Watch the recording: Reforming the UK's corporate governance, audit and reporting regime

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57:16

Hemione Hudson speaks to BEIS officials about the Government’s recent consultation on reforming the UK's corporate governance, audit and reporting regime.

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Hemione Hudson:

Good morning everyone and welcome to today's event. For those I haven't met before, I am Hemione Hudson, PwC’s UK Head of Audit, and I'm delighted to host the discussion today on the BEIS consultation, restoring trust in audit and corporate governance. It's a subject that's very close to my heart and has been the focus of a number of reviews over the last few years. I certainly welcome the comprehensive consultation, bringing together so much, and looking to set out a plan for the future of corporate governance in the UK. The consultation deals with more than 150 proposals for consideration, and the proposals focus on a number of aspects of corporate governance and reporting and certainly not just auditing. Over the next hour, we will very briefly summarise the main points, and then have a discussion, prompted by the questions we've received in advance, or that you pose in the session. Given the number of people that we have on the event today, we are using a live stream format, so you can enter your questions in the bottom of your screen. Please keep them coming, and thanks to those who've already sent through questions. I know a number of you attended our event in February, when we were joined by Sir John Thompson, the CEO of the FRC, who outlined the proposals and took questions. Today, we are focusing on the government's perspective on the proposed reforms. Unfortunately, we do have a late change to our speakers, as you will be aware, we are in a period of national mourning after the death of His Royal Highness the Duke of Edinburgh on Friday. Normal practice is that members of the government conduct only essential business in public during a period of national mourning, and for this reason, Lord Callanan is unfortunately unable to join us as planned this morning. However, I am delighted that I am joined by Mark Holmes and Andrew Death, Deputy Directors for BEIS, who will share the Government's perspective on the proposals and answer any questions you may have. They are the BEIS officials responsible for writing the document and responding to the consultation. I know you're all keen to hear what they have to say and to share your views and questions. I am also joined today by Gilly Lord, who many of you will already know. She's PwC’s Head of Audit Strategy and Public Policy. Let me first hand over to Gilly, to provide a brief overview of the main themes coming out of the BEIS consultation, so we all have a common understanding before we get into a discussion. Gilly, over to you.

Gilly Lord:

Thanks Hemione, and good morning everyone. This topic of reform to reporting governance and audit in the UK has been hotly debated for a very long time. As you all will remember the current round of debates was catalysed at least in part by the collapse of Carillion. That prompted the government to commission an independent review of the FRC carried out by Sir John Kingman. After that, the Competition and Markets Authority, formed a market study at the large company audit market. Then we had a third independent review, led by Sir Donald Brydon, which looked at the quality and effectiveness of the audit product itself.

There has already been a tremendous amount of work involved, but the consultation we are looking at today marks a real watershed moment, because what government has done here, is pulled together a policy package, informed by all three of those independent reviews by much more besides into a single package of proposals. Inevitably, this gives rise to a huge document. Those of you who have tried to print it out will know that it is a mighty 232 pages long, and it contains more than 150 recommendations. Hemione has given me a slightly unenviable task of trying to summarise all of that in a few minutes.

On my first slide, which hopefully will come up just now, you'll see that I thought I'd start off by sharing this quote from Kwasi Kwarteng, as you know, he is the Secretary of State for BEIS. This quote comes straight from the forward of the consultation. He wants to ensure that investors can get high quality focused reliable information on UK companies, so that investors can invest here with even greater confidence, and these are plans to strengthen the UK’s audit and corporate governance framework to empower shareholders, which will help companies to build that stronger and better equipped to face tomorrow's challenges and enable the UK to remain a premiere global centre for investment. For me that's a really good summary of the policy objectives that government has brought in mind with this consultation.  I am sure Mark and Andrew will tell us more about those objectives later. What I think is particularly important about this quote is that it's absolutely clear that these reforms are designed to improve reporting, audit, and corporate governance, and to empower shareholders. There's something here for everyone. It's really a system-wide approach to reform. Now, what I've done on the next slide, which I will turn to now, is pull out some of the headline recommendations from the consultation. Please do bear in mind that this is by no means complete, I definitely can't do justice to 232 pages on a single slide, but this is my selection of some of the really important elements.

