Government Proposals for New Audit and Corporate Reporting Regimes
Tom Maple considers how the government’s proposed new auditing and corporate reporting regimes may impact companies, as further statutory requirements look set to be imposed on directors and auditors.
In March 2021, the Government published a white paper titled “Restoring trust in audit and corporate governance”. The white paper considers a reformed audit process, with a new regulatory body, new regulatory measures, and new obligations on company directors.
The Government is proposing to establish the Audit, Reporting and Governance Authority (“ARGA”) as a new regulatory body. The objective given for ARGA is “to protect and promote the interests of investors, other users of corporate reporting and the wider public interest”.
ARGA will regulate auditors, having responsibility for the approval and registration of firms and individuals as statutory auditors of Public Interest Entities (“PIEs”), while also having the power to impose requirements on audit committees and place observers on such committees. Significantly, ARGA will set the behavioural standards for directors, imposing sanctions where they breach their corporate reporting duties. Further, ARGA will be able to impose direct changes on company reports and accounts, and require rapid explanations from companies to investigate any issues with compliance in greater depth; they may also require an expert review, at the company’s expense, to explore any underlying causes of non-compliance.
The focus of most of the proposed regulatory measures are PIEs, which are already subject to a number of additional regulatory measures. Under the current definition, PIEs are predominantly publicly listed companies. However, the Government is looking to expand this definition to cover a wider group of companies, including the largest private companies. There are two options being considered for this wider definition.
The first would require the private company to have 2,000 employees or a turnover of more than £200 million and a balance sheet of more than £2 billion, to be considered a PIE. Alternatively, under the second definition, a private company would need over 5000 employees and a turnover of more than £500 million to fall within the PIE class. This change in definition is important to note, as your company may now fall within the PIE category for the purposes of the new auditing regime, imposing increased regulatory burdens on your directors. The more numerous auditing requirements, coupled with a greatly widened category of PIEs, should also substantially increase the workload of auditors.
As part of these new proposals, the Government intends to require PIEs to publish an annual Resilience Statement.
The Resilience Statement would have the directors set out their assessment of the company’s prospects and challenges over the short, medium, and long term. Directors would also be obliged to include at least two “reverse stress testing” scenarios, covering other resilience issues such as supply chain dependency, digital security and climate change risks. PIEs would also have to publish an Audit and Assurance Policy in which the directors would explain how they are seeking to obtain internal and external assurance of the information being reported to shareholders.
New Reporting Obligations
The new regime would also impose new disclosure and reporting obligations on the directors of PIEs. Directors would have to report on the effectiveness of their internal controls and risk management systems, although the white paper considers several options for how this reporting would work.
The Government’s current preference is to require a responsibility statement and explanation to be given by the entire board, without the need for mandated auditor assurance. Additionally, directors will be expected to report on the steps taken to prevent and detect any material fraud. Directors would also have to use the financial statements to disclose the company’s total amount of distributable reserves. An obligation would also be imposed on the directors to state that any proposed dividend is within known distributable reserves, that they have had regard to their duties, and that the payment of the dividend will not, in the directors’ reasonable expectation, threaten the company’s solvency over the next two years.
New Requirements on Auditors
New requirements are also set to be imposed on auditors. The white paper proposes a new corporate auditing profession, with a remit extending beyond financial statements to cover other types of information companies want audited. Auditors would also have new statutory duties to consider director conduct and wider information in reaching their audit judgments. Auditors of PIEs will need to report on the accuracy of the directors’ statements on steps to prevent and detect material fraud.
Shared Audits for FTSE 350 Companies
The Government also intends to introduce managed shared audits for registered FTSE 350 companies.
These companies would be required to appoint one audit first with overall responsibility for the group audit, along with a second “challenger” firm, which would be responsible for conducting at least a meaningful proportion of the group’s statutory audits. This might involve auditing a large subsidiary, or a collection of smaller subsidiaries.
The managed shared audit scheme is intended to reduce the concentration of market share among the large audit firms. However, if it is unsuccessful in this regard, the Government plans to allow ARGA to introduce a managed market share cap, requiring some FTSE 350 companies to appoint challenger firms for their next group audits.
A consultation on the white paper is running until 8 July 2021, with the Government accepting comments on the proposed changes until this time.