The Draft Audit Reform Bill – Does it go far enough?

What was your initial reaction to the Draft Audit Reform Bill following its publication in May? My initial reaction was one of disappointment that many of the measures previously discussed in the Kingman, CMA and Brydon reviews have been scaled back significantly from the original proposals. I accept that the draft Bill represents an important milestone and that some progress has been made, but it could be a missed opportunity to go much further. The announcement in the Queen’s Speech demonstrates that this is still on the Government’s agenda, but I question if it is a political priority. The reforms are unlikely to be implemented in legislation until June 2023 at the earliest. Further delays are possible when the main focus will be on the General Election in 2024. The main driver of the audit and corporate governance reforms was to restore and enhance society’s trust in the wider business community, following recent high profile corporate scandals and collapses. The current economic landscape will only increase risk and will heighten the risk of fraudulent behaviour making it even more important for our capital markets to have resilient and well-controlled companies. Despite the slow progress, it is encouraging to see many UK companies acting on some of the earlier ideas for reform. It has been widely accepted that enhancing internal controls over financial reporting is important and many FTSE 100 companies are focusing on this. In the light of proposals for directors of public interest entities (‘PIEs’) to report on the steps taken to prevent and detect material fraud, many companies, including Frasers Group, have already started assessing and improving their fraud risk framework. Do the proposals go far enough? Where does it fall short and in what ways could it go further? Many people were underwhelmed by the proposals, with UK lawmakers doing a U-turn on plans to create a tighter internal controls framework comparable to the US Sarbanes-Oxley Act, as well as the watering down of plans to widen the scope for companies subject to the tightest requirements. The importance of strong internal controls, particularly over financial reporting, was highlighted in the Kingman and Brydon reviews. I would have liked the Bill to go further in this respect and continued with one of the original proposals to introduce a UK SOX style regime. During my professional career as a Big Four audit partner I was always concerned about the audit expectations gap, balance and proportionality. The audit expectation gap is the difference between what an auditor actually does (and is required to do by legislation and auditing standards) and what stakeholders and commentators think that the auditors’ obligations might be and what they might do. The balance of responsibility and accountability in the corporate ecosystem is important and I feel that the scaled-back plans and the pace of change will result in this balance not being achieved. A managed shared audit requirement is a core proposal of the new Bill. What are the benefits of managed shared audit, and is this something that has been embraced at Frasers Group? The requirement would apply across the FTSE 350, giving those companies a greater choice of auditor. It would also offer audit firms an opportunity to gain exposure to statutory engagements and audit committees of the largest and most complex companies. However, there is work to do to make shared audits function well in practice. Without completely disregarding the use of managed share audits, the introduction of a market share cap would be easier to deliver, less disruptive and would achieve the objectives of reform in a shorter timescale. Some challenger firms have significant concerns that it will be difficult to deliver and could adversely affect audit quality. There are other barriers to challenger firms entering the market, liability and regulation arguably top of the list and, resource and capacity being a further consideration. If the government wants to make real and significant progress in making the audit market more resilient and open to new entrants, alterations to the liability regime, such as by mandating proportionate liability or introducing a statutory liability cap, should be given serious consideration. At Frasers Group we appointed RSM, who are a challenger firm, as our group auditor in 2019 and we are now in our third audit cycle. On their appointment we made it clear to RSM that we wanted a robust and challenging audit and we have been satisfied that they have delivered. The quality of their audit planning, approach and people has been of a high quality and the challenge provided and level of professional scepticism has been robust. In addition to RSM we do use PKF who audit some of our subsidiary companies which helps to de-clutter our year-end reporting timetable. How will the Bill’s planned redefinition of PIE benefit firms? Can you explain how expanding its definition will be beneficial? It was one of the recommendations of the Kingman Review that the Government should review the UK’s definition of a PIE to ensure that large businesses that are of public importance are subject to appropriate regulation. The Government is right to want to increase scrutiny for PIEs, in particular, some large private companies with employees, pensioners and suppliers who rely on them and would benefit from them being subject to stronger regulation. There