The government has launched a consultation on a series of wide-ranging proposals for reform of the UK’s audit and corporate governance regime in the wake of large-scale company failures such as Carillion, Thomas Cook and BHS.

Under the proposals, large companies would be required to use a smaller ‘challenger’ firm to conduct a meaningful portion of their annual audit, watering down the supremacy of big-name auditors that put markets at risk whilst boosting jobs and growth of smaller audit firms across the country. The Big Four could also face a cap on their market share of FTSE 350 audits if competition in the sector does not improve.

A new regulator, the Audit, Reporting and Governance Authority, or ARGA, would oversee the largest unlisted companies as well as those on the stock market, and would have the power to impose an operational split between the audit and non-audit functions of accountancy firms, to reduce the risk of any conflicts of interest that may affect the standard of audit they provide.

New reporting obligations would be introduced on both auditors and directors around detecting and preventing fraud, and audit will also be able to extend beyond a company’s financial results to look at wider performance, including against key climate targets, to ensure investors and other interested parties are fully informed and can hold companies to account as the UK seeks to eliminate its contribution to climate change by 2050.

Plans also aim to make directors of the country’s biggest companies more accountable if they have been negligent in their duties. Directors of large businesses could face fines or suspensions in the most serious cases of failings – such as significant errors with accounts, hiding crucial information from auditors, or leaving the door open to fraud.

Under the UK’s Corporate Governance Code, companies could be expected to write into directors’ contracts that their bonuses will be repaid in the event of collapses or serious director failings up to two years after the pay award is made, clamping down on ‘rewards for failure’.

Large businesses would need to be more transparent about the state of their finances, so they do not pay out dividends and bonuses at a time when they could be facing insolvency. Directors would also publish annual ‘resilience statements’ that set out how their organisation is mitigating short and long-term risks, encouraging their directors to focus on the long-term success of the company and consider key issues like the impact of climate change.

Responding to the proposals, CBI chief policy director, Matthew Fell said recent high-profile failures make a compelling case for overhauling the UK’s corporate governance and audit regime but that some of the proposed measures would take careful implementation to be meaningful.

“The UK’s reputation as a world leader on corporate governance is highly-prized and a vital part of what makes the UK an attractive place to invest and do business.

“The new audit and company reporting regulator, and a new audit profession should inject focus and momentum behind efforts to maintain the highest possible standards.

“Furthermore, an increasing emphasis on non-financial information, especially climate, will help provide a rounded view of firms’ performance; underscoring efforts to build back better.

“But many businesses are still to be convinced that mandating shared audits will get to the heart of the issues around rigour and quality, not just add complexity.

“It’s welcome that the government has thought carefully about directors’ accountability, rather than simply copying the more burdensome aspects of the US-style regime. Nonetheless these measures will require careful implementation to be meaningful without stifling entrepreneurial spirits.”

D&O

Law firm DWF said the UK’s plans were in line that of other countries and that the proposals would add further pressure to the D&O market. Partner and D&O insurance specialist at the firm, Andrea Scafidi commented: "This latest development is in line with a common trend that's impacted most of the European jurisdictions in the last few years. In fact, corporate executives are under the spotlight like never before, as they face an increasing range of exposures and claims scenarios.

"Not all of the proposed new UK regulations immediately increase exposure of insurers to coverage claims, to the extent that regulatory fines and sanctions are uninsurable by law, however it is undeniable that the costs of serving as a director are dramatically rising in the UK, as well as in other countries, and that these do not only include compliance-related costs, but also the costs of litigation and insurance."

Partner and deputy global insurance head at the firm, Matteo Cerretti added: "The profitability of the D&O insurance sector is also being challenged due to a number of factors, including increasing competition and rising levels of litigation, alongside to a general cultural shift to bring more D&O security claims both against individuals and companies. The increased number, severity and tail of claims has inevitably resulted in higher rates for D&O insurance being offered on the market."

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