The UK’s corporate governance landscape continues to evolve, but frustrations grow over slow progress and a scaling back of the reforms.
A significant milestone was reached in May with the publication of the government’s response to the Department for Business, Energy and Industrial Strategy’s consultation white paper, Restoring trust in audit and corporate governance.
This 197-page document sets out the government’s plans for action with a broad range of high-level proposals to strengthen the UK’s audit, corporate reporting and corporate governance systems. The aim is twofold: to restore public trust in large businesses and to reinforce the attractiveness of UK capital markets.
The primary legislation required to set up Arga was not included in the current legislative programme
Long-awaited reforms
These long-awaited reforms combine recommendations from three independent reviews (the first, by Sir John Kingman, was finalised in 2018), with the main themes from more than 600 comments received during the consultation, which closed in July 2021.
Frustration at the slow pace has now been compounded as the government’s response does not set out a precise timetable for implementation. The proposals will be delivered over several years by a variety of mechanisms, including primary and secondary legislation and changes to the UK Corporate Governance Code. Most are unlikely to take effect before 2024.
There is also some concern that the reform programme has been scaled back. For example, far fewer companies will be brought under regulation than originally proposed. Also, ideas to introduce a ‘SOX-light’ governance regime in the UK, with directors personally liable for internal controls over financial reporting, have been dropped.
Missed opportunity
Sir Jon Thompson, CEO of the Financial Reporting Council (FRC), describes this as ‘a missed opportunity to improve internal controls’. However, the government wants the new regime to be proportionate, thereby reducing the costs of compliance. Given the many challenges that businesses currently face, this is understandable.
Dr Roger Barker, director of policy and corporate governance at the Institute of Directors, provides a measured summary. ‘These are welcome and necessary reforms that address some of the shortcomings in UK corporate governance exposed by the collapses of companies like BHS and Carillion,’ he says. ‘The government has probably struck the right balance in terms of which companies will initially be encompassed by the new regime.’
The government’s action plan will bring significant change to all parts of the UK’s business ecosystem. The main measures are summarised below.
Broader scope
The definition of public interest entities (PIEs) will be extended to include large private companies with both 750 or more employees and an annual turnover of £750m or more. AIM-listed companies, LLPs and certain third-sector entities will become PIEs if they meet the threshold test.
‘The most important feature of the proposed reform is the establishment of a new statutory regulator’
Around 600 new entities will be brought under regulation – less than originally proposed but a significant broadening of the UK’s corporate governance lens nevertheless.
Tougher regulation
The establishment of a new regulator, the Audit, Reporting and Governance Authority (Arga) to replace the FRC is confirmed. Arga will be accountable to parliament and will have a range of statutory responsibilities and powers that the FRC does not have. These include greater enforcement powers – for example, over directors of PIEs (executives and non-executives) for breach of directors’ duties relating to corporate reporting and audit. (See Jane Fuller’s comment, ‘Regulator must capitalise on new remit’).
Barker views Arga as essential. ‘The most important feature of the proposed reform is the establishment of a new statutory regulator, Arga, which will be empowered to respond to deficiencies in corporate reporting and audit in a more robust and timely manner than the FRC’, he says.
Primary legislation is required to set up Arga and this is delayed; the government failed to include it in its current legislative programme. Although a draft audit reform bill is scheduled for 2023, Barker is concerned that there remains ‘significant uncertainty around the timing of the legislation required for the reforms’. (See also Jane Fuller’s column, ‘Waiting for Arga’.)
Stronger internal controls
Measures to strengthen the UK’s internal controls framework will be introduced through the UK Corporate Governance Code. The FRC published a position paper in July, setting out how it will support the government’s reforms as it transitions to Arga, including an overhaul of the code and updated guidance notes.
The code’s provisions relating to internal controls will be strengthened by providing for an explicit statement from the board on the effectiveness of the internal control systems and the basis for that assessment. Audit attestation of the statement is not mandatory, though directors may feel that it is prudent to seek external assurance.
The revised code will apply to periods commencing on or after 1 January 2024.
These measures are directed at premium-listed companies rather than PIEs, although the government believes they will have wider application because the code is such an important influencer of governance best practice.
Mike Suffield, director of policy and insights at ACCA, welcomes the FRC’s position paper. ‘It’s a helpful document that begins to put some meat on the bones of the government’s proposals,’ he says. ‘On specifics, the proposed revision to the code will be pivotal.’
Audit and reporting
The government response confirms that a ‘managed shared audit’ regime is to be introduced on a phased basis for FTSE 350 companies, aimed at boosting resilience, competition and choice in the audit market.
To improve the available information about the risks faced by PIEs, the government will introduce legislation requiring:
- a new resilience statement
- a new audit and assurance policy
- a requirement for directors of PIEs to report on the actions they have taken to prevent and detect fraud
- new disclosures around capital maintenance and the legality of dividends (following guidance from Arga on the definition of realised profits).
