy changes into four key categories:

  • The establishment of a new Audit, Reporting & Governance Authority (ARGA)
  • Directors’ responsibilities and reporting requirements
  • Auditing

Establishment of a new regulatory body

The vast majority of the proposals being put forward in this BEIS white paper hinge on the establishment of a new regulatory body.

This new body, the Audit, Reporting & Governance Authority (ARGA), would need to be created by an act of the UK Parliament (“when Parliamentary time allows”).

Upon its creation, ARGA will be given a defined set of roles and powers in order to protect and promote the interest of investors, corporate stakeholders and the wider public where corporate reporting and auditing are concerned.

Directors’ responsibilities and reporting requirements

Without doubt the highest volume of proposals within the BEIS white paper centres on the responsibilities and reporting requirements that UK company directors have got to fulfil.

First and foremost, the white paper proposes a new regulatory regime for directors that will include handing the newly-formed ARGA the power to investigate fulfilment of corporate reporting and auditing responsibilities by directors. Authorities will now be able to take civil enforcement action (as opposed to criminal enforcement action) against directors if they’re found to be in breach of their existing reporting or audit duties.

In terms of the reporting regime, boards are still going to be expected to keep adequate accounting records, approve accounts, sign annual accounts, approve the directors’ report and provide a statement around the disclosure to auditors.

Beyond this, the white paper also expresses a desire to see the regime supplemented by organisations placing more emphasis on contractual provisions in the pay packets of their company directors around malus and clawback. This would ensure that remuneration can be recovered or withheld if a company director is found to have seriously failed the company.

The BEIS suggests this could initially be done by getting ARGA to consider changes to the UK Corporate Governance Code to recommend clawback or “trigger points” be included in director contracts for a minimum period of time.

Meanwhile, the white paper’s second section opens with a proposal to seek views on three different options surrounding attestation on internal controls.

Those three proposed options include:

  • Company directors should be required to conduct reviews of how effective their company’s internal controls are each year. Then, they should make a statement on that effectiveness as part of their company’s annual report. This statement should include and explain the benchmarking system used to give stakeholders confidence in the review system.
  • The company’s audit report should describe the work that auditors are already required to do so that stakeholders can better understand internal control systems and the necessary extent of any audits that are carried out.
  • It should be mandatory for company auditors to give formal opinions on the company director’s annual attestation concerning the effectiveness of internal controls.

The BEIS makes clear in its white paper that the preferred option here is to require a director’s statement on effectiveness.

But it’s important to note that these three proposals aren’t mutually exclusive — and so as a result of further consultation, the UK Government might choose to introduce any of them or none of them.

Similarly, with this white paper the UK Government is proposing the introduction of a statutory requirement on public interest entities to publish a so-called ‘annual resilience statement’.

This statement would consolidate and build on the existing concern and viability statements in which organisations already produce. But in this new statement, regulators would require companies to disclose any material uncertainties considered by management during existing concern assessments that were only deemed material after a significant judgement or mitigating action took place.

This information will then sit alongside other required sections, which are to include disclosure of:

  • Any threats to business continuity, liquidity or solvency
  • Information on existing supply chain resilience
  • Cybersecurity risks
  • Investment levels the organisation requires to maintain viable and sustainable operations
  • Risk posed by climate change
  • The organisation’s dividend policies and their sustainability

To begin with, the BEIS white paper is suggesting that this resilience statement should initially only be required for premium listed companies. Two years later, the requirement should then be extended to other public interest entities.

The UK Government’s intention as laid out within the white paper is to implement enforcement of this resilience statement through legislation, which will then be supported and maintained by ARGA.

Finally, there are significant proposals being put forward around capital maintenance, fraud and payment practices.

The white paper proposes that companies should henceforth be disclosing the total amount of reserves that are distributable — which must be higher than any proposed dividend. Likewise, if the organisation is part of a wider group of companies, the parent company should always offer an estimate of distributable reserves across the entire group of companies to ensure full transparency.

Company directors must then be able to state that the proposed dividends are less than known cash reserves — and above all else, that payment of dividends won’t threaten insolvency of the company within the next two years.

The BEIS is inviting additional views on how directors and companies should calculate and report on their distributable reserves. Those responses can be submitted as part of the UK Government’s white paper consultation.

Similarly, the BEIS is calling on the UK Government to create legislation requiring directors of public interest entities (PIEs) to report on the steps they’ve taken to detect and prevent fraud. A specific proposal has also been submitted which would require PIEs to include a summary of payment practices within their annual reports.

Changes to auditing

A major aspect of the BEIS white paper centred on the regulatory frameworks in place for auditors and auditing committees.

