Government response on audit and corporate governance reform consultation

The Department of Business, Energy and Industrial Strategy has published the response to its March 2021 consultation on audit and corporate governance reform, Restoring trust in audit and corporate governance (for further details, see our corporate update from March 2021). Most of the proposals contained in the consultation will be implemented, a number in modified form following feedback received.

The reforms will see the creation of the Audit, Reporting and Governance Authority (ARGA) as the successor regulator to the Financial Reporting Council (FRC). The ARGA will have a broader remit and significantly expanded powers as compared to the FRC.

The majority of the changes will impact public interest entities (PIEs), a concept derived from the EU Audit Directive (as implemented into UK law). The reforms expand the current UK definition of PIEs to include all UK incorporated companies (and groups) with both 750 or more employees and an annual turnover of £750 million or more (the 750:750 threshold). AIM companies and LLPs which meet the 750:750 threshold will also be PIEs under the reforms.

The wide-ranging reforms will introduce a number of fundamental changes to the corporate governance and reporting landscape. These include:

• Directors’ duties – The ARGA will be given the power to enforce breaches by directors of their duties in relation to audit and corporate reporting. All directors of PIEs (and in exceptional cases, directors of their subsidiaries) will be within the scope of this new enforcement power.
• Internal controls – The FRC will amend the UK Corporate Governance Code to require an explicit board statement on the effectiveness of the company’s internal control systems and the basis for that statement. This was one of the three options the Government consulted on to strengthen the requirements in relation to internal control systems – another of the options that is not being taken forward was a statutory reporting and assurance regime similar to the US Sarbanes Oxley regime.
• Dividends – PIEs meeting the 750:750 threshold will be required to explain their long-term approach to the return of value to shareholders and how that policy has been applied in the reporting year. Directors of these PIEs will also need to confirm the legality of any dividend proposed or paid in year. They will not need to provide a two year solvency statement prior to payment of any dividend, as had been proposed.
• Reporting – A number of changes are being introduced in relation to corporate reporting. These new reporting requirements will apply to PIEs meeting the 750:750 threshold.  They include:
  • replacing the existing UK Corporate Governance Code viability and going concern statements with a new statutory resilience statement, which will form part of the strategic report;
  • requiring the publication every three years of an audit and assurance policy (AAP), and an annual report on the implementation of the AAP; and
  • requiring directors to report on the steps taken to detect and protect against material fraud.

The Government has also confirmed a number of measures to reform the audit market and to amend the regulation of auditors.

The reforms will be implemented through primary and secondary legislation and amendments to the UK Corporate Governance Code. As a result, and in order to give companies time to prepare for the new regime, the reforms will be implemented over a number of years.

An easy snapshot of the reforms can be found here. We have also produced a more detailed briefing on the reforms, which can be found here.