are a number of entities not caught by the current PIE regime that have several thousands of stakeholders, dominate markets providing essential services, and operate infrastructure facilities. In those cases stronger regulation would be of public benefit. The proposed definition is too widely drafted, based primarily on quantitative measures, and would bring too many entities into scope and risk overwhelming the entire audit and assurance system. The audit sector is already capacity constrained following the latent demand that built up during the Pandemic with audit firms struggling to satisfy the demand for assurance services. The Government needs to be very careful not to extend the definition of a PIE too far. If this were to be the case, there is a risk of overwhelming the audit ecosystem, which could undermine competition and adversely affect audit quality. What other proposals within the Bill would be particularly beneficial for businesses and the future of audit? A key proposal in the Bill is the establishment of a new regulator, the Audit, Reporting and Governance Authority (‘ARGA’) to replace the FRC and ensure it is properly equipped with appropriate, targeted powers. A trusted and effective regulator is a pre-requisite for effective reform. The extended powers enabling ARGA to direct changes to reports and accounts will be a welcome change. This will enable issues of non-compliance with accounting and other reporting requirements to be dealt with more directly and efficiently. Having said this, ARGA’s powers need to be better targeted, for example, there is no good reason for introducing statutory regulation of individual chartered accountants. ICAEW already has effective oversight by a range of regulators. Another example is the proposed power for ARGA to require an auditor to take on an audit that could create a perceived conflict of interest if it has both the power of appointment and oversight. We must ensure that ARGA is a success and is respected by all stakeholders. Care must be taken to ensure that it does not fail through unnecessary extension of powers. It is important that ARGA recognises that the ICAEW is a world class organisation with 157,800 chartered accountant members in 147 countries. Do you believe this Bill was overdue? Should it have been put into motion before now? I do believe that the proposals in the draft Audit Reform Bill, which have been subject to extensive consultation, are long overdue. We cannot afford further delay, it is important that government ensures that momentum is maintained in order to create a successful sustainable economy and resilient capital markets in these challenging times. Government cannot achieve this alone, they need all the key players - large corporates, audit committees, the regulator and professional bodies - to work together to make this happen. The Government claims that the reform proposed will finally restore confidence in big business. Do you agree with this claim and, if so, can you explain more about how it will do this? The Government’s objectives set out in the Bill to restore confidence in UK audit and corporate governance are clear and should be supported. The right challenges have been set to restore and reinforce the UK’s world-class reputation in corporate governance and the ecosystem of professional services. The key word here is ‘reinforce’ which the Secretary of State uses in his foreword and it is important that the focus is on strengthening rather than rebuilding. All interested parties need to work together with government, business, the audit profession, and the new regulator to address weaknesses, while enhancing the international competitive advantages of UK businesses, capital markets and professions. In the ICAEW’s road map for reform it sets out five steps for rapid action, which in my opinion are right on the money. These are: Step 1. Set up ARGA and focus it on encouraging improvement in corporate reporting and audit Step 2. Make directors accountable for high standards of internal control. Step 3. Reinforce the core audit with targeted action on fraud and resilience. Step 4. Legislate as soon as possible to introduce the Audit and Assurance Policy. Step 5. Equip ARGA to deliver robust corporate reporting reviews. The recent high profile corporate scandals and collapses have been a wake up call and following Brexit and the Pandemic our leadership position in capital markets and professional services has never been more vulnerable. Debates and consultations need to be replaced with a coherent and well-structured implementation plan. We need to demonstrate clearly that we can work together proactively to achieve the necessary reforms. Does Frasers Group believe that the reform will have a positive lasting effects for business? Within the retail sector we have experienced a number of corporate collapses, some whereby we have been an investor and we have been openly critical of the management and regulation of those businesses. At Frasers Group we welcome the Draft Audit Reform Bill and the proposed reforms aimed at restoring trust in audit and corporate governance. Having said this, my main concerns are implementation and pace of change, the high level principles are sound but, the Bill does not include a plan or timescale setting out how and when the policies will be implemented. Answers by Richard Bottomley OBE FCA, Chair of Audit and Senior Independent Non-Executive Director at Frasers Group Plc