Changes to be navigated by Ecovis UK over the coming years

Primarily as a result of some high-profile corporate failures, several reviews are being undertaken to ensure that UK audits meet the needs of all stakeholders in future. The reviews being undertaken are as follows:

• Department for Business, Energy and Industrial Strategy Select Committee (“BEIS Select Committee”) – review on the future of audit
• The Competition and Markets Authority (“CMA”) – review on the statutory audit market
• Kingman Review – independent review on the future of the Financial Reporting Council (“FRC”)
• FRC review of the 2016 ethical and auditing standards
• Druckman Review – FRC review of the future of corporate reporting
• Brydon Review – independent review of auditing standards
• FRC review of the proposed revisions to the UK Stewardship Code

Most of these reviews are expected to be completed by the end of 2019 or early 2020 with clear guidance on the changes to be issued, but at the time of writing we have had an update paper from the CMA, the recommendations from the Kingman Review and the publication of the BEIS Select Committee report. Some of the key announcements are as follows:

CMA update paper

• operational split of the Big 4 which will require separate management, accounts and remuneration: a separate CEO and board for the audit arm, populated by a majority of independent non-executives
• mandatory joint audits, except in the case of the largest audits
• greater oversight of audit committees by regulators and shareholders
• increased oversight powers for regulators – replacing the FRC with a new body with increased powers called the Audit Regulation and Governance Authority (“ARGA”)
• review of the changes to the audit market to take place five years after implementation

Kingman review recommendations

• The FRC needs to be rebuilt from the ground up, with “a clear and precise sense of purpose and mission”.
• The FRC board and staffing need an overhaul, with its current approach to board and council recruitment “surprisingly, and inappropriately, informal”.
• The proposed new body, the ARGA, should receive statutory funding rather than rely on a voluntary levy from audit firms.
• The ARGA should maintain the remit of improving corporate reporting, but it needs to have an expanded role in addressing and discussing audit quality.
• It would not be “practical or desirable” for the ARGA to have “general responsibility” to prevent corporate failures, but it should keep an eye on market “warning signs” that companies may be at risk.
• Introduction of a “duty of alert” for auditors to report “viability or other serious concerns” which is similar to the system in place in France
• ARGA to be given certain expanded powers, for example to be able to commission a “skilled person review”, paid for by the company, in which a suitable individual inspects a firm.
• ARGA to have the power to make recommendations to a company’s shareholders that they take action such as cutting dividends or firing senior staff, in “serious cases” where “the severity of the facts” merits an intervention

BEIS Committee recommendations

• full structural separation (not just operational) of the Big 4 audit businesses
• segmental market cap to increase competition
• piloting of joint audits
• more frequent audit rotations of seven-year non-renewable terms, with a cooling-off period of three years if there is an operational split of the Big 4 audit businesses
• backing of the Kingman Review recommendations
• ARGA should make graduated findings mandatory and Sir Donald Brydon should consider extending the scope of audit to cover the entire annual report.
• FRC to remind directors and auditors of their duties urgently and impose severe sanctions for breaches in respect of capital maintenance and accounting for distributable reserves

The recommendations have met with mixed responses from the profession and it is likely that there will be changes and developments over the coming months. But what is clear is that change is coming and it is time to embrace the change and find the opportunity.

Author

Stuart Hinds, Audit and Advisory Partner, ECOVIS Wingrave Yeats, London, UK

Email: stuart.hinds@ecovis.co.uk