UK audit shakeup: Big Four face FTSE client caps, new watchdog and a clampdown on directors
Big Four dominance in the UK audit market may be diluted under new plans announced today that would see stricter regulation of the sector and executives at major firms.
The government hopes the proposals, published in a consultation today by the Department for Business, Energy and Industrial Strategy (BEIS), will lead to greater transparency in the sector, as well as more robust and rigorous audits of the UK’s largest firms.
The consultation also confirmed the creation of a new watchdog, the Audit, Reporting and Governance Authority (ARGA), which will take over from the current Financial Reporting Council (FRC) and will have the power to impose an operational split between the audit and non-audit functions of accountancy firms.
ARGA will be funded by a mandatory levy on the industry, and given stronger powers to enforce standards.
Where a serious problem occurs, for example, ARGA will be able to order companies to go back and redo their accounts without having to go through the courts.
Audit firms have come under increasing pressure in recent years following accounting scandals and administrations such as Carillion and Patisserie Valerie that undermined public and investor confidence in the sector.
Business secretary Kwasi Kwarteng said: “Restoring business confidence, but also people’s confidence in business, is crucial to repairing our economy and building back better from the pandemic.
“When big companies go bust, the effects are felt far and wide with job losses and the British taxpayer picking up the tab. It’s clear from large-scale collapses like Thomas Cook, Carillion and BHS that Britain’s audit regime needs to be modernised with a package of sensible, proportionate reforms.
“By restoring trust in our corporate governance regime and encouraging greater transparency, we will provide investors with clarity and certainty, cement the UK’s position as the best place in the world to do business, and protect jobs across the country.”
The consultation will run until 8 July.
Clampdown on ‘rewards for failure’
Proposals around making directors of the UK’s biggest companies more accountable if they have been negligent in their duties, including fining, suspending or even clawing back the bonus of directors, were also included in today’s consultation.
Directors of large businesses could face fines or suspensions in the most serious cases of failings – such as significant errors with accounts, hiding crucial information from auditors, or leaving the door open to fraud.
Under today’s proposals companies could also be expected to write into directors’ contracts that their bonuses will be repaid in the event of collapses or serious director failings up to two years after the pay award is made.
According to BEIS, large businesses would need to be more transparent about the state of their finances under the proposals, so as to not pay out dividends and bonuses at a time when they could be facing insolvency.
Directors would also publish annual ‘resilience statements’ that set out how their organisation is mitigating short and long-term risks, encouraging their directors to focus on the long-term success of the company and consider key issues like the impact of climate change.
Big Four to share with challengers
In order to water down the supremacy of the big-name auditors, the government proposed large companies would be required to use smaller ‘challenger’ firms to conduct a “meaningful” portion of their annual audit of FTSE 350 companies.
The government said ‘meaningful’ would be defined and calculated with reference to one or more of the total audit fee (in the prior year), group revenues, profits and assets of the company, with the challenger’s proportion to be no less than 10 per cent of those criteria and preferably closer to 30 per cent.
‘Challenger’ firms – the likes of BDO, Grant Thornton and Mazars – audit FTSE clients, but they continue to be snubbed by FTSE 100 companies, which is dominated by the Big Four.
If shared audits do not make enough progress watering down Big Four dominance, the government will introduce a market share cap.
The details of the market cap are yet to be worked out, but today’s BEIS report said there would not be a numerical or percentage market share cap applied to any single audit firm, rather ARGA would review the pipeline of FTSE 350 audit tenders and reserved a proportion of them for challenger firms.
Audit failure ‘not an abstract problem’
Audit will also be able to extend beyond a company’s financial results to look at their wider performance, according to today’s proposals, including against key climate targets, to ensure investors and other interested parties are fully informed and can hold companies to account.
Minister for Corporate Responsibility Lord Callanan said: “Audit failure isn’t an abstract problem, it has real life consequences. Thousands of jobs have been lost in the wake of collapses like Carillion, and many more lives impacted, while wider confidence in big business is undermined.
“Auditors and rogue directors who have been asleep at the wheel must be held accountable. So, as part of our plans, we will look to ensure the new regulator is fully equipped to take action where serious lapses have occurred.”