I will kick off by talking about a proposal that's actually not on this slide, but which underpins everything, and that's the creation of ARGA. ARGA, the Audit Reporting and Governance Authority, will be the new regulatory body that government proposes will be the successor to our current Financial Reporting Council, FRC. But to call it the successor of the FRC, vastly underplays how important this new regulator will be. What we have in ARGA is a new regulator with statutory powers, that set standards for corporate governance, the reporting for audit, supervise and monitor the implementation of those standards, and if necessary, to enforce against anyone who breaches those standards. That's very different from today's FRC, which actually have quite a limited power over anyone outside the auditing and accounting professions. If ARGA is created as contemplated in this consultation, we can certainly expect a much larger regulator, with the potential to wield a lot of power over corporate UK, but that's really a radically different regulatory regime than the one most companies face today. If I look now at the left-hand column of the slide, what does the consultation contemplate for directors and obviously these are the areas which will be most relevant to you today. Let's start off and look at director’s accountability. The consultation proposes for directors and public interest entities, and I am going to come back to that definition later, should have very clear responsibilities for corporate reporting and governance. If things go wrong, that they should be held accountable to not meeting those responsibilities. What that could mean in the future, is that the next time we have a big corporate scandal, we could see ARGA take high profile enforcement action against directors. The next treat in store for directors is a regime which will ask directors to attest to the effectiveness of internal control over financial reporting. Sometimes this is referred to as UK SOX as of course the US already have a similar regime which came in via the Sarbanes Oxley Act.

A really important point to focus on here, is that though government have made their support for this type of regime very clear, the exact details of what the regime will entail, what will be covered, what directors would have to do to make the attestation, whether or not audit would be required, all of those details are still very open. Consultation responses in this area will be particularly important as there is an awful lot of shaping of the regime left to be done. Moving down the list, and very relevant to audit committee members, who are joining us today, the consultation suggests that the role and responsibilities of audit committee should be strengthened with the introduction of minimum standards for audit committees, and the ability of ARGA to monitor and supervise how audit committees are keeping to those standards. Again, we see this theme of a move towards a more intrusive regulatory regime for directors.

Then the final headline in this column, which I think is a really interesting idea, is the suggestion audit committee should publish an audit and assurance policy. The idea here is that each year, a public interest entities audit committee, which sets out exactly what assurance is or isn't being commissioned over the entire annual report and other corporate information. Then our shareholders for an advisory vote on that policy, very much in the same way that shareholders currently vote on the remuneration policy. For those of you in the audience who like me might be audit geeks, you'll know that when you look at today's annual reports, the audit report covers the financial statements, but not much else that's in the annual report. By suggesting this audit insurance policy, I feel that government is trying to do two things. Firstly, make it absolutely clear, which corporate information is and isn't subject to audit, but secondly to get shareholders and other stakeholders to really engage in discussion with the company's audit committee about how much extra assurance might be needed over and above the financial statements audit.

An example, maybe, of how this could work in practice, might be if a company was thinking about its new TCFD disclosures on climate risk. In the audit and assurance policy, the audit committee of that company would need to set out if they decided to commission any assurance over those TCFD disclosures, and if so, how much assurance and from whom. Moving on to the right-hand column of my slide, I've set up here the big proposals and document that could have an impact on auditors. The first one, I am sure you will be interested in as well, and that's the proposal to introduce managed shared audit regime for the FTSE 350. Now, the objective here is to increase the number of audit firms, who compete at the very top end of the UK audit market. This is a view that one of the barriers to entry for that market for so-called challenger audit firms, is that they don’t have the right experience and therefore credibility of working with top tier audit committees. Under a managed shared audit scheme, FTSE 350 companies would be required to either just go for it, and appoint a non-big four auditor, or if they did want to appoint a big four auditor to sign their group accounts, the company would also have to ensure that a meaningful proportion of the audit effort was done by a non-big Four auditor. That smaller auditor would then report the big four auditor, who would rely on the challenger firms work in signing the overall group opinion. Some of you might remember here that the CMA, a couple of years ago now, suggested a different remedy in this area, which went one step further, so they recommended joint audits of FTSE 350 companies.

