The Charter Institute of Internal Auditors (Chartered IIA) has penned a letter to the business secretary Kwasi Kwarteng raising its concerns that the government may considering “watering down” its proposed audit reforms.
The letter comes after recent speculation that the Government could be planning to change the original proposals it put forward in its audit White Paper for a strengthened internal control framework for financial reporting.
In the letter the Chartered IIA said it believes that audit reform is “fundamental” for the success of businesses and the wider economy and that “encouraging greater transparency will provide investors with clarity and certainty and help cement Britain’s position as the best place in the world to do business”.
It highlights one of the areas of concern is that of the plans for a strengthened internal control framework for financial reporting involving certification by company directors signing an internal controls statement.
It said that if the government was to deliver the proposal via the UK Corporate Governance Code instead of the intended legislation it “would not carry the same weight, opening up the possibility of evasion and make it more difficult for the audit regulator to enforce”.
The letter, signed by Chartered IIA chief executive John Wood, urges the business secretary to ensure that the Government delivers the “robust reform programme now needed to restore trust in audit and corporate governance”.
The full letter can be found below.
Dear Mr Kwarteng,
It was good to meet you and your officials for the introductory meeting we had earlier in the year.
Since we met, the Chartered Institute of Internal Auditors submitted our detailed consultation response to the Government White Paper ‘Restoring Trust in Audit and Corporate Governance’. Like you we believe that audit reform is fundamental for the success of businesses and the wider economy – encouraging greater transparency will provide investors with clarity and certainty and help cement Britain’s position as the best place in the world to do business. Indeed, we were encouraged when you made reform of audit one of your top priorities on being appointed Secretary of State.
One of the proposals that we strongly supported in our White Paper consultation response was for a strengthened internal control framework for financial reporting involving certification by company directors signing an internal controls statement, learning the lessons of the Sarbanes Oxley (SOX) regime in the USA. However, we are increasingly concerned by reports in the media that the Government may be looking to significantly soften and scale back its approach to this proposal, and we would urge you not to falter now. As originally proposed in the White Paper we believe it would be entirely appropriate for this requirement to be delivered via legislation – this would underline its importance and ensure it cannot be evaded. Delivering this proposal via the UK Corporate Governance Code, which is complied with on a comply or explain basis, would not carry the same weight, opening up the possibility of evasion and make it more difficult for the audit regulator to enforce.
We would observe that many of the corporate collapses linked to ‘external audit failures’ have also been characterised by weaknesses and deficiencies in the governance, risk management and internal controls of the audited companies. Stronger regulation of internal controls must therefore be a fundamental component of any effective audit and corporate governance reform programme.
We believe strengthening the internal control framework using certification, by requiring company directors to sign an internal controls statement, is likely to improve the reporting of control effectiveness. This is acknowledged as being one of the key benefits of SOX in the USA.
In the USA there are indeed fewer significant accounting restatements and a higher focus on greater clarity on the robustness of internal financial controls within an entity. Evidence from Audit Analytics shows, since the introduction of SOX, a reduction in the number of reissuance statements from accelerated filers in the US, from 460 in 2005 to just 29 in 2017.
By strengthening the internal control framework and improving the quality of reporting, this should in turn help to reduce the risk of corporate collapses linked to weak or deficient financial controls.
More reliable financial reporting and greater investor confidence in the corporate governance of British businesses, has the potential to decrease the cost of capital, by reducing the risk of corporate failure, making Britain an even safer place to invest.
Whether it is BHS, Carillion or Patisserie Valerie, the significant costs associated with corporate
collapses linked to job losses, audit and corporate governance deficiencies cannot be overstated.
Along with the proposals for a strengthened internal control framework, we also urge the Government to implement the proposal for companies to have an Audit and Assurance Policy. We further believe that putting the audit regulator on a statutory footing with the legal powers it needs to do its job properly should be front and centre of any audit reform programme.
As we have stated previously, we hope you will use your influence in the coming weeks to ensure that the Government delivers the robust reform programme now needed to restore trust in audit and corporate governance.
With the four-year anniversary of Carillion’s collapse fast approaching, it will also be essential that parliamentary time is found to implement the legislation in a timely manner. We would be very happy to arrange a further meeting to discuss these issues with you and your officials in more detail if you would find that useful.