Financial Accounting News

May’s Resignation Threatens U.K. Audit Reform (1)

May 24, 2019, 5:56 PMUpdated: May 24, 2019, 6:12 PM

Political chaos erupting in the wake of Prime Minister Theresa May’s resignation could derail U.K. audit reform despite a promise by the accounting regulator to press ahead with changes in advance of needed Parliamentary endorsement.

The Financial Reporting Council said in budget plans published May 23 it will inaugurate regulatory reforms, including hiking the level of audit scrutiny and corporate reporting standards to prepare for the transition to a new, more powerful regulator.

May’s departure June 7 throws into doubt the FRC’s promise to install the reforms that don’t require a Parliamentary vote.

“This is the way reforms are stymied and a lame-duck government does not help,” Prem Sikka told Bloomberg Tax. The Sheffield University accounting professor chaired a review of the audit market for the main opposition Labour Party, “Could politics delay reforms? Of course. The curse of Brexit has affected so many things.”

“The whole question of whether we will get any serious audit reform is still in the air,” Karthik Ramanna, professor of business and public policy at Oxford University’s Blavatnik School of Government, said in an email. “Given the current political turmoil in the UK, I’d say it’s a 50-50 shot that we’ll still be living with the FRC in two years.”

A commission headed by Legal and General Group Plc Chairman John Kingman on behalf of the government’s Department for Business, Energy and Industrial Strategy recommended in December a complete revamp of the accounting regulatory structure. It includes creating the new Audit, Reporting and Governance Authority, a measure requiring Parliamentary approval.

“While legislation will be needed to establish ARGA, we will be working with the government as a priority to take forward those aspects of the transition that can be undertaken or initiated in advance of the legislation,” the FRC said in a statement.

The FRC plans to hire an extra 80 staff over the next year to improve audit monitoring and prepare for the creation of the new regulator.

It is also working to implement many of Kingman’s proposals, adopting new procedures against conflicts of interests and changing the way it handles and reports complaints.

The accounting regulator also is looking at clawing back the power to approve and register the auditors of large companies, currently handled by outside bodies such as the Institute of Chartered Accountants in England and Wales (ICAEW), and consulting over the level of future penalties for bad auditing.

These are all Kingman proposals. Some investors aren’t convinced that the FRC should be forcing them through before Parliament has approved his central ideas, principally the creation of the new accounting authority.

Jumping the Gun

“This seems to be jumping the gun,” Tim Bush, head of governance and financial analysis at Pensions & Investment Research Consultants Ltd., said in an email about the FRC activity. He pointed out that that the regulator was looking to appoint a new boss, who would eventually take over ARGA.

Michael Izza, ICAEW chief executive, disagrees. He said the urgency of audit reform means it can’t wait on Parliament’s schedule, with a vote on the Kingman proposals unlikely before 2020.

“Restoring public trust in audit cannot wait, and it is too important to leave to the uncertainties of next year’s parliamentary timetable,” Izza said. “It therefore makes sense for the government to get the process of reform under way, and to achieve as much as possible without new legislation.”

The big accounting firms have fiercely opposed some U.K. audit reforms, notably December proposals by the Competition and Markets Authority to force the separation of audit and consulting and to require big listed companies to hire smaller accounting firms as auditors.

However, the accounting industry would be supportive of the FRC’s efforts to force the pace of reform, Izza said. “Chartered accountants acknowledge this as a watershed moment and embrace the need for change,” he said.

Bush also pointed out that the prime minister’s resignation didn’t necessarily mean a collapse of political will for audit reform.

Parliament’s cross-party Business, Energy and Industrial Strategy Committee has supported the conclusions of audit reviews by Kingman and the market authority.

Sikka said that if there is a danger that May’s departure could lead to a less reformist prime minister taking power, there is also a chance that it could force an election and change of government.

Sikka’s Labour Party review in December suggested more radical reforms than the markets authority or Kingman.

They included splitting up the Big Four and capping at 50% their audit market share of the the top 350 companies traded on the Financial Times Stock Exchange. The review also recommended an independent body to hire and pay corporate auditors, with large financial companies such as banks to be audited by a public body, rather than private accounting firms.

In this light, the reforms being adopted by the current regulator are simply inadequate, Sikka said.

“The FRC is not making any transition to openness or public accountability and such matters are completely missing from its plan,” Sikka said. “These can be implemented even without legislation but do not appear be on its radar.”

“The regulatory debate will change if the U.K. gets a general election and a different government,” Sikka warned.

(Updates with Oxford professor comment in fifth graph.)

To contact the reporter on this story: Michael Kapoor in London at correspondents@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Steven Marcy at smarcy@bloombergtax.com

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