Under a joint audit regime, you'd actually have two different firms finding the group audit opinions, so two different names at the bottom of the audit opinion. Under the BEIS proposal for managed shared audit regimes, you’d only have one firm, one overall firm signing the group audit, but relying on another firm for a meaningful proportion of the work. There were two other proposals have listed there, which are of great interest to those of us who are auditors. Firstly, there's a requirement for the largest audit firms to become operationally separate. That means that the audit practices within those firms have to become somewhat separated from the rest of the firm in terms of governance arrangements, and other elements as well. Now that's something that the FRC has actually already sought to introduce voluntarily and said the largest four audit firms are already working towards a form of operational separation. Finally, there is a proposal in the consultation document that in the UK, we should have a brand-new profession, the profession of corporate auditors. The idea here is that whereas today we have a professional accountants some of who might be auditors as well, in the future, maybe we will need auditors, who can give assurance over a whole range of risks, which actually might have nothing to do with accounting or financial reporting, the climate risks, cyber risks, all sorts of things. Government is therefore suggesting that we need a separate profession that anyone who wants to be an auditor, whether or not they are an accountant. Now there is an italicized line at the bottom of my slide, which is really important. As I've gone through those headlines, a few times I've mentioned public entities, and most of the proposals in this consultation document ultimately will apply to public interest entities, even if implementation is quite gradual.

A really critical proposal in the document is that the definition of public interest entities should be changed and expanded. Companies which could be included in the definition in the future include large AIM companies, and also large private companies, and the proposal is that any such new PIE would be subject to all of the existing rules applying to PIEs like mandatory audit firm rotation for example, as well as all of the new requirements that this consultation brings in. One last point to cover before I draw back. The single most common question that I get on this whole consultation is about timing. So, Gilly, just tell us when is this actually going to happen? Unfortunately, the answer is that the consultation doesn't precisely tell us that. We've got Andrew and Mark with us today and they may be able to share some more views on likely timing of implementation, but what I would say, having gone through the consultation really carefully, is that If I think through the steps that need to happen before we get to implementation. I would say, ‘well, first of all we need to go through this consultation process of course that runs until July. Government then need to go through a legislation drafting process, that legislation needs to get in front of parliament. All of that needs to happen before anything can become law. There is obviously quite a lead time there. My best guess is that the very earliest that any of these changes could start happening is 2023, but the consultation document is also very clear that many of the changes impacting companies are going to be introduced very gradually thereafter.

Hemione I'm going to stop there, because I've got my eye on the clock and I know I'm nearly out of time. Now we should hear from the people who actually wrote the consultation, hoping they are not going to point out too much that I got wrong. Hemione, hand back to you.

Hemione:

Thank you very much Gilly and thank you for getting us through a huge amount in a short period of time. Yes, without further ado, Mark, why don't I bring you in to give us the government perspective on the proposals. Mark, over to you.

Mark Holmes:

Good morning and thank you very much for having us at this session this morning, and indeed for convening so many people to discuss the white paper on restoring trust in audit and corporate governance. Thank you to Gilly for doing such a great job of explaining a lot of the substance of the proposals. It forced me to present a bit of an overview as to what the government is seeking to achieve through these proposals, where they came from, and what it is we are really dealing with. As Gilly hinted at in the beginning of her comments, although this came from a couple of corporate scandals that happened three or four years ago, it needs to be seen in the context of where we are now with the economy. From the government's perspective, this whitepaper is very much about economic growth, about supporting recovery from the economic effects of the pandemic and looking forward as part of the government's plan for growth, which was published with the budget.

The UK has long been a magnet for the international investment really, that's partly because the UK has a skilled labour force, it's partly about a competitive tax environment, it's partly about the UK’s approach to better regulation, but it's also about a long built reputation in corporate governance, and in the strength of audit practice in the UK. Those two together give everyone that confidence that what large companies are saying about their performance and their prospects and can be trusted. That makes a difference to not just to shareholders, but to suppliers, to customers, to pension holders, and to the whole economy. That underpins the strength of the UK as a global capital market. That’s what the government is seeking to achieve through these reforms. Given that events such as the collapse of BHS and Carillion, and other sinks, have illustrated some potential weaknesses in the UK’s environment and systems. As Gilly explained three independent reviews have looked at the systems, looked at what happened, and came up with over 150 recommendations to improve the way things work.

