Blog: Business takes aim at audit reforms that threaten Brexit freedoms –

As a backbench MP, Kwasi Kwarteng made a habit of denouncing cumbersome regulation and big government.

Shortly after he was elected to Parliament, he helped pen Britannia Unchained, a book that condemned the UK’s “bloated state, high taxes and excessive regulation”.

The current business secretary was also an early backer of Brexit and said in January that the UK’s departure from the EU was a “once in a lifetime opportunity.”

Given such credentials, business leaders have been left scratching their heads about a 232-page White Paper on audit reform that he put out to public consultation in March.

The paper suggests sweeping changes to auditing and corporate governance after auditors failed to raise red flags before corporate collapses at the likes of BHS, Carillion and Patisserie Valerie. 

The proposals include making directors personally liable for the accuracy of financial statements, similar to rules under the US’ Sarbanes-Oxley regulations.

Ministers also want to establish a new audit watchdog to oversee the UK’s corporate governance code. The number of companies supervised by the regulator will increase by changing the definition of  “public interest entities” (PIEs) to include smaller firms. 

A public consultation on the White Paper ends Thursday, and the responses are likely to make uncomfortable reading for Kwarteng.

The Quoted Companies Alliance, which represents small and medium-sized listed firms, says it is “deeply concerned” about some of the regulations given that the UK’s public markets are already shrinking due to “overburdensome regulation.” 

The QCA’s submission, which was first reported by the Financial Times, also condemns plans to increase the number of PIEs. It says the proposal, if introduced, will have “significant negative impact on the growth of smaller companies” listed on the Aim market.  

These concerns are echoed by the Building Society Association, which says the pool of auditors prepared to work for small PIEs has already contracted and is far too small to continue to support the existing number of smaller firms.

“Such status adds extra burdens on top of arduous prudential requirements but adds little of value,” says Robin Fieth, BSA’s chief executive. “Looking ahead this could result in a massive cost burden and significant capacity gaps at audit firms.”

Other business groups agree that such reforms will suffocate companies, stifle growth and push up costs. They believe they fly in the face of the Government’s promise to cut red tape and decrease the burden on companies post-Brexit.

“Whilst Brexit promised less red tape, these reforms go completely against that commitment,” says Jonathan Fisher QC of the firm Bright Line Law. 

“Accountants and auditors will be faced with additional regulatory requirements that could stifle growth as much more time will be spent meeting these new measures, which will increase the cost to clients.”

“Now that we have left the EU there is the opportunity for a UK domestic definition of PIEs to include larger firms currently excluded and a far more proportionate approach for smaller, simpler organisations,” BSA’s Fieth adds. 

Among the most controversial proposals in the White Paper is a plan to impose fines and bans on directors for inaccuracies in their companies’ accounts. Ministers hope that ensuring directors have “skin in the game” will improve financial reporting and controls.

David Herbinet, head of audit at challenger firm Mazars, claims there are aspects in the