Audit and corporate governance review

Overview

Reliable corporate reporting is vital to well-functioning financial markets, business investment and growth. It enables all interested stakeholders to make an informed assessment of a company’s performance and governance. It helps safeguard investors, creditors, employees, customers, suppliers and the wider public from corporate mismanagement. High quality reporting by directors allied with robust and challenging external audit should give confidence to all those with an interest in a company’s activities, position and prospects. Corporate failure can happen but it should rarely be a surprise.

However, stakeholder and wider public trust in the credibility of directors’ reporting and the statutory audit has been shaken by a succession of sudden and major corporate collapses which have caused serious economic and social damage, including the insolvencies of BHS in 2016 and of Carillion in 2018. Alongside this, the audit regulator has in recent years found up to a third of audits carried out by the seven largest audit firms to be in need of improvement or significant improvement. There are also more long-standing concerns about a lack of competition and resilience in the statutory audit market covering our largest companies, and a perceived failure of the audit product to meet the growing expectations of its users.

To address these concerns, the Government commissioned three indepenent reviews in 2018: Sir John Kingman’s Independent Review of the Financial Reporting Council (FRC), the Competition and Market Authority (CMA)’s Statutory Audit Market Study and Sir Donald Brydon’s Independent Review of the Quality and Effectiveness of Audit. The FRC Review found that the existing regulator lacked the necessary powers and clarity of purpose to hold auditors and directors sufficiently to account and recommended that it be replaced. The Brydon Review concluded that statutory audit needs to become more informative, and that higher expectations should be placed on both directors and auditors to deliver more useful information to the users of reports. The CMA Market Study showed an unhealthy dominance of the statutory audit market for larger companies by a small number of audit firms and called for new measures to increase quality, competition and resilience in the delivery of audit.

The Government agrees with the findings of all three reviews, and thanks Sir John Kingman, Sir Donald Brydon and the Competition and Markets Authority for the rigour and depth of their analysis and for their detailed recommendations for change. The Government is also grateful to the Business, Energy and Industrial Strategy Committee of the House of Commons for its work on audit reform and the recommendations set out in its The Future of Audit report published in 2019.

Problems with corporate reporting and audit are by no means exclusive to the UK, as the recent belated discovery of a major fraud at German payments processor Wirecard illustrates. But there are problems here that the UK must address. Fundamental reform of the framework underpinning audit and corporate reporting is needed to rebuild public trust in the way our largest companies are run and scrutinised. The UK has long had a hard-earned reputation for high standards of corporate governance and robust protections for investors and other stakeholders. It is vital to making the UK attractive to international business and investment. If that reputation is to be maintained, and enhanced, we must act now to address the weaknesses and lack of accountability that the three reviews have highlighted.

Why your views matter

This Consultation sets out a package of measures aimed at improving the UK’s audit, corporate reporting and corporate governance systems. It includes views expressed in responses to initial consultations on recommendations made by the Independent Review of the Financial Reporting Council to create a new regulator responsible for audit, corporate reporting and corporate governance, and by the Competition and Markets Authority’s market study on the audit of Financial Times Stock Exchange (FTSE)350 companies. It also sets out proposals in response to the findings of Sir Donald Brydon’s Independent Review of the Quality and Effectiveness of Audit.

Through this consultation, the Government is seeking views on its intended reforms, both individually and as a whole. This includes looking for evidence on their likely impact and suggestions for how they might be improved. Your contribution would be greatly appreciated.

What happens next

The intention is for responses to this consultation to inform draft legislation that the Government will introduce to Parliament when Parliamentary time allows. Some of the proposed measures include the ability to set important details at a later date through secondary legislation brought forward for Parliament’s approval by the Government. Many measures not requiring legislation are being taken forward already by the FRC.

There is scope for auditors and others to take action on their own initiative while legislation is being developed, including action towards defining and developing a new audit profession.