New regulator will have sharper teeth, but may soon have more on its plate.
A core part of UK government proposals to improve the quality of audit, the introduction of the much-anticipated Audit, Reporting and Governance Authority (ARGA) is expected to finally give investors clarity and confidence about the financial health of investee companies.
“ARGA will have the power – simple as that,” Peter Swabey, Policy and Research Director at the Chartered Governance Institute (CGI) of the UK and Ireland, told ESG Investor.
ARGA is set to replace current UK audit watchdog, the Financial Reporting Council (FRC), next year following criticism of its limited remit.
“The FRC has been criticised for the way it has regulated the audit profession in the past, but it simply doesn’t have the power to penalise offenders, unless they happen to be accountants. In many cases, the only thing it can do is issue a public statement. ARGA will be better able to hold companies to account,” Swabey said.
The imposition of a new regulator is part of the UK government’s wider plan to implement audit reform. Despite concern that audit reform was at risk of being excluded from the Queen’s Speech earlier this month, a draft bill was included within the supporting papers issued alongside the speech.
The draft audit reform bill outlines the government’s intention to provide new measures to “open up the market” for audit services and reform the regulation of insolvency practitioners to give greater confidence to creditors and strengthen the corporate governance of firms. However, many details remain to be finalised.
The bill further noted that a response to the audit reform consultation published by the UK Department for Business, Energy and Industrial Strategy (BEIS) in March 2021 will be “published shortly”.
“Some may argue introducing ARGA through draft legislation means it is effectively kicked down the road for another year or so. Others would argue this means a parliamentary committee can be formed to go over the draft with much more scrutiny, resulting in a better bill when it is presented in Parliament,” said Swabey.
Poor quality audits have resulted in a number of corporate scandal headlines – most notably companies such as Carillion and Patisserie Valerie. On the former, Big Four accountancy firm was recently fined £14.4 million by the FRC due to providing the watchdog with misleading information as part of its audit quality reviews for the company. The FRC is separately investigating KPMG and former Carillion directors over the auditing of 2016 accounts.
Swabey argues that a new regulator with sharper teeth and greater powers can improve the quality of traditional audits and ensure firms and their auditors handle arising challenges.
In April, the FRC published its three-year plan toward establishing ARGA in its place, considering how and when it will need to increase its capacity to adapt to new powers and responsibilities.
A high-quality audit should provide investors and other stakeholders with assurance that financial statements give a transparent view of the company’s performance and governance, with audit firms demonstrating their ability to conduct robust risk assessments and due diligence.
The importance of audit quality is only going to increase as investors demand more information about sustainability-related risks and impacts in line with mandatory requirements.
Prior to COP26 last year, a group of asset owners and managers wrote to COP26 President-Designate Alok Sharma to urge governments to set a timeline for the introduction of net zero accounting and auditing.
Ashley Alder, Secretary General of the International Organisation of Securities Commissions (IOSCO), also previously said auditors will increasingly be required to verify companies’ reporting of ESG risks against the International Sustainability Standards Board (ISSB) disclosure standards.
Asset owners are outlining their expectations. In its 2021-2022 voting policy document for this AGM season, UK pension scheme Railpen warned it would vote against the audit committee chair or auditors if investee companies do not appropriately incorporate material information about climate-related issues into their financial statements.
“There is an ‘S’ component as well,” said Swabey. “Companies have the privilege of limited liability. If they go bust, shareholders and managers can effectively walk away from their debts, as the debts stay with the company which is then liquidated. In return for this privilege, we as a society have a right to expect a reasonable amount of attention is paid to keep proper accounts and ensuring a high-quality audit, so that society doesn’t have to pick up the tab.”
Ahead of ARGA’s establishment, last year the FRC published two reports outlining the parameters of high-quality audit and assessing the current standard of auditing in the UK.
The ‘What Makes a Good Audit?’ report noted that there are six key attributes audit firms should implement in their risk assessments, including quality monitoring, information and communications, and quality risks.
The ‘Developments in Audit’ report said that audit quality remains “mixed and inconsistent”, with 33% of 147 reviewed audits requiring improvement or significant improvement.
Ultimately, investors “want to be able to be clear on what they can rely on and what audits are telling them”, Swabey said.