The reviews themselves undertook a lot of engagement in the process of that work, gathered views from outside. The government consulted on both the FRC review by Sir John Kingman and the Competition and Markets Authority, market study in the course of 2019. These proposals have had a long gestation with a lot of input from, I am sure many people on the call, and interested parties and the experts all over the economy, but it is now formulations as Gilly said into a holistic package of government proposals for change. To a large extent they are pretty specific, we are very long way from the consultation that was conducted in 2019, which was asking people what they thought of the recommendations. This is much more an emergent. the government proposes to do this. Do you agree, can you see unintended consequences that we would need to be mindful of and what are the impacts in real life is going to be, because the people who are dealing with these at the sharp end will understand those better than people like me. In some cases, the whitepaper presents alternative options and the government is seeking to weigh up the pros and cons of those. The breadth of the three reviews has given us a rare opportunity to look at the whole system. The whitepaper presents proposals that would affect investors, proposals that would affect companies, and their directors, and their audit committees, auditors and the audit profession, and the regulator, the transformation of FRC into ARGA as Gilly has explained. That kind of change will take time. I’ve got no argument with any of Gilly’s comments about timescale. I am not in a position to tell you when the government will be able to legislate. Most of these proposals would require legislation, would require a bill to go to Parliament, bills take time to develop and take time to pass.

But if you were after a broad indication, then I suppose probably the best thing to point you to is that the FRC's published strategy for the current year makes a planning assumption out of necessity that ARGA will be up and running and will succeed the FRC in April 2023. Is only a plain assumption, but is based on some understanding of how quickly these things might come in. But the white paper itself also contains a good deal of discussion in chapter one, that some of the proposals will have quite an impact on corporations, and on directors, will take some time to think through and therefore may require some lead time. There's discussion in the whitepaper that perhaps some of the proposals should be brought in sooner than others, that there may be opportunity to face them in. For example, there are suggestions in a couple of places that it may make sense to introduce new requirements on premium listed companies first and on other public interest entities later, and potential exemption from some more all of the requirements from newly listed companies, so that growing companies that are seeking a public listing for the first time don't suddenly become subject to all of the requirements on public interest entities. Nevertheless, this is very much about large companies. The definition of public interest entities at the moment is about listed companies, and a good number of financial services firms. As Gilly has explained the whitepaper proposes to expand that definition to include the largest private companies and larger AIM listed companies.

There are two suggestions in the whitepaper for exactly what the definition of large should be, and the consultation is also open to other suggestions, but it's safe to say we are talking about companies with revenues in the hundreds of millions of pounds and employing hundreds if not thousands of staff. This is about reform of a large company end of the market, because public interest entities are, what they say on the tin. They are companies of the size of the scale and an importance to the economy, that means, there is a public interest in their disclosures and in their success or failure, and indeed we've seen that with some of the failures in the past. I am sure we will get into much more detail in the question and answer session, but I hope these introductory comments have given a sense that this is about strengthening the UK’s system in corporate governance and audit to sustain and build on the UK strength as a global capital market. As it says on the front cover to restore trust in audit and corporate governance. I look forward to discussing further in Q&A.

Hemione:

Thank you very much Mark. It's certainly a very comprehensive document and clearly articulates how you and the team at BEIS alongside the FRC have thought about all of the recommendations and how they might fit together. I can see and everyone who has read it can see that there is a huge amount of work have gone into it, and a lot of thought. I am going to start by trying to pull together some of the questions, we've had lots of questions in, at the sort of more macro level and themes that have come out and then we will go through some of the more detailed areas. We've obviously had quite an unprecedented year since the last of the reviews was completed, the Brydon review was completed. Understandably other priorities have taken first priority. As we get back on track as an economy, what is the government's appetite for significant reform in this area, and how will you stop it overburdening companies with additional cost at what is already a very challenging time?

