By Jessica Tasman-Jones
This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards
Boards of large unlisted UK companies should prioritise planning for forthcoming government reforms to audit and corporate governance, experts say.
More companies will fall under greater scrutiny of their corporate reporting after the UK government this year broadened its definition of a "public interest entity" to include unlisted companies with at least 750 employees and turnover of over £750mn.
Those changes will come into effect in December 2024, according to an update by the Financial Reporting Council to its ethical standard, which sets the general parameters for the conduct of audits.
The timing is subject to the government first legislating for a new regulator, the Audit Reporting and Governance Authority, which will replace the FRC and have greater powers to scrutinise company accounts.
The reforms are the government’s response to past corporate-audit failures, including at outsourcer Carillion and cafe chain Patisserie Valerie. They will amount to a "new regime" for directors of companies that fall under the broader definition of public interest entity, says Roger Barker, policy and governance director at the Institute of Directors.
The reforms are also about increasing directors' reporting roles and accountabilities, says Sally Baker, head of corporate reporting policy at the Institute of Chartered Accountants in England and Wales, a professional membership organisation.
Non-executive directors will likely take on more risk and greater time commitments once the reforms come into force, Jon Thompson, FRC chief executive, said in an interview last month.
That will probably mean higher rewards, he added.
The government has made it clear what it expects from the reforms, Sally Baker says. Changes following the FRC consultation in early 2023 are only likely to be to the detail.
Boards of directors should read and understand Restoring Trust in Audit and Corporate Governance, the white paper, she says.
One of the most important changes for boards are new disclosures, including a requirement for an explicit statement on the effectiveness of internal controls signed by directors, says Tim Copnell, associate partner, KPMG UK.
The scope of such statements is still uncertain, says EY UK chair Hywel Ball.
Sir Jan du Plessis, chair of the FRC, said in a speech that the regulator plans to redress the government's "missed opportunity" to adopt tougher Sarbanes-Oxley-style rules, with its own review of the corporate governance code.
The US Sarbanes-Oxley Act requires boards to assess and report annually on the effectiveness of their company’s internal control structure and procedures for financial reporting.
Du Plessis’ comments suggest the regulator will take a serious approach to internal-controls rules, says Baker. The ICAEW also wanted the government to introduce stricter requirements for directors, she says.
"Until now investors haven't had that assurance around internal controls and directors haven't had to take as much responsibility for those internal controls," she says.
The effectiveness of the reforms will be determined by investors rather than the regulator, given the UK corporate governance code only requires companies to "comply or explain", says Kari McCormick, a partner at law firm Eversheds Sutherland.
Investor engagement is currently low when it comes to internal controls, according to EY analysis of FTSE 350 financial reports and conversations with audit committees, says Ball.
"A more informative statement about internal controls could help investors engage," he says.
Boards should now ask themselves whether they would sign off on the effectiveness of their current internal controls and, if not, what would it take to address their concerns, says Jayne Kerr, director for public policy at PwC UK.
