Casting the net wide on regulation: many more companies, auditors and directors will be caught by the BEIS proposals

19 March 2021

Auditors, business leaders and interested observers have been eagerly awaiting the proposals of the Secretary of State for Business, Energy and Industrial strategy (BEIS) on audit reform. The BEIS proposals, entitled “Restoring trust in audit and corporate governance” were published 18 March 2021 . Responses to the consultation are requested by 8 July 2021. The proposals contained within the consultation document are extensive, wide ranging and potentially onerous for individuals and entities either running or auditing companies in the UK. We are considering the proposals in full, and members of Kingsley Napley’s Accountancy Advisory and Corporate teams will be preparing analysis and commentary on the various aspects of the proposals shortly.

I have been following the developments in the audit market, from a regulatory perspective, with interest. The results of Kingsley Napley’s recent survey of Managing Partners of the top 50 accountancy firms showed that there is a widely held belief that some form of audit reform is necessary. What remains to be seen is whether those who would be most affected by the proposals agree with the proposed extent of the widening of the regulatory net in the UK. Will this restore trust in audit and corporate governance, as is intended by BEIS, or will it simply have a chilling effect on directors and mid-tier firms?  Aspiring directors may think twice about whether taking on a board leadership role is worth it; the mid-tier audit firms which should ostensibly benefit from the proposals may want to consider carefully what the risks and benefits are of either entering into the PIE (Public Interest Entity) market, or taking part in a managed shared audit.

Let’s consider a couple of the proposals to assess the anticipated widening of regulation in the UK.

Expansion of the PIE market
Leaks to the press over the last few weeks have alerted the industry to the potential for the PIE market to be extended beyond the current definition, which largely focuses on listed companies, credit institutions and insurance undertakings. Under the BEIS proposals, the PIE market may be extended to incorporate a much larger array of companies, which fall into two possible categories:

Proposed option 1 is that the definition of a PIE could potentially also include large (non-listed) companies which have more than 2,000 employees; or a turnover of more than £200 million and a balance sheet of more than £2 billion.

Proposed option 2 would include in the PIE market large companies with both over 500 employees, and a turnover of more than £500 million.

Under option 1, approximately 1,960 entities would be brought within the definition of a PIE, whereas with option 2, around 1,060 additional entities would be caught by the definition.

The impact on the companies which would potentially fall within those categories is quite significant.  There would also be an impact for those companies’ auditors. If the first option was adopted, it is anticipated that around 90 additional audit firms would be brought into the scope of the new regulator ARGA’s regime (as they would then be auditing a PIE). Under the second option, 20 additional firms would be brought into the scope. These numbers are significant, where it is estimated that currently only 30 firms carry out PIE audits (many of which are in relation to companies with listed debt, which are of relatively low risk).  Under either scenario, audit firms which previously may have opted to avoid the PIE market, given the additional regulatory scrutiny it attracts, may now be caught in the regulator’s net.

This may be a timely opportunity for firms which could fall under that widened category to consider their future plans carefully. Now is a time for reflection on whether they wish to embrace the new potential regime and the additional regulatory requirements that it may bring; or whether their appetite is too conservative. I would hope that the former category would apply, as given some preparation, and effective collaboration with the regulator, firms should be able to operate efficiently and effectively in this market, if their systems and processes can withstand any additional regulatory scrutiny.

Increase in competition in the PIE market
One further headline of the BEIS proposals is the intention for managed audits to be enforced in relation to FTSE 350 companies. There is currently a monopoly at the top level of the audit market, with the ‘Big Four’ firms carrying out 97% of those audits. Mid-tier firms trying to break into this market have thus far found it extremely difficult to do so.

The BEIS proposal is that there will be a ‘managed shared audit’, which would see an audit firm appointed to lead the group audit, for which it bears the overall liability.  When tendering the statutory audits of entities within the group, companies would be required to appoint a ‘Challenger firm’ to conduct a meaningful proportion of the statutory audits.  This certainly seems sensible in seeking to promote competition and experience in this market. The proposals suggest that there should be a gradual introduction to these large and complex audits, to allow mid-tier firms to upscale over a period of time. The ultimate aim is for the mid-tier firms to become able to successfully tender to carry out the full group audits in their own right.

The CMA’s initial proposals that the large leading firm and the smaller mid-tier firm should have joint and several liability for the audit has been rejected by the Government, given the significant risk that this would impose upon the mid-tier firms. Instead, it is suggested by BEIS that the Challenger firm would be liable for its share of the audit (which might be in relation to one of the relevant subsidiaries) but would not be joint and severally liable for the main elements of the audit. Any work performed by the Challenger firm would, however, fall within the scope of the regulator’s audit quality review regime.

We will consider the proposals in more detail, but, on a first view, although this seems like a golden opportunity for the mid-tier firms who have been struggling to access this market, some may still feel reluctant to enter into a world where the consequences of a failure in the audit can be so severe. If something went wrong on an audit, a Challenger firm might not only face a regulatory sanction (which can be quite significant in relation to PIE audits), but also potentially a sizeable costs order, which can be difficult for one of the Big Four, but might be more difficult to bear for a firm with lesser means.

I hope that mid-tier firms will address these concerns within their responses to the consultation, and the regulatory regime of ARGA can reflect the fact that competition might be stifled if regulation is too overbearing for those mid-tier firms. A two-tier regulatory system may not be effective, however, there has to be some latitude for mid-tier firms who are learning and developing: audit standards must be maintained, but there has to be a balance with also seeking to encourage competition in the audit market.

The implications for directors
There were rumours prior to these proposals being published that directors may be more in the spotlight to uphold standards across the UK business sector. These rumours have proved to be founded. The current FRC regulatory regime only applies to regulated accountants; the BEIS proposals extend responsibility and liability to all directors sitting on boards in PIE entities. The Government intends to legislate to provide ARGA with the necessary powers to investigate and sanction breaches of corporate reporting and audit related requirements by PIE directors.

The proposals and suggestions by BEIS are detailed and more full commentary on them will follow.

Conclusion
The implications of the BEIS proposals are significant, not just for those in the audit profession, but also for those who currently sit, or had planned to investigate the possibility of sitting, on a board of a company.

The views of those in the industry are vital to ensure that the impending legislation is, fair, reasonable, fit for purpose and has the desired effect of restoring trust in audit and corporate governance. I implore those affected to read the consultation paper in full, and respond by the deadline of 8 July 2021. We at Kingsley Napley will be carefully considering the proposals, will be discussing the proposals with our contacts and will be providing our views from working with and assisting firms and individuals in the audit industry.

These are interesting times in the corporate and audit worlds. Just how wide the regulatory net is cast will now depend upon how BEIS responds to feedback and the final details of the statutory changes.

FURTHER INFORMATION

Should you have any queries regarding the issues raised in this blog please contact Julie or any member of our Regulatory team.

 

ABOUT THE AUTHOR

Julie Matheson is a Partner in the Regulatory team, specialising in advising accountants and accountancy firms on regulatory issues, particularly in relation to proceedings brought by the FRC, ICAEW and ACCA.  She also advises senior public finance officials on their roles and responsibilities under the Local Government Act 1972.

 

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