True Transparency: reforming the Audit Industry

At a time where Brexit is causing market uncertainty and Britain is creating new global alliances, the transformation from a failing Financial Reporting Council (FRC) to a more powerful and diligent Audit, Reporting and Governance Authority (ARGA) couldn’t come soon enough. A strong and competitive audit market is vital to the UK’s business framework, safeguarding its position as a global power in accounting services.

The Government announced on the 11th March that it would be creating a new, enhanced regulator to transform the audit and accounting sector in response to an independent review led by Sir John Kingman. The review is currently subject to government consultation, and in its response to the Department for Business, Energy & Industrial Strategy (BEIS), the government stated ‘good progress is already being made on some of the recommendations’.

The call for change comes off the back of numerous audit failures and sub-standard financial reporting. For example, KPMG, one of the UK’s four largest accountancy firms, managed Carillion’s accounts since 1999, and approved its figures in March 2017. Four months later, the firm issued its first profit warning. The review is in response to how KPMG and others failed to spot warning signs before numerous British businesses collapsed. Professionals within the audit industry welcome the reorganisation, recognising the need for change. ARGA will have a new mandate, new leadership and more stringent powers set down in law.

ICAEW’s Technical Strategy John Boulton says: “The expectations of investors and other stakeholders have increased in the last few years, and the purpose, scope and practice of audit need to keep pace. We welcome the prospect of ARGA’s implementation as a strong regulator for audit.”

The key differences between ARGA and the FRC include:
1) ARGA is a statutory body, meaning it will be authorised to address changes, instead of needing to act through the court. This will lead to greater transparency
2) ARGA will set high standards of statutory audit, corporate reporting and corporate governance, holding organisations and professional advisers to account
3) Unlike the FRC, ARGA will regulate the biggest audit firms directly
4) ARGA will promote a change of culture, rebuilding the trust of those it regulates
5) ARGA will possess greater sanctions including authority to call for fast explanations from offending companies

As ARGA will have the power to investigate company directors, it will have the autonomy to deal with corporate negligence. Currently the FRC can only investigate company directors if they are also registered with an accounting body. UK governance has been self-regulated up until now, so moving governance of auditors out of the hands of those linked to the firms is a clear indication that things are changing.

The current FRC CEO Stephen Haddrill states “The FRC’s Plan, published in May, sets out a clear pathway towards the establishment of an enhanced authority, with stronger powers and greater resources, as quickly and effectively as possible. Ahead of full implementation of the Kingman proposals, the FRC will do all in its power to promote transparency and integrity in business, and improve audit quality, corporate governance and investor stewardship.”

Sir Jon Thompson, currently CEO of HMRC, will take over as CEO, initially of the FRC and then of ARGA, and GSK’s former CFO Simon Dingemans has been appointed chair. The Review recognised that the FRC had some strong points, like its active custodianship of the UK Corporate Governance Code, but it was largely very critical, describing it as “a rather ramshackle house, … built on weak foundations”. Boulton reveals what industry professionals now want to see from ARGA:

“It’s important that ARGA is set up to be a success. There are strong expectations that it needs to be more robust in helping to avoid the disorderly corporate failures that can result from having insufficient reporting information.

“We believe that its ambition and scope should be very carefully defined so that it’s not over-burdened when it’s implemented, while it’s acquiring the necessary resources and capabilities need to undertake all its proposed functions. So, we recommend that ARGA concentrates from the start on improving audit quality, governance and reporting.”

The new regulatory body aims to address the following flaws:

Power – The FRC’s powers were described as “clearly deficient”, while its leadership failed to make the case for greater powers and to shape the debate around audit
Sanctions and Enforcement – While it had a range of sanctions available to it, the FRC took “an excessively consensual approach to its work”
Independence – The FRC lacked independence because it was not on a statutory footing and didn’t have regulatory oversight over the firms who voluntarily funded it
Appointments – There were flaws in its appointment processes, which meant that its Board and Council were “largely self-perpetuating”, and often reliant on “the alumni networks of the largest audit firms” and “inappropriately informal” recruitment methods

However, things are looking clearer and more transparent, and a government spokesperson told Accountancy Age: “The Audit, Reporting and Governance Authority will build on the UK’s status as a great place to do business and will form an important part of strengthened public trust in businesses and the regulations that govern them.”

The FRC report for 2018/19 highlights the work it has undertaken to begin its transition into the ARGA, notably increasing its enforcement resourcing by 25% and establishing the Investor Advisory Panel to complement its existing stakeholder outreach activities with investors. The audit regulator also plans to revise the UK Corporate Governance Code and consult on an overhaul of the Stewardship Code. Stricter guidelines have already taken shape, and figures released by the FRC show that total fines imposed on auditors in 2018–19 almost tripled on the previous year, from £15.5m to £42.9m.

Coming into 2020, auditors will face a much tougher atmosphere when their work goes wrong. Accounts need to be accurate, reliable and trustworthy, and the future of the audit sector is currently under the microscope. The recommendations have been made, so it is now down to the industry to see them through.