Key proposals that relate to companies in the BEIS consultation on restoring trust in audit and corporate governance.– part two
We look at the key aspects for companies of the BEIS consultation on restoring trust in audit and corporate governance.
BEIS has published its long-awaited consultation on restoring trust in audit and corporate governance. The consultation paper runs to 230 pages and the consultation will remain open until 8 July 2021. The key proposals that relate specifically to companies are set out below.
Public interest entities (PIEs)
PIEs are the focus of most of the proposed new regulatory measures relating to audit, corporate reporting and corporate governance. Two options for expanding the extant PIE definition are set out, both of which would expand it to include the largest private companies. Views are sought on other types of entity that could be included in a new PIE definition, including third sector entities with a public benefit purpose.
Views are sought on the following three options, which are not intended to be mutually exclusive:
(i)company directors should be required to carry out a review of the effectiveness of their company’s internal controls each year and make a statement, as part of the annual report, as to whether they consider them to have operated effectively. The statement should disclose the benchmark system used and explain how the directors have assured themselves that it is appropriate to make the statement;
(ii)the audit report should describe the work the auditor is already required to do to understand the company’s internal control systems to the extent needed to perform the audit, and to state how that work has influenced the audit, but without a formal auditor opinion on the internal controls’ effectiveness being required; and
(iii)the auditor should be required to provide a formal opinion on the directors’ annual attestation about the effectiveness of the company’s internal controls, potentially limited to key internal controls over financial reporting, or a sub-set of that.
The chapter sets out a tentative preferred option which would require a directors’ statement about the effectiveness of the internal controls, but (unlike the US’s approach to internal controls which mandates external auditor attestation in most cases) leave the decision on whether the statement should be assured by an external auditor to the directors, audit committee and shareholders. The preferred option is not, however, intended to shut down discussion of alternatives.
Dividends and capital maintenance
The following reforms are proposed in relation to dividends and capital maintenance:
* companies (the parent company in the case of a group) should disclose the total amount of reserves that are distributable, or – if this is not possible – disclose the “known” distributable reserve, which must be greater than any proposed dividend;
* in the case of a group, the parent company should provide an estimate of distributable reserves across the group; and
* directors should state that any proposed dividend is within known distributable reserves and that payment of the dividend will not, in the directors’ reasonable expectation, threaten the solvency of the company over the next two years.
Resilience statement and audit and assurance policy
Views are sought on the following proposed new reporting requirements for directors of PIEs:
- an annual Resilience Statement, setting out how directors are assessing the company’s prospects and addressing challenges to its business model over the short, medium and long-term, including risks posed by climate change; and
- an audit and assurance Policy, describing directors’ approach (over a rolling three year forward look) to seeking internal and external assurance of the information they report to shareholders, including any external assurance planned beyond the scope of the annual statutory audit.
Proposals are included to:
- give the audit regulator investigation and enforcement powers in relation to wrongdoing by directors of PIEs; and
- strengthen malus and clawback provisions within executive directors’ remuneration arrangements.
The investigation and enforcement powers would apply to breaches of statutory duties relating to corporate reporting and audit of PIEs. They include the power for the regulator to impose more detailed requirements for how directors should meet these duties. The Government is also considering requiring directors to meet certain behavioural standards in fulfilling these duties.
The strengthened malus and clawback arrangements involve the identification of minimum clawback conditions which would apply in all cases and have a minimum two-year application period. These conditions could include clawback for serious misconduct, a material misstatement of results or an error in performance calculations and failures of internal controls and risk management. Subject to consultation responses, the Government proposes to invite the FRC to implement these stronger arrangements through changes to the UK Corporate Governance Code.
The Government’s proposals include:
- new obligations on both auditors and directors relating to the detection and prevention of material fraud.
The Government has also published an impact assessment, a summary of stakeholder responses to the Government’s initial consultation on the recommendations of CMA’s Market Study, and a summary of how each of the 150-plus recommendations of the Kingman, CMA and Brydon reviews is addressed either by the proposals contained in the consultation document or through action by the Financial Reporting Council.
Just prior to the publication of the BEIS consultation, ICAS published its vision exploring how various recommendations from the reviews might be combined to deliver a tapestry of reform which will recalibrate the corporate ecosystem of UK Public Interest Entity (PIEs). This paper also sets out our thoughts on how ARGA can help rebuild public trust by encouraging higher standards of corporate governance, corporate reporting and audit.