Capital Quarter Summer 2019: Audit world set for a shake-up
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Service: Capital markets
These high-profile corporate crises have highlighted pre-existing concerns over audit quality and the need for robust reforms of the UK audit market.
In response to these failures, and the increasing awareness and scepticism of the public and media, there have been three separate reviews in the last 12 months.
After the collapse of Carillion, Sir John Kingman led an independent review into the operation of the Financial Reporting Council (FRC), the audit sector’s regulator. The review also considered auditor appointments and remuneration, particularly in major companies of public interest.
New regulator proposedKingman published his findings last December, setting out 83 recommendations for fundamental reform. Foremost is the idea to replace the FRC with an independent statutory regulator (proposed as ARGA – the Auditing, Reporting and Governance Authority). ARGA would be accountable to Parliament, with a new mandate, new leadership and increased powers and responsibility. The goal of Kingman’s recommendations is to establish an audit regulator with the resources and ability to identify and take early action to reduce the risk of corporate collapse.
‘Big Four’ split suggestionThe Competition and Markets Authority (CMA) published its final report in April following a formal market study into the audit sector. The report focused on concerns about inadequate choice and competition. It also highlighted the vulnerability of the sector because of its reliance on the ‘Big Four’ firms – which conduct over 95% of the audits of FTSE 350 companies. The third focus was on incentives for producing high-quality audits.
The CMA’s recommendations include an operational split between audit and non-audit services for the ‘Big Four’. Its aim would be to ensure professional scepticism was not hindered by potential conflicts of interest.
To open up competition in the sector and allow firms outside the ‘Big Four’ a role in auditing the UK’s major companies, the CMA has proposed a ‘joint audit’ regime. FTSE 350 companies would be audited by two firms, one of which would be outside the ‘Big Four’.
The CMA also proposes closer scrutiny of audit appointments so that those doing the appointing are held to account. There would also be guidelines to ensure they were independent enough to make such a decision.
Government responseIn response to both the Kingman and CMA reports, the Department for Business, Energy & Industrial Strategy (BEIS) has commissioned an independent review into the quality and effectiveness of the UK audit market. This review, led by Sir Donald Brydon, is ongoing and is expected to conclude by the end of the year.
It aims to consider how the audit product should be adapted in the future to serve public interest and expectations more effectively, by addressing the points raised in both reports as well as wider quality issues.
In a keynote speech the former Chair of BEIS, former Secretary of State Greg Clark, put forward suggestions for the evolution of audit. These included issuing graduated audit findings to develop a more informative audit, and a broader remit for audit to include a wider consideration of the effectiveness of a company’s corporate governance.
Appetite for reformAlthough there isn’t yet a definitive conclusion on the reforms or on changes to legislation relating to the UK audit market, it’s clear there is an appetite and intent for a fundamental shake-up of the sector.
Amid the uncertainty over Brexit, there is no better time to regain the lost confidence and trust in audit, in order to serve the public interest and strengthen the perception of the UK’s business environment.