First and foremost, the UK Government is proposing to let ARGA introduce extra requirements on audit committees surrounding who appoints and oversees auditors. These requirements would include the need for audit committees to continuously monitor the quality of audits — consistently challenging auditors and asking them to demonstrate the veracity of reporting.

This requirement would apply to audit committees of FTSE 350 companies initially, setting a minimum level of standards that audit committees will be invited to exceed. New powers will be handed to ARGA in situations like the resignation of an auditor or when a PIE is unable to find a suitable auditor.

Likewise, the BEIS white paper has agreed with previous recommendations submitted by the Brydon Review which proposes a new requirement on public interest companies to publish an annual audit and assurance policy.

This policy would describe the organisation’s approach towards getting assurance for its reported information over the three years that follow. This rule would initially apply to premium listed companies only — then getting extended to other PIEs two years later.

In terms of content, the BEIS white paper is asking for consultation views on what that policy should include. The three suggestions the UK Government has already outlined are:

  • An outline of what independent assurance the organisation is planning to get in the next three years, which should relate to the company’s annual report, plus any other organisational disclosures.
  • An explanation of the company’s internal audit and assurance processes, A description of the company’s internal auditing and assurance processes, which would include how management decides what goes into the annual report and accounts.
  • An outline of any policies an organisation has around taking on external audit services
  • Information on whether (and if so, how) stakeholder views have been considered in terms of setting up the organisation’s audit and assurance policy

The publication of shareholder views is also furthered upon in section seven of the white paper. In addition to assurance policies, the UK Government is proposing to introduce a formal mechanism that would enable audit committees to gather shareholder views on an existing or future audit plan.

That being said, the white paper does specify that this mechanism should be voluntary rather than mandatory. The audit committee would then put forward any gathered shareholder suggestions as part of its inclusion in the company’s annual report.

Just like many of the freshly proposed directors’ responsibilities we’ve already covered, this auditing mechanism would only apply to premium listed companies to begin with. It would likely need to be introduced via a change to the UK Corporate Governance Code.

More important still, the BEIS has proposed the creation of a new, stand-alone professional body that would be responsible for overseeing all forms of corporate reporting — not just a company’s financial statements. It’s yet unclear what this body would be called, and no timetable has been proposed in relation to its creation.

The UK Government also said in its BEIS white paper that it is minded to create legislation that will require the auditors of PIEs to report on all of the work they carried out in order to decide whether the directors; statement regarding fraud was indeed accurate. This would enable stakeholders to better understand the extent of any audits and the extent of work a company carries out to ensure that fraud has been mitigated.

Finally, the BEIS white paper seeks to address one of the key points of contention that shareholders, politicians and the general public are constantly debating about: breaking up the so-called “big four”.

In the CMA’s independent review on auditing practices in 2019, it called for an operational split between the audit and the non-auditing operations of the UK’s top four accounting firms: KPMG, Deloitte, PwC and EY.

In March’s white paper, the BEIS said it had taken into account that recommendation and agrees there’s merit in reforming the balance of incentives within these organisations — while stopping short of calling for the firms to be broken apart.

The UK Government’s proposal is to strengthen governance of these firms through the creation of independent audit boards. These boards will then be given oversight of audit partner payment, ensuring it’s linked to the quality of audits. The government is also proposing a new requirement to publish a separate profit and loss account for audit practices that account for cross subsidies between the audit function and non-audit function of these big companies.

When will these measures take effect?

It’s important to note that the proposals we’ve covered don’t include every single change recommended as part of the white paper. The paper is more than 200 pages long, and also includes points around oversight of the investor community. Yet by and large, we’ve broken down the key changes being proposed.

So, when are these proposals going to come into force?

Although a timetable has yet to be released, the paper makes clear that measures which don’t directly impact on business could be introduced relatively quickly. These measures would include establishing a new regulator and assigning its duties.

Meanwhile, measures that would have significant impacts on companies (particularly those which will be overseen by the new regulator) will include a transition period in a relatively quick fashion after the regulator has been established.

How can you submit your views on these proposals?

Above all else, bear in mind that the changes outlined in this white paper are still only proposals. On 18 March 2021, the UK Government launched a public consultation in order to gather views on these proposals and how they would impact businesses and stakeholders.

This consultation is open until 8 July 2021.

If you’d like to take part in this consultation, you can do so online using the BEIS website.

Want to learn more about corporate finance and taxation in the UK?

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About the author

Nicholas joined in 2018 to set up the Company Secretarial Department in the group’s company formation divisions. After establishing the department, he was a key stakeholder in the development of Linnear CoSec. Prior to joining the group, Nicholas worked in a variety of client-facing positions at an international provider of corporate services, caring for a diverse portfolio of companies. He is a Chartered Secretary and Governance Professional, and holds a bachelor's degree in Politics as well as a Masters in Corporate Governance.

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