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New accounting watchdog risks doing more harm than good

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The role, scope and even name of Britain’s next accounting regulator has been called into question by several industry luminaries concerned it may not translate into an effective authority.

14th Jul 2021
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The Audit Reporting and Governance Authority (ARGA) is set to replace the Financial Reporting Council (FRC), but there is growing worry the new body has too wide a remit and is trying to cover too many bases.

High-profile corporate collapses including Carillion, Thomas Cook and BHS led to promises of a major shake-up of the audit world, but multiple responses to the now-closed consultation by the business department on restoring trust skewered the powers laid out for the new regulator. 

BEIS laid plans

“The objective for ARGA as set out in the whitepaper is too broad,” said John Boulton, ICAEW director of technical policy. “It’s objective talks about corporate governance in general terms, when the focus should be on directors’ duties especially relating to reporting, accounts and audit.”

Under government proposals, which would deliver the most significant changes to the audit and accounting profession for several generations, the new watchdog would have significantly stronger legal powers than its predecessor.

ARGA may open antitrust probes, have more say on corporate reporting reviews, a wider oversight of audit committees and the ability to enforce the corporate reporting duties of directors. 

However, it is not clear where the boundaries of ARGA’s remit will be drawn and whether it might overlap with other regulators, added ICAEW’s Iain Wright, managing director, reputation and influence. “At a top level, you could question whether the objective set for the regulator is targeted enough,” he said.

ACCA, in its wide-ranging response, also highlights potential conflicts of risk regarding the oversight of an auditor if ARGA becomes involved in a dispute between auditor and audited company. 

Unnecessarily complex and over-reaching

Experts say although the need for change is clear given the extraordinary circumstances afflicting audit in recent years, it risks promising more than it can deliver.

ICAS said the “scale and magnitude of the proposed reform package may be difficult for the regulator, business and the profession to absorb in short succession”.

“The proposed changes will require considerable additional resources across all aspects of the corporate ecosystem – including ARGA,” said James Barbour, ICAS director, policy leadership.

In turn that may lead to cases of regulatory arbitrage, some have argued.

“The proposed powers for ARGA are very broad and wide-reaching,” said Julie Matheson, partner at Kingsley Napley. “For example, the proposed power for ARGA to set and enforce a new code of ethics begs the question of whether this is needed, bearing in mind there is no evidence of the current ethical framework creating a public interest concern.”

Currently, the code of ethics adopted by the UK professional accountancy bodies including ICAEW, ACCA, and CIMA, as members of the International Federation of Accountants (IFAC), is set by the International Ethics Standards Board for Accountants. 

“This long-established and international code has the benefit of offering standardisation and consistency across the multiple global jurisdictions in which many UK chartered accountants also operate within,” Matheson said. “To establish a new and different UK code of ethics for professional accountants carries the risk of the regulatory framework becoming unnecessarily complicated and duplicative.”

The hazy definition of scope also leads some parties to conclude ARGA won’t be as effective.

ShareSoc and the UK Shareholders Association made a joint submission in a detailed 77-page response. They said wider public trust in the credibility of directors’ reporting and the statutory audit “has been shaken by a succession of sudden and major corporate collapses” which led to serious economic and social damage.

The proposals set out in the consultation document should improve the situation, “if implemented”, but that in many cases they “do not go far enough”.

“The FRC Board and its main committees have been dominated by accountants,” the authors said. “This approach has not worked well for shareholders and other stakeholders. ARGA and its main committees must be representative of the users of accounts, the customers.”

What’s in a name?

International auditor Mazars said the problems start with the title of the regulator, which promises too much.

“The regulator should be called the Corporate Governance Authority,” said David Herbinet, Mazars head of audit. “As reporting and audit form part of corporate governance, we continue to believe the regulator should be called the Corporate Governance Authority and this would also highlight the integrated nature of its work rather than suggesting the proposed Audit, Reporting and Governance Authority has three separate roles.”

But Mazars’ issues don’t end with its moniker. It also wants proof misconduct has taken place before enforcement action is taken, whereas under the proposals this would not necessarily have to happen.

“We are also not persuaded it is in the public interest for findings on the results of individual company audits to be published,” said Herbinet.

More power to intervene when things go wrong is a compelling argument for change, however, said Julia Penny, director of JS Penny Ltd, as ARGA would be able to sanction senior managers inside errant firms who themselves may not be accountants.

“But the range of powers and scope of public interest entities risk giving the new regulator so much work in so many areas that it loses focus on what’s actually important – good corporate governance of our biggest companies and good quality audit,” she added. 

The balance between market opening measures and audit quality must also be carefully considered, she said.

Humble PIE

One of the most heated aspects of the proposals is for ARGA to have responsibility for deciding which individuals and firms should be approved to audit Public Interest Entities (PIEs); organisations with publicly listed securities in the UK, credit institutions or insurance undertakings.