Mark:

That’s a very fair question. The Secretary of State has been very clear in his comments that firstly one of the reasons why the consultation is open for 16 weeks is to recognise that this is a difficult time for companies and indeed for auditors grappling with the impacts of the pandemic, but also that this is not about bringing in change tomorrow at a time that really wouldn't be appropriate. It will take time anyway. When the legislation has gone through, the government will consider carefully, which elements to bring in at what time and what is appropriate, and that's the word that the Secretary of State has kept coming back to, that the timing for introduction of these measures needs to be appropriate. We are talking about measures that affect the largest companies, which I would expect to be in the best position to accommodate this kind of change, but at the same time, as I said earlier, it will take time to adapt, and the lead time will be needed, and will need to be clear about how all of that works. For our costs involved in these kinds of proposals, the government has been clear about that by publishing an impact assessments alongside the white paper. It doesn't come up with a single figure, because this is a broad package of proposals and it's not yet clear exactly what the shape of the whole package will be, because it's a consultation, but there are some significant numbers in there, and particularly attached to the proposals that might need to be given the longest lead time, but there are also some real benefits which are sadly as ever harder to quantify, but if trust can be restored, and the degree of information and quality in corporate reports can be improved, then I think there will be benefits of that to the whole system, which will ripple through to companies as well as all of the other stakeholders involved.

Hemione:

Yes, thank you, we've had a number of questions that actually about the kind of cost and proportionality of it, and some questions about the impact analysis and what's the estimated cost for the average FTSE 350 company. I’d be interested in any thoughts you have on that. There's also some questions about what will this do in terms of preventing high corporate failure, does it go, will it address the issue that has been outlined around corporate failure, and a question that's come in around SOX in the US, and how it has influenced companies flowing into chapter 11 and what analysis has been done around that. Essentially does this actually move the dial on corporate failure and that's something is a bit of a concern actually, is that all of these responses, whilst they will also absolutely will improve the quality of corporate reporting and auditing. I can't see that they will prevent corporate failure, because corporate failure is a part of the market economy, so interested in your thoughts.

Mark:

That’s absolutely right, the corporate failure is part of the market economy and is sometimes unavoidable. At the same time, it shouldn't usually come across as a surprise, where previous corporate failures have suggested that there may be weaknesses in the systems. The reviews that looked at those circumstances have come up with recommendations, which have led to proposals in the package. The whitepaper includes measures, for example, on fraud with additional responsibilities for both directors and auditors on internal controls as Gilly explained and I am sure we will get into in more detail. On quality of corporate reporting, on regulation and transparency of audit, and audit quality reviews, there is a quite a number of proposals in the whitepaper that respond to some of the criticisms and suspicions we've heard about previous instances. It's not going to stop corporate failure. Will it reduce the risk of unnecessary and sudden corporate failure, it looks as though it should do all other things being equal. I am not going try and read a crystal ball. I am sure corporate failure will continue to happen, but it's a delicate balance which, Sir John Kingman tried to steer also in his review of the FRC, in judging how far the regulator ought to be trying to avoid corporate failure, at the same time as recognising that at the end of the day, it can't. As with all of the things in the consultation views, welcome on that point, but that's the government's intention to reduce the risk, but certainly not to avoid.

Hemione:

Thank you. Let's look at some of the specific areas now. Moving to internal controls, you talked a bit about the internal controls. Looking at the consultation, it looks like the proposals apply to all of the board, so the executive and non-executive members. We had a number of questions about is that appropriate, what is the role of a non-executive going forward, how can they meet their obligations, and do we think that therefore the role of the non-executive director remains attractive?

Mark:

Yeah, I can see that’s a salient and central question. The government is very clear that directors play a vital role in shouldering the legal responsibility for running companies, and it is apparent that in the vast majority of cases they do that very well, and conscientiously. It is a significant responsibility to hold in one of the largest companies that we're talking about. Those roles come with legal responsibility, and those legal duties in the Companies Act are the foundation of the proposals in the whitepaper for regulatory enforcement of those duties. To a large extent, it's not really anything fundamentally new that the whitepaper is proposing in that space. It seems to me that non-executive directors, who are fulfilling their duties conscientiously and carefully, have nothing really to fear from that, because it's the same principle of collective responsibility around the board table for the corporate reports and accounts that companies publish as we've had in statute for decades. The internal controls regime, I recognise does add another layer to that. In terms of the attractiveness of roles, I hope that by doing what it says on the front cover, by restoring trust in the system, the package of proposals will help to make the role of non-executives perhaps more visible, and perhaps in some respect more valued as a way of making sure that the company is following the practice, is doing all of the things it needs to be doing, and is being entirely honest and transparent in what it publishes to its shareholders, to its suppliers, its customers, its workers, and everybody else within interest. Particularly the role of the audit committee where, as Gilly mentioned, the proposals involve a strengthening of the role of the audit committee, and some additional degree of scrutiny coupled with that.

