The proposals

The proposals are wide-ranging and detailed, but key impacts on companies and their directors include:

• New audit regulator. A new Audit, Reporting and Governance Authority (ARGA) will replace the Financial Reporting Council (FRC) and be given a broader remit and expanded powers. As expected, these powers will include the ability to impose an operational split on the audit and non-audit functions of the accountancy profession. However, the government also proposes to give ARGA wider powers in relation to companies and corporate reporting, including new investigatory powers (coupled with the ability to require 'rapid explanations', or even expert reviews paid for by the company), oversight of audit committees and new powers to enforce breaches of directors' corporate reporting and audit duties with fines and other sanctions.
• Reporting and attesting internal controls. To improve companies' internal controls, the government is considering a range of options imposing new reporting and attestation obligations on directors. Its preferred option is to require the directors to make an annual statement about the effectiveness of the company's internal controls. This is an acknowledged step in the direction of the US Sarbanes-Oxley regime, although, unlike the US approach (which requires external auditor attestation in most cases), the UK government proposes to leave the decision on whether the statement would also require auditor assurance to the board, audit committee and shareholders (except where there have been past failures). Coupled with ARGA's new powers to investigate and sanction directors, this could result in a significant increase in liability risks for directors.
• Dividends and capital maintenance. To give greater clarity on a company's ability to pay dividends, the government proposes to require companies (parent companies in the case of a group) to disclose their total amount of 'known' distributable reserves. Parent companies would also have to provide an estimate of distributable reserves available for passing up through the group, and any constraints on this. When proposing any dividend, the directors would have to make a compliance statement, incorporating their reasonable expectation that the dividend will not threaten the company's solvency in the next two years.
• Reporting on resilience, audit and assurance. Directors would be required to make an annual Resilience Statement that assesses the company's prospects and challenges to its business model over the short, medium and long-term (and incorporates existing going concern and viability statements, as well as climate change risks). Quoted companies would also have to publish an Audit and Assurance Policy, and submit this to a shareholder advisory vote. This would describe the directors’ approach (over a rolling three year forward look) to seeking internal and external assurance on the information they report to shareholders, including any external assurance planned beyond the scope of the annual statutory audit. The government suggests that companies should routinely consider risk and viability reporting, and the effectiveness of a company’s internal control framework, for possible additional assurance. Shareholders may also be given a formal opportunity to propose to the audit committee areas of emphasis to be considered within the auditor’s annual audit plan.
• New sanctions for director wrongdoing. ARGA would have new powers to investigate breaches of directors' corporate reporting and audit-related statutory duties, and to impose civil sanctions. These could include fines, reprimands, orders to mitigate, declarations of non-compliance and temporary suspensions from acting as a director of a PIE. The government will also invite the regulator to consult on changes to the UK Corporate Governance Code requiring executive director contracts to include stronger remuneration withholding (malus) and clawback provisions. These would apply for a minimum two-year period and could include clawback for material misstatement of results or an error in performance calculations, material failure of risk management and internal controls, misconduct, conduct leading to financial loss, reputational damage, or unreasonable failure to protect the interests of employees and customers.
• Audit committee and the managed shared audit regime. FTSE 350 companies would be required to appoint a 'challenger' audit firm to conduct a 'meaningful proportion' of the statutory audit in conjunction with a larger firm. The government proposes that ARGA would have the ability to monitor and enforce additional requirements for FTSE 350 audit committees in the appointment and oversight of auditors, and to take action against directors for breaches. The government is also consulting on whether the regulator should also be able to appoint an auditor where more serious problems exist with a company’s audits.
• Audit purpose and scope and fraud detection. Auditors would have a new duty to take a wider range of information into account in reaching their audit judgments, and in giving their opinion as to whether the financial statements give a 'true and fair view'. The government also envisages directors of PIEs having to report on the steps they have taken to detect and prevent material fraud, and auditors reporting on the work they have done to confirm that this report is factually accurate, to detect any material fraud, and to assess the effectiveness of relevant controls.
• Audit profession. Following on from the Brydon review, the government proposes a new, stand-alone audit profession supervised by ARGA, underpinned by a common purpose and principles – including a clear public interest focus – and with a reach across all forms of corporate reporting, not just the financial statements.

The consultation paper sheds some welcome light on the direction of travel for the government's proposed reforms, but concerns will remain about the additional compliance costs the changes will impose on businesses at an already challenging time. Once the legislation has been published, companies will need clear guidance on the new requirements and an implementation timetable that allows them to adapt and put in place new procedures well in advance of the new regime taking effect. In the meantime, there remains an opportunity to input into the scope of the new rules, and to articulate concerns (either online or by email).

Client Alert 2021-084