The tone and attitude from ARGA will be “absolutely crucial” in injecting greater resilience, competition, choice and quality into the PIE audit market, said ICAEW’s Wright. “ARGA shouldn’t be a soft touch and may sometimes need to use or threaten to use hard powers like sanctions to punish poor audit quality,” he said. “But the threat of ever-growing time demands for compliance, coupled with increasing fines, does not encourage new entrants into the market.”

The finalised definition of a PIE will be crucial to understanding ARGA’s responsibilities, said Alex French, director at Xeinadin, the UK and Ireland-based accountancy group.

“For example, by bringing AIM-listed entities into the scope there would be a logic to having all entities with tradable securities under one audit regulator,” he told AccountingWEB.

Increasing the number of PIEs puts more audit firms are under the direct remit of ARGA, and so sensible timelines for adoption and conversion are necessary Ffrench said. “The focus on competition will potentially have a material impact on the market and audit firms will need time to adapt and provide suitable capacity,” he said.

Risk of widening the PIE market too far creating unnecessary regulatory burden on private companies and a fear of entering the market

Some firms believe the expansion of covered firms will not have the desired effect, however.

“The proposed scope of the PIE definition is too wide and care must be taken to ensure that unnecessary burden is not placed on SMEs through unintended consequences of the government’s response,” said Carol Warburton, UK head of audit and regulatory compliance at Azets. “Proposals to double the number of entities classified as PIEs would have significant counterproductive consequences.”

Rather than increasing competition within the market, the proposals may deter a large portion of audit firms in the UK from offering services to PIEs, Matheson added. “With more private companies and third-sector organisations potentially becoming PIEs and fewer small to mid-tier firms willing to audit them, the danger is that these new entrants to the PIE market will not have the professional services available to them at the cost which they can afford.”

Ultimately, the BEIS audit reform proposals must be supported by a clear public interest need for them. Extending the PIE market by over 50% (option 2) or nearly 100% (option 1) would mean a substantial increase in the number of private companies which would be subject to increased regulatory scrutiny and costs.  The pertinent question is whether failure of these businesses would be a matter of public interest? At a time when the UK economy is focusing on recovery from the difficulties presented by the COVID-19 pandemic, a widening of the PIE market to such an extent may do more harm than good. Mid-tier audit firms too will be cautious about the additional level of regulation that comes with operating within the PIE arena. Our research of 11 leaders of such firms in March 2021 suggests this reluctance may have unexpected and negative consequences. Rather than increasing competition within the market, the proposals may deter a large portion of audit firms in the UK from offering services to PIEs. With more private companies and third sector organisations potentially becoming PIEs and fewer small to mid-tier firms willing to audit them, the danger is that these new entrants to the PIE market will not have the professional services available to them at the cost which they can afford.

This would pose pertinent questions over whether the failure of these businesses would be matter of public interest. “At a time when the UK economy is focusing on recovery from the difficulties presented by the Covid-19 pandemic, a widening of the PIE market to such an extent may do more harm than good,” Matheson told AccountingWEB.

Regulatory creep resulting in an overly complicated and duplicative regulatory framework

The proposed powers for ARGA are very broad and wide-reaching. For example, the proposed power for ARGA to set and enforce a new code of ethics begs the question of whether this is needed, bearing in mind there is no evidence of the current ethical framework creating a public interest concern. Currently, the code of ethics adopted by the UK professional accountancy bodies including ICAEW, ACCA, and CIMA, as members of the International Federation of Accountants (IFAC), is set by the International Ethics Standards Board for Accountants (IESBA). This long-established and international code has the benefit of offering standardisation and consistency across the multiple global jurisdictions in which many UK chartered accountants also operate within. To establish a new and different UK code of ethics for professional accountants carries the risk of the regulatory framework becoming unnecessarily complicated and duplicative.

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By johnjenkins
15th Jul 2021 10:54

What's it called? The office of Accounting and Audit Simplification?

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By Hugo Fair
15th Jul 2021 11:39

Why not just make Auditors responsible for their errors, just like the automatic liability incurred by almost any other supplier of goods or services?
Guilt, whether due to minor incompetence or wholesale collusion, should be the default - without the need for lengthy court cases that the major players simply 'price in' to their fees.

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Replying to Hugo Fair:
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By johnjenkins
15th Jul 2021 16:03

Good idea but that would (sometimes) destroy the relationship with client and Auditor.

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By flightdeck
15th Jul 2021 12:03

Just another layer of government. Just another expense. The FSA (as was) completely missed the biggest financial scandal of our times. This will be no different. Waste of money. No change there then. Why aren't audit firms partners made personally liable - that would focus them.

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