Hemione:

Okay. Thank you. It's often been referred to as a SOX light regime or a UK SOX regime, so I think it’d be interesting to understand your thoughts on how does this compare and contrast to the rules in the US and how do we make it proportionate in the UK? The impact assessment looks at the annual cost, and it seems quite low compared to experience in the US from an annual basis. So, I am interested in, do you think this is a SOX light regime, or is this SOX as we had experienced it in the US before the UK?

Mark:

The Sarbanes Oxley Act was brought in pretty quickly in the States after the collapse of Enron. It's a lot broader than just about attestations on internal controls, so let's be clear, we tried to avoid calling it SOX, because SOX is so much more than just this one little corner of proposals. But the problem that the US was dealing with at the time of Enron, is not the same as the problem we are trying to tackle in the UK now. On top of which the UK approach to corporate governance more widely is not the same as the one in the US, broader and slightly different makeup, and the underlying philosophy is a bit different. So, what the proposals in the white paper try to do is, draw on the lessons from the US experience, and understand what has worked, understand what it is about the US model that and a lot of audit committee chairs are quite attracted to and quite in favour of as found by both Sir John Kingman and Sir Donald Brydon and the comments they made in their reviews, and to find a way of fitting that comfortably into a UK context, but it does not just propose a single approach. There are three separate options in the consultation, and one of them is down as the preferred option. That's not intended to exclude other possibilities. It's one of the areas of the white paper that is a bit more open to views that's quite deliberate and the government will genuinely welcome thoughts on what would work best. So, at one end of the spectrum as an option, which would just involve requiring audit to sustain more about what they already see over the other company's internal controls regime. At the other end is something more like the US approach where directors have to sign off a statement about the effectiveness of the internal controls regime, and have it externally assured that the government's preferred option in the middle involves the statement but not a mandatory external assurance set, and that does make quite a difference to the cost, and that shows in the impact assessment.

Hemione:

Thank you very much. I'm keen to bring Andrew in now. Andrew, I wonder whether we could move to the accountability over requirements for audit committees in the new regime, I think we've had a number of questions in about what are the skills and make up that you're looking for audit committees in the future, and what indeed do you think that will be the primary responsibilities of the audit committee going forward?

Andrew Death:

Okay, thank you. I think the white paper sets out, what we're proposing around audit committees is to provide the regulator with additional powers to be able to oversee audit committees. We're not saying that every audit committee is wrong now or that there needs to be significant changes to the running of most audit committees, and the CMA in their review identified that there was a lot of really good practice in audit committees, and we want to make sure that is maintained. I think what we're looking for with the additional scrutiny or additional oversight for audit committees is to make sure that every audit committee is performing to that kind of standard and is holding the auditor to account, it is ensuring that they are getting effective scrutiny of their accounts and financial reporting so that shareholders and investors can be confident of what the auditor is saying, and all of that. I don't think that in the audit committee space we are looking at substantial change, what we are looking at is a series of controls that the regulator will be able to have if something is going wrong in audit committees. There was something that the CMA identified that some audit committees appeared to be valuing closeness, appeared to be valuing similar culture to the company, when they are selecting their audit firm. Now, some of that was a little bit of a misunderstanding from the CMA in terms of how audit committees work. It's right that audit committee should be looking at whether or not they can work with an audit firm effectively, and have a really robust relationship with the audit firm, when they are selecting their auditor, but what we don't want is audit committee selecting auditors on a chummy basis, and looking for auditors that are going to give them a light ride It's giving the regulator those oversight powers, so that if there are concerns around that, they have the opportunity to go in and actually review that.

Hemione:

Thank you very much. In this you’ve mentioned that the impact on auditors and their relationship with auditors, we've had a lot of questions in about managed shared audits, and whether this is really practical, and particularly some people are writing in about their specifics of where a large group for example has one significant entity and the document suggests that the way that you carve up the audit through managed shared audit is actually by allocating out subsidiaries, what if that doesn't really work? Another question in around investment trusts. There are lots of investment trusts in the FTSE 350 and how can these be subject to a managed shared audit regime? Very interested in your thoughts on those.

