Reporting intelligence white paper 05/ Making sense of governance and reporting regulations.
This is the fifth paper in our series of white papers that explore the challenging landscape of corporate governance and reporting, focusing on the implications to those preparing annual reports for listed companies.
In this paper we will focus on the future of audit, monitoring and enforcement following the recent Kingman and Brydon review.
In this paper we will focus on the future of audit, monitoring and enforcement following the recent Kingman and Brydon review.
Following a string of corporate failures and scandals, as part of its package of initiatives to reform corporate governance and reporting, the Government commissioned two key independent reviews in 2018 and 2019; the Kingman Review focused on the FRC and the Brydon Review focused on audit. Alongside these reviews, the CMA undertook a statutoryaudit market study of competitiveness and the BEIS (the Department of Business, Energy and Industrial Strategy) Select Committee launched an inquiry into the Future of Audit.
The future of monitoring and enforcement
The Kingman Review headed up by Sir John Kingman, chairman of Legal and General since 2016, involved a root-and-branch review of the FRC with the view of making the regulator a beacon for the best in governance, transparency and independence. The Review was performed during 2018 with Sir John publishing his conclusions and recommendations in December 2018.
The Review made 83 recommendations but acknowledged that many of the FRC’s shortcomings are largely due to a weak statutory footing, leaving the FRC with limited powers that were mismatched to what is expected of them.
The ultimate outcome of the Kingman Review will be a tougher regulator with much stronger statutory powers to monitor compliance and enforce against misconduct, albeit that it will take a number of years to fully implement. The FRC has been subject to a huge amount of criticism and scrutiny, and questions have been asked, perhaps somewhat unfairly, as to why it allowed so many high-profile corporate scandals and failures to happen in recent times. That heightened scrutiny will continue and the new leadership of ARGA, the Audit, Reporting and Governance Authority, will be expected to deliver results.
Some recommendations that do not require changes to legislation have already been implemented. If all the recommendations are implemented, companies can expect the scope of monitoring reviews to increase to include compliance with the UK Corporate GovernanceCode, and to take place more frequently, namely every three rather than five years. ARGA will be expected to be far more transparent about its monitoring activity, therefore companies can expect any correspondence and the outcomes of any monitoring review to be made publicly available.
ARGA will also be given powers to intervene where it is in the public interest, directing companies to take action where concerns have been raised, for example compelling a company to commission a skilled person review or independent governance evaluation. Companies can also expect updated guidance and/or related enhanced requirements on internal controls, risk management, going concern and viability.
The scope of ARGA’s new enforcement powers will be widened to include all non-accountant directors holding posts as CEO, CFO, Chairman or Audit Committee Chair, compared to current powers which only relate to accountants. The speed of investigations will also be improved with most investigations being completed within two years.
ARGA will also be upping their engagement with the investor community and, coupled with the new and improved UK Stewardship Code 2020, companies can expect institutional investors to be more engaged in ESG and remuneration matters, and provide greater challenge.
Auditors will be under a huge amount of scrutiny from the new regulator and, therefore, companies can expect greater challenge from their auditors; a possible consequence of which may be that audits will require more time and effort, resulting in increased costs.
The future of audit
Concerns over the audit market are both widespread and longstanding. A string of high- profile corporate failures being associated with sub-standard audits, from Enron and Arthur Andersen in 2002 to Carillion and KPMG in 2018 and beyond, lead to BEIS (the Department of Business, Energy and Industrial Strategy) initiating a Competition and Markets Authority (CMA) statutory audit services market study, an independent review into audit quality and effectiveness through the Brydon Review and a BEIS Select Committee Inquiry into the Future of Audit.
At the time of writing (May 2020), no changes have been implemented as yet, however a lot of change can be expected in the not too distant future. The changes are likely to be far reaching, affecting all aspects of audit. Changes may affect the way the audit market operates, how audit firms are structured, how they are regulated, how they are appointed and how long they can stay appointed. The scope of the audits performed will probably widen and the way in which auditors report their findings; the language used in audit reports; when audit reports are published; mandatory attendance of auditors at AGMs will change.
The role audit committees, company directors and shareholders play in improving audit quality will be brought into sharp focus with increased responsibility and accountability expected from audit committees and increased reporting from directors.