UK business secretary Kwasi Kwarteng has launched a major overhaul of the UK audit sector, which aims to break-up the dominance of the Big Four and hold company directors of big business to account.
In a 232 page-long white paper, Kwarteng has set-out a series of reforms to the audit industry which aims to safeguard jobs, avoid company failures and boost the reputation of the UK as a destination for investment.
Reforms have been on the horizon for a couple of years, following a number of high-profile company collapses and a number of review into the audit market (The Competition and Markets Authority’s (CMA), the Brydon review, and the Kingman review).
The major proposals in the white paper are:
- Large companies would be required to use a smaller “challenger” firm to conduct a meaningful portion of their annual audit, watering down the supremacy of big-name auditors that put markets at risk whilst boosting jobs and growth of smaller audit firms across the country.
- The Big Four could also face a cap on their market share of FTSE 350 audits if competition in the sector does not improve.
- A new regulator, the Audit, Reporting and Governance Authority (ARGA), which could oversee the largest unlisted companies as well as those on the stock market, will also have the power to impose an operational split between the audit and non-audit functions of accountancy firms, to reduce the risk of any conflicts of interest that may affect the standard of audit they provide.
Kwarteng said: “Restoring business confidence, but also people’s confidence in business, is crucial to repairing our economy and building back better from the pandemic.
“When big companies go bust, the effects are felt far and wide with job losses and the British taxpayer picking up the tab. It’s clear from large-scale collapses like Thomas Cook, Carillion and BHS that Britain’s audit regime needs to be modernised with a package of sensible, proportionate reforms.
“By restoring trust in our corporate governance regime and encouraging greater transparency, we will provide investors with clarity and certainty, cement the UK’s position as the best place in the world to do business, and protect jobs across the country.”
Efforts to boost investor and public confidence in audit include:
- New reporting obligations would be introduced on 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.
- Audit will also be able to extend beyond a company’s financial results to look at their wider performance, including against key climate targets, to ensure investors and other interested parties are fully informed and can hold companies to account as the UK seeks to eliminate its contribution to climate change by 2050.
- The new regulator will be backed by legislation, funded by a mandatory levy on industry, and 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.
As part of the reforms, Kwarteng aims to make directors of the UK’s largest companies more accountable if they have been negligent in their duties:
- Directors of large businesses 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.
- Under the UK’s Corporate Governance Code, companies could be expected to write into directors’ contracts that their bonuses will be repaid in the event of collapses or serious director failings up to two years after the pay award is made, clamping down on ‘rewards for failure’.
- Large businesses would need to be more transparent about the state of their finances, so they do not pay out dividends and bonuses at a time when they could be facing insolvency. Directors would also publish annual ‘resilience statements’ that set out how their organisation is mitigating short and long-term risks, encouraging their directors to focus on the long-term success of the company and consider key issues like the impact of climate change.
Leaders of the reviews into the audit market provided comment on the white paper. Donald Brydon said: I welcome the Government’s consultation and am pleased that they have accepted the core principles and the majority of the recommendations of my 2019 Review. I would urge all participants to engage with the important detail in this paper. The need for progress on these reforms remains urgent.”
John Kingman said: “Since my 2018 report, much has already been done to strengthen regulation of UK audit, reporting and governance under new leadership at the FRC. The critical missing piece is to fix the regulator’s legal status and powers. I therefore very much welcome the Government’s consultation, and look forward to seeing this followed through with legislative action as soon as possible.”
CMA CEO Andrea Coscelli commented: We welcome the Government’s commitment to restoring trust in audit through these reforms. The consultation contains many good proposals, which reflect the CMA’s recommendations and – if they become law – will help improve the health and quality of the audit market.
“Ultimately these reforms must be judged on their results, so we are also pleased that the Government intends to take reserve powers to go further than the current proposals, if these do not deliver the deep change that is needed to fix this broken market.”