Fifteen long months after launching its consultative White Paper, “Restoring Trust in Audit and Corporate Governance, the UK government of Boris Johnson has surrendered on the “audit “ portion.
That’s on reading the Response of May 31, 2022, from Kwasi Kwarteng, Secretary of State for Business, Energy and Industrial Strategy.
His Ministerial Foreward promises “ambitious plans to further strengthen the UK’s audit and corporate governance framework” (p.3). But a slog through its 197 pages reveals a mélange of delay, retreat, and withdrawal.
Four years and counting after the January 2018 collapse of Carillion that triggered this latest spasm of public dissatisfaction with the functioning of Big Audit, the Response devotes massive verbiage to corporate governance, but a mere nine pages to the only two topics with direct bearing on the performance of large-company audits.
Even for the former, the Response natters on, its proposals reflecting a “built-in scope for fine tuning” (p.4) that is euphemistic for “who knows what may work, or what the unintended consequences may be.”
Readers are largely left to speculate –- generously assuming that Johnson can stay in office in the face of a dramatic loss of confidence in his leadership -- on the particulars that may be expected in possible legislation to be put to an unspecified future session of Parliament, by way of possible legislation to replace the discredited Financial Reporting Council as the profession’s regulator with a new Audit, Reporting and Governance Authority.
Among the multiple examples of what the ICAEW generously called on May 31 a “half-hearted” Response:
- The absence of Sarbanes/Oxley-style corporate reporting and assurance on internal controls (§2.1.27).
- The absence in the new proposal for a corporate Resilience Statement of a similar statement by statutory auditors (§3).
- Leaving for the market the consideration of widened financial information assurance (§6.1.48).
- The absence of commitment to the new qualification of “corporate auditor,” as proposed in Sir Donald Brydon’s December 2019 report (§6.1.48-49).
- Leaving with the accountancy bodies the consideration of auditor training, qualification and skills (§6.1.54).
- Explicitly taking a “wait and see” view on the intractable problems with fraud detection and prevention (§6.2.16).
- Passing entirely on the existential threat posed under the existing regime for auditor liability (§6.1.70).
On the lesser topic bearing on the audit firms –- “operational separation” of Big Four audit and consulting (§8.2) -– the air has long since gone out of any energy for further change; authorizing ARGA to legislate on what is already in process would be inconsequential.
On the second -- competition, market share and auditor choice -- the Response would inject the challenger firms into FTSE 350 audits by legislating ARGA’s power to set the terms: the percentage of a FTSE 350 audit to be performed by a challenger firm (§8.1.16), definitional metrics (§8.1.17), international reach (§8.1.18), and exceptions for the unavailability of a challenger (§8.1.19).
Importantly, such steps would phase in only over the ten years of the audit tender cycle under §C.3.7 of the FRC’s Corporate Governance Code (§8.1.2). Big Four dominance of FTSE 350 audits not having budged in the nine years since imposition of that requirement, however, suggests the passage of another decade over which evidence might emerge of market share changes perhaps supporting an enforced market share cap (§8.1.15 and §8.1.20).
The necessary conclusion -- implicit in the Government’s comprehensive passivity, and in the Secretary’s explicit readiness to “(set) market participants the challenge of shaping their own future” (p.4) -- is that developments over the next generation will be shaped by already evident market dynamics:
First, KPMG’s announcement of an intent to carry out a cull of its client list, if taken seriously, could open challenger opportunities, if only:
- To the extent its Big Four colleagues were to stand aside voluntarily in the tender process.
- Subject to the challengers’ resource development, risk appetite, and survival in the face of litigation and regulatory exposures.
Second, the roaring enthusiasm for extended corporate reporting and assurance on “Sustainability,” the catch-all adopted by the newly-launched International Sustainability Standards Board, has potential. Whether the advocates are rushing headlong toward a promised land of opportunity or a cliff-edge of disaster remains to be seen, however; there are such overhanging and unresolved issues as the extent of convergence of “standards,” the permissible scope and structure of the audit firms’ ESG resources and practices, and the impact of the litigation and regulatory exposures for which the SEC’s recent enforcement actions in America for ESG reporting deficiencies by both Vale and BNY Mellon are canaries in the mine.
Last, potentially most significant and least appreciated is the very viability of the large-firm assurance franchise itself –- now brought to the fore with the news of EY’s consideration of a global separation of its audit and consulting practices.
Not for now to ponder pro’s and con’s -- the challenges facing CEO Carmine Di Sibio and his global team are dire. The prospects should not be minimized that the outcome –- rather than a clean global split with all pieces intact and a handsomely-financed windfall for at least some groups of EY partners –- may instead be the exposure of an organization riven with anxieties and antagonisms, ill-equipped for the stresses of publicly-visible divorce proceedings.
Arthur Andersen’s unhappy history is this movie’s prequel. Briefly put, EY’s leaders have put the entire enterprise into play, with the potential that critical numbers of partners in country firms and practices may opt to serve their local and personal interests.
Should that happen, the Government Response to the question of large-firm viability -- that “to provide ARGA with the ability to operate a market share cap in the event of the failure of a major audit firm” would be “intended to give the regulator the ability to react quickly and to limit further concentration in the FTSE 350 audit market in the event of firm failure” (§8.3.23) –- would be exposed as an empty and meaningless charade.
The environment of another large-network disintegration should instead recall the late William McDonough, preparing to step down as chairman of the American PCAOB in the fall of 2005, with his warning -- never since modified or disavowed by any of the profession’s regulators -- that “none of us has a clue what to do if one of the Big Four failed.”
In which case, the irrelevance of the Government’s Response will be well and truly evident. For readers with the fortitude to follow this dreary story, there will be reason for another installment, for this look:
At the level of energy, vision and intelligence brought by the Government to this highly relevant set of issues for the capital markets, its flaccid Response is probably the best it has the capability to deliver.
Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription sign-up is easy and free – both at the Main page.