After a negative response to high-profile corporate failures, the Government have taken action.
After the spectacular corporate failures of Carillion, BHS and Patisserie Valerie, the Government decided on sweeping reforms to both audit and governance to prevent such catastrophes from happening again.
Seen as the UK’s answer to the US’s Sarbanes-Oxley (SOX) Act of 2002, a consultation White Paper called, ‘Restoring Trust in Audit and Corporate Governance’ was published in March 2021. On its closure in July 2021, it became clear that there was little disagreement in the sector over the need for change in some form or another.
Why should company directors care?
There are compelling reasons why company directors and management teams, as well as their advisers, should take the proposed reforms seriously.
The definition of a Public Interest Entity (PIE) will expand to cover a far greater number of companies, including large private companies and, more specifically, those listed on the Alternative Investment Market (AIM). This means that private companies with 2,000 employees and a £200m turnover; or 500 employees and a £500m turnover; and AIM-listed companies with a market cap of more than €200m will need to comply with PIE rules for the first time.
PIE requirements will expand considerably, so even existing PIE companies will face an unprecedented increase in their corporate governance and reporting responsibilities. Initially, the changes will only impact Premium-listed London Stoke Exchange (LSE) companies, however after two years other qualifying entities will need to comply.
Not only will PIEs be obliged to have an Audit Committee and produce a ‘Corporate Governance Statement’, but they’ll also need to include an ‘Internal Controls Statement’. There are also very many additional requirements including a new ‘Resilience Statement’ to replace the ‘Viability Statement’, where new and longer-term disclosures are asked for, along with a new ‘Audit and Assurance Policy’.
These new statements are the tip of a substantial iceberg of new internal planning, processes and implementation commitments. All will increase both the risks and the compliance workload for companies and, although many larger FTSE entities will already have significant controls and procedures in place to be SOX compliant, most will need to devote significant resource to meeting the new standards.
Proposed new audit requirements such as, making the wider information in the annual report subject to an assurance regime, together with the introduction of new policies and statements will mean extra work for accountancy firms and consequently increased costs to companies.
Under the proposed Directors’ regime the four key roles of Chief Executive Officer, Chief Financial Officer, Chairperson and Chair of the Audit Committee will all take-on more responsibilities. It will also make them more accountable, more visible and easier to prosecute. In addition, there’ll be increased penalties, including a claw back provision in remuneration packages, to encourage good behaviour.
Because the majority of their focus is on building their business, entrepreneurs often have a minimalist internal compliance infrastructure. Introducing a new control regime along the proposed lines will not only cut into their time on developing their businesses, but also force them to recruit extra staff to deal with compliance at additional cost. Therefore, it’s possible that the proposals, when applied to smaller listed companies, will impact growth as well as stifle enterprise.
Early responses to proposed reforms
We asked our listed clients for their opinions on the proposals. Although 73% of respondents agreed that some changes are needed, the overall impression was that it means a lot of extra work for little reward and only 36% believed that the reforms would improve the current situation.
Some of the key views were as follows:
Lack of proportionality – this was a common view, with the key concern being a significant increase in costs and bureaucracy due to the ‘one size fits all’ perspective rather than a tiered approach taking into account market capitalisation and other size criteria.
Of the sample, 81% believed the new PIE definitions will discourage companies from listing in the UK.
Of the measures to strengthen internal control frameworks, 68% believed they would be burdensome and restrict entrepreneurship for smaller listed companies.
71% didn’t think that the measures proposed improved on the brevity and comprehensibility of financial statements.