The U.K. government on Thursday unveiled proposals designed to end the Big Four accounting firms’ dominance of the region’s audit market while also making companies and executives more directly accountable—and liable—for failures in corporate reporting.
Following several reviews into the audit profession, the effectiveness of the U.K.’s corporate governance regulator, and the state of the audit market, the government’s proposals would require large companies to use a smaller “challenger” firm to conduct a “meaningful” portion of their annual audit. The Big Four (Deloitte, EY, PwC, and KPMG) could face a cap on their market share of FTSE 350 audits altogether if competition in the sector does not improve.
The government also further defined the authority of a new regulator to oversee large listed and unlisted companies and be empowered to impose an operational split between the audit and non-audit functions of accountancy firms to reduce the risk of any conflicts of interest.
The proposals are largely divided into those that impact audit firms and those that impact companies.
For audit firms there will be:
- The replacement of the Financial Reporting Council with the Audit, Reporting and Governance Authority (ARGA). ARGA will provide stronger oversight of the accountancy and actuarial professions. Its objectives and governance will be underpinned by legislation and funded by a mandatory levy on industry. It will be given much stronger powers to enforce standards. For instance, where serious problems occur, ARGA would be able to order companies to go back and redo their accounts without having to go through the courts. It will also have improved powers to monitor the quality of audits, including publishing inspection reports in full.
- A managed shared audit regime in which a subsidiary company audit is done solely by a challenger firm in an effort to improve competition in the audit market. If necessary, ARGA will be empowered to introduce a managed market share cap reserving a proportion of listed company audits for challenger firms.
- A duty for auditors to take a wider range of information into account (including against key climate targets, for example), with powers for the regulator to set enforceable principles for auditor conduct.
- New reporting obligations for both auditors and directors around detecting and preventing fraud, with boards required to set out what controls they have in place and auditors expected to look out for problems.
- A voluntary scheme for the audit and assurance of more non-financial information over and above the statutory audit.
- Efforts to encourage audit and assurance professionals to work towards a new audit profession, rather than maintain it as a subset of the accountancy profession as is presently the case.
For companies there will be:
- New reporting requirements for larger companies on anti-fraud measures and the level of independent scrutiny given to their published reports.
- New directors’ duties relating to internal controls and risk management (modeled on those under the U.S. Sarbanes-Oxley Act, but with the aim of being less burdensome in practice).
- New powers to hold directors of large companies to account in relation to their reporting and audit obligations. Directors could face fines or suspensions in the most serious cases of failings, such as significant errors with accounts, hiding crucial information from auditors, or leaving the door open to fraud.
- Improved powers to review companies’ corporate reporting, including proposals to extend those powers to the whole annual report.
- An expectation under the U.K.’s Corporate Governance Code to write into directors’ contracts that executive bonuses will be repaid in the event of collapses or serious director failings up to two years after the pay award is made, thereby clamping down on “rewards for failure.”
- A duty to be more transparent about the state of a company’s finances so that a corporate does not pay out dividends and bonuses at a time when it could be facing insolvency.
- A requirement for directors to publish annual “resilience statements” that set out how their organization is mitigating short and long-term risks, encouraging boards to focus on the long-term success of the company and consider key issues like the impact of climate change.
- An expansion of the definition of “public interest entity” (PIE) to include very large non-listed companies and ensure they must meet more stringent reporting and audit requirements to reflect their importance following the high-profile collapses of private companies such as clothing retailer BHS. The government will also consider an option to exempt newly listed firms from requirements associated with becoming a PIE to ensure the United Kingdom stays competitive on listings.
The consultation, which closes July 8, also asks for views on other key corporate governance topics, including whether companies should set out their approach to audit through a published policy on which shareholders would vote; whether shareholders should have a formal opportunity to propose to the audit committee where the auditor should focus more closely; and whether to establish a new set of enforceable principles for corporate auditing.