The department for Business, Energy and Industrial Strategy (“BEIS”) has announced that it is launching a consultation on wide-ranging reforms to overhaul the country’s audit and corporate governance regime in a bid to improve corporate transparency.

Following the collapse of a number of household names such as Carillion and BHS (prior to the onset of the COVID-19 pandemic), BEIS has announced a number of proposed new measures intended to break up the dominance of the big four accounting firms (KPMG, Deloitte, PwC and EY) (the “Big Four”), avoid company failures and maintain the UK’s reputation as a leading market to invest in.

Main proposals for the audit and corporate governance reforms

In summary, the most significant of the proposals for the audit and corporate governance overhaul are:

Audit Reforms

Under the proposal, large companies will be required to use smaller accounting firms to carry out a significant part of their annual audit. Furthermore, the Big Four would be required to make their audit processes more rigorous and could face a cap on the number of FTSE 350 firms they can audit if those enhanced processes do not go far enough. It is intended that these measures will reduce the supremacy of the Big Four that puts markets at risk whilst also creating jobs in and the growth of smaller audit firms.

Additionally, a new Audit, Reporting and Governance Authority is being set up to replace the Financial Reporting Council which currently regulates audit firms. The Big Four will also be required to operationally separate their audit and consulting business in order reduce the risk of any conflicts of interest.

Director Accountability

The proposals also seek to hold directors of the largest companies more personally accountable for a company’s failure if they have been negligent in carrying out their duties as a director. Directors of failing companies could face fines or suspensions in circumstances such as a company’s accounts being substantially incorrect or information being deliberately hidden from auditors. It is anticipated that this will face significant resistance from company directors who, although already bound by statutory and fiduciary duties, will not want to be personally responsible in circumstances where errors and risks were beyond their control.

Director/Shareholder Remuneration

Finally, under the proposed Corporate Governance Code companies could be required to include in their directors’ service agreement the ability for the company to clawback bonuses paid to directors in the event that the company collapses or is seriously mismanaged by the directors, for up to two years after the bonus has been paid. Such requirements are already in place in respect of banks, and the aim is to crack down on “reward for failure” in other companies too.

Companies would not be permitted to pay out dividends and bonuses if the company is facing or is likely to face insolvency.

The largest companies would also be required to publish annual “resilience statements” which would set out the risks faced by the companies’ businesses, including climate risks, in order to encourage directors to focus on the long term success of the company.

There is now a 16 week consultation period during which the proposals will be considered. The consultation will include asking businesses and the public for their views on a number of issues, including:

• whether companies should be obliged to set out their approach to audit through a published policy, on which shareholders would vote;
• whether shareholders should have a formal opportunity to propose to the audit committee where the auditor should focus more closely; and
• whether to establish a new set of enforceable principles for corporate auditing.

Following the conclusion of the consultation period, the government will decide whether to push ahead with the proposals in the form of primary legislation.