Andrew:

Okay. If I can take a little bit of a step back, in terms of what we're proposing to increase competition within the audit market what we identified, and what CMA identified was that there is a lack of capacity within the audit market, within challenger firms, and so that they don’t have sufficient resources at the moment to be able to take on some of the biggest audits, and they don't have the experience doing both. As well as potentially sort of a buyer bias towards a larger audit firm. So, what we’re trying to do with these proposals is address both of those issues, by providing a platform for smaller firms to be able to grow their business, in order to work, in order to grow their capacity, in order to be able to take on larger audit firms, as well as getting exposure to the group audit committee, in order to build reputation as well, and so therefore to change some of the buyer bias. Now, the shared audit proposal is going to be challenging to make work for every company and that is acknowledged within the document, that the ARGA will need to oversee this quite carefully, will need to have conversations with the audit committee when they are approaching tender to explore what components they can make available for challenger firms. There will be circumstances where it's not suitable for a challenger company, not suitable for shared audit. Those are going to be quite rare, and also as the policy takes effect and challenger firms are able to grow, they will become rarer even further, because whereas you said you've got a single large subsidiary within a group company. Once capacity in challenger firms has expanded sufficiently, that shouldn’t be a barrier for them to taking that on, but that is going to need to be managed and reviewed carefully. That's one of the things that we're looking for reviews on in the consultation as to how it can work and what some of the barriers may be, and the ARGA will be setting out guidance on that. What we are clear on is that the ultimate aim for this, for managed shared audit is to expand the number of audit firms that can take on an audit within the FTSE 350 on their own. We don't want managed shared audit to be a future permanently. Because what we want is to have a greater number of firms that can actually undertake an audit independently across the FTSE 350, but that's going to take time to build up.

Hemione:

Okay, that's helpful to understand that in your mind, it's a interim move to something else and in the document we've had a question in about it, it seems to indicate that it actually slightly unsure as to whether it will work and therefore there is this backstop reserve power if it doesn't work on sort of capping market share. Question goes on to say, is this really going to work given the international nature of audit. That links into another question we’ve had, which is around, how does this play out on the international stage, is the UK going to end up being isolated in terms of its approach to corporate reporting and governance, or will it be seen as leading?

Andrew:

Certainly, we are very keen for the UK to be seen as leading in this area and that's already been shown by the EU is very interested in what we're doing, so is the US, so is Japan. I think there's a lot of eyes on us at the moment, and we are very keen to make sure that, we are seen to be leading, we are shown to be leading. It's absolutely correct that the audit market and FTSE 350 is international. We are very keen to acknowledge that. One of the things that we haven’t yet determined, is whether under shared audit, the subsidiaries can only be UK subsidiaries or whether they can be international subsidiaries, because I think in order for an audit firm to be able to conduct many of these audits, they need to have their international base, actually having a challenger firm expanding their international base by taking on a subsidiary audit is valuable for the UK as well. Yeah, we are very open and aware that we need to be looking globally in this. Now, UK legislation can only apply to the UK, but given this is talking about group audits which are groups listed in the UK that is how that will apply.

Hemione:

Thank you, and Gilly, I'm going to come to you now. Audit and assurance policy, we've had a lot of feedback on the audit and assurance policy, and it's something that a number of non-executives have talked about, is this something they should be getting on with sort of now. I guess a number of questions have come in about what do we see this covering, will this really cover the whole of the annual report, and if so, who will be providing the assurance, a specific question in on do you see the audit and assurance policy covering the half year particularly, and a general question about, what is the next step for audit committees particularly they want to embrace it? 

Gilly:

Okay, let me try and tackle those Hemione. In terms of what the audit and assurance policy might cover, I should definitely start off and remind everyone, it’s a proposal, and I'm sure, Andrew and Mark would say it’s all subject to development. The way I think it could work is that an audit committee could look at the whole annual report and look at the different elements that we might refer to as the front part, the strategic review, climate disclosures, risk disclosures and set out, how or what assurance is in place to cover those. I think it's important to say and I think this is covered in the consultation document that assurance may or may not come from your existing external auditor, or it could come from other sources. It might come from your internal auditor; you might choose to go out and get a different external assurance provider. And so the idea would be that all of those different sources of assurance would be gathered and pulled together in a single document. Here is a good question. I don’t think that’s specifically dealt with in the consultation document, it would make lot of sense for audit committees to incorporate in half year and then the other interim results, and to make it clear to the outside world, what assurance they have chosen to commission or not over those results. In terms of next steps, I personally think it might be a useful exercise for audit committees to begin to have a discussion about what are the areas outside of the financial statements which are most important in their company's corporate reporting and that the outside world, most relies on and just ask themselves the question, how much assurance do we have over the quality of that information, do we think we need more, or are we absolutely all set. I think that would be a helpful first discussion to have.

