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published on 3 november 2022 | reading time approx. 4 minutes
Following a consultation last summer, the government has announced that a new regulator, the Audit Reporting and Governance Authority (ARGA), will take over from the Financial Reporting Council (FRC). It will act as the lead body for local authority and health audits, audit market regulation and corporate governance regulatory enforcement.
Among the reforms included in the Consultation Outcome, councils will be mandated to form an audit committee with at least one independent board member. New regulations will be introduced for all public interest entities (PIE) and their directors.
These changes have been effective since September 2022, with a 'shadow' system implemented alongside FRC functions while the new regulator is established.
ARGA results from a long-running challenge, addressing issues such as audit transparency, reliability, quality and sustainability.
The developing new leadership and regulatory approaches are intended to prevent corporate failures, such as the collapse of Carillion (2,000 jobs lost with debts of £7 billion) or BHS (11,000 jobs lost with a pension deficit of £571 million).
As a statutory body, ARGA will have greater enforcement power and mitigate the overwhelming dominance of the Big Four; KPMG, EY, Deloitte and PwC. Those four audit firms currently handle 97 per cent of the listed audits related to FTSE 350 organisations.
The FRC fined KPMG £14 million following the failure of Carillion, relating to misleading information and forged documentation, as reported by The Guardian.
During the tribunal (alongside a separate investigation into the Carillion 2016 accounts audit), the QC representing the FRC noted that the case constituted 'extremely serious' misconduct and was against the public interest.
ARGA will have a remit to hold companies to account as a key component of the government efforts to tackle audit reform, open the audit services market, evolve the regulation processes for insolvency practitioners and boost corporate governance.
The published government response sets out some detail about how ARGA will function, including an objective of ensuring efficient functionality within the local audit system:
ARGA will be funded by the Department for Levelling Up, Housing and Communities with accountability to parliament and managed with governmental strategic direction.
The FRC currently has limited powers and has attracted criticism for its approach to regulating the audit profession. However, that has been hampered by the lack of enforcement measures available, with the only actionable option in many cases to issue a public statement.
The general purpose of ARGA is to advocate for the interests of corporate reporting, public interest and investors, with operational targets related to competition and quality.
Non-executive board members, including the chair, will be publicly appointed, with new powers to:
All directors of PIE will fall under the scope of ARGA, an expansion of the original proposal, which only incorporated key board members such as the CEO, chair, audit committee chair and CFO.
ARGA is designed to step in where directors have breached their statutory duties, such as:
If a breach is proven, ARGA will be able to apply a graduating level of sanctions based on the balance of probability when judging the outcome where the facts are disputed.
Potential sanctions include fines, orders to take action, compulsory declarations, or even the removal of the right to function as a PIE director.
The development of ARGA as a new regulatory body with greater powers and sharper oversight is incorporated within the FRC three-year plan, which addresses the need to increase capacity to introduce these new responsibilities.
Within the plan, the FRC sets out expenditure targets, expected costs and staffing requirements for 2022-23.
Objectives detailed within the plan act as a phased structure to support the implementation of ARGA:
Jon Thompson, the FRC CEO, says the body has made 'significant progress' and will 'continue to lay the groundwork for ARGA'.
ARGA's scope includes large private businesses within which there is a public interest, in terms of shareholders, employees and the UK economy.
Currently, the definition of a PIE within the context of ARGA is as follows:
Audit regulations are intended to be proportionate to the size and impact of the company, which means that PIEs just over the threshold and previously not considered as such may have less rigid audit requirements than an existing PIE.
The regulatory framework applicable to current PIEs will also be reviewed. The UK government now has greater post-Brexit freedoms to potentially deregulate or build on existing legislation to foster improvements.
Much of the expected framework relates to ensuring that directors are held accountable for deviations from their duties around true and fair reporting.
At the moment, only certain listed businesses above a threshold size are required to implement the UK Corporate Governance Code. However, this looks set to be rolled out on a much wider basis.
Auditors may be able to assess director statements reporting on internal controls and fraud-prevention measures to strengthen confidence that dividend and capital maintenance laws are being upheld.
Finally, a series of new statutory statements and policies will be introduced in the form of a Resilience Statement and Audit and Assurance Policy, both applying to PIEs above those minimum thresholds mentioned earlier.
Faisal Khalid
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