Audit reform
Background
The FRC has been concerned for some time about the impact of concentration in the audit market and, in particular, the potential impact of a major firm failure on capital markets. The FRC are working with the major audit firms to develop contingency plans which can be activated in the event of a firm finding itself in serious difficulty. The FRC have also been actively involved in helping to shape the timing of audit tenders, advocating a 10 year audit tender period for FTSE 350 companies in line with the 2012 revisions to the UK Corporate Governance Code.
Project Milestones
The FRC provided their comments to the Competition Commission, who initially proposed that FTSE 350 companies put their statutory audits out to tender at least every five years. The FRC comments were considered by the Competition Commission and on 15 October 2013 the Competition Commission published their final package of remedies. This included the requirement that FTSE 350 companies put their statutory audit engagement out to tender at least every ten years.
In January 2014, the Competition Commission announced that they would delay the release of their package for audit reform in the UK in light of the announcement by the Lithuanian EU Council Presidency and the European Parliament of agreement on EU audit reform.
The new EU rules, which were adopted by the Council of the European Union in April 2014 introduce mandatory rotation of auditors for PIEs, requiring such companies to retender at 10 years and change the auditor at least every 20 years. The reforms include a prohibition on the provision of certain non-audit services to PIE audit clients (including tax advice and services linked to the financial and investment strategy of the audit client) and also introduce a cap on the fees that can be earned from the provision of permitted non-audit services to PIEs. Additionally the rules prohibit the use of restrictive clauses in contracts which limit a company’s choice of auditor in order to promote market diversity. The new rules, in the form of a Directive amending the Statutory Audit Directive (Directive 2006/43/EC) (link to Europa website) and a Regulation on specific requirements regarding the statutory audit of public-interest entities (PIEs), have been published in the Official Journal of the European Union. Both the Directive and the Regulation will enter into force 20 days after their publication in the Official Journal of the European Union. The EU Member States have to incorporate the rules of the Directive within their national law by 17 June 2016. The Regulation is effective from 17 June 2016.
In light of the EU rules the Competition Commission announced that it would review its draft Orders to consider the implications that the EU legislation would have. In July 2014, the Competition and Markets Authority (CMA) issued a consultation on a draft Order seeking to implement aspects of the Competition Commission’s package of remedies for audit reform in the UK in light of agreement at European level on audit reform. The consultation period closed on 24 August 2014.
In September 2014, the Competition and Markets Authority (CMA) published its final Order implementing reforms of the audit market in the UK, following on from the Competition Commission's report into the market and in light of agreement at a European level on audit reform.
The final Order includes:
- a requirement for FTSE 350 companies to put their statutory audit engagement out to tender at least every 10 years, in line with the EU Regulation on the statutory audit of public interest entities; and
- measures to strengthen the accountability of the external auditor to the Audit Committee and reduce the influence of management.
The Order will come into force on 1 January 2015 and apply to financial years beginning on or after 1 January 2015. This means that the audit committee’s terms of reference will need to be revised for 2015. However, in relation to tendering it contains transitional provisions, which align with those contained in the EU Regulation.
The Department for Business, Innovation and Skills’ (BIS) issued a discussion document on the implications of the EU and wider reforms to auditor regulation and the Financial Reporting Council issued a consultation paper on the implementation of the EU Audit Directive and Audit Regulation. Both were issued in December 2014.
A policy update on the UK implementation of the EU Audit Reforms was issued by BIS in August 2015. The Financial Conduct Authority and the Prudential Regulation Authority both issued consultations on changes to audit committee requirements as a result of EU audit reform in September 2015. In May 2016, the PRA issued finalised rules on audit committees under the revised statutory audit directive.
Current status of the project
In December 2019 Sir Donald Brydon published his final report setting out his personal views on the quality and effectiveness of audit to the Secretary of State. The Department for Business, Energy and Industrial Strategy (BEIS) has issued a White Paper on strengthening the UK's framework for companies and the way that they are audited. There are a number of proposals in relation to the future of audit. Comments were requested by 8 July 2021. On 10 May a draft audit reform bill was included within the Queen's speech. On 31 May 2022 the government published its response to the White paper and on 12 July the FRC published a position paper setting out the next steps to reform the UK’s audit and corporate governance framework. In December 2022 the FRC published a policy paper outlining its approach to competition in the audit market. Comments are requested by 28 February 2023.