Hemione:

Thank you, Gilly, and I'm conscious of time but Andrew I just wanted to come back to you because we've been talking about climate change and we've had some questions about climate change and the TCFD requirements, and the recommendations of this consultation and how they tie into what you're expecting to see on TCFD disclosures, particularly around kind of the resilience statement, for example where there is a suggestion of linking the two, but I'm interested in your thoughts on that.

Andrew:

Thank you. Yeah, there is another consultation out at the moment on introducing statutory requirements for TCFD reporting. That one actually closes on the 5th of May. So, there's a shorter time frame for that, and that is just using regulations, so what we're keen to get from that is to understand people's appetite for TCFD reporting, concerns for that around TCFD reporting, and how that will work. Now that's very much the first step with regards to climate related financial disclosures. We are working with the International Accounting Standards Board on their development of proposals around sustainability reporting standard, that they are working towards a moment, and they've just created a committee within the IAASB to take that forward. What we are wanting to do is to position the UK effectively so that we can both lead and be in a position to respond and join international work on climate related disclosures, because I think this is an area which anyone listening will know is going to be a significant element. It fits very well with the UK’s role in hosting COP-26 this year. Now, in regard to this consultation, what we have proposals within the white paper are around expanding resilience statement, around expanding what companies are reporting against as could have impact on their business and the resilience of that business. I think climate risk is very much a key component of that and I think what I'd like is when people are responding to the TCFD consultation they bear that in mind, and when they are responding to this white paper, they are bearing in mind the TCFD proposals as well, because I think they both fit well together.

Hemione:

Thank you, Andrew, yes brilliant, that’s absolutely right, let's bring them together. I’m conscious of time, but a final question for you Mark. Comment on ARGA, and the amount that is being asked of ARGA to oversee and to lead and how will the government ensure that ARGA has the appropriate skills and resources to be able to do everything that you are setting out for it?

Mark:

Yes, another fair question. The FRC has already made significant progress in transforming itself from the regulator it previously was, and is doing what it can subject to the fact that of course it doesn't have any new powers yet to position itself for transformation into ARGA and that set up quite clearly in its strategy for the current year which I've already mentioned, and it has been investing in the capacity and capability of some of its teams, very much in line with the recommendations of Sir John Kingman's review. The other thing to bear in mind in this context is, as I said earlier, not all of these proposals need to be brought in on the same day, when the legislation has eventually gone through, it may make sense, not just to switch on some of the requirements on companies at a later date than others, but it may also make sense to give ARGA some of its additional powers a little bit later, depending on how quickly it's been able to grow the capability of the team in the relevant area and develop the maturity and the outside confidence, that it’s ready to take on all of these additional roles. They are significant, they will need to be exercised with care and the governance of the regulator has also been changed in light of the recommendations of the review. So, there's a lot of work to do, and due credit to the leadership of the FRC for driving that forward.

Hemione:

Thank you very much, Mark and I think that's all the questions that we've got time for. I hope that you have all found that helpful. We had lots of questions in, and we will attempt to come back and think about how we take that forward. As a reminder to everybody, the consultation closes on the 8th of July, and I hope what you've heard, and certainly what I have taken away from talking to Mark and to Andrew who are after all those that are receiving the responses and will be processing and thinking all of that through. They are open to and really want to receive your thoughts and questions and comments. I would encourage everybody to think about responding.

 

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Hemione  Hudson

Hemione Hudson

Head of Audit, PwC United Kingdom

Sotiris Kroustis

Sotiris Kroustis

Partner, UK Head of Public Policy, PwC United Kingdom

Tel: +44 (0)7841 490928

Marco Amitrano ACA MCMI ChMC

Marco Amitrano ACA MCMI ChMC

Managing Partner & Head of Clients and Markets, PwC United Kingdom

Jayne Kerr

Jayne Kerr

Director, UK Public Policy, PwC United Kingdom

Tel: +44 (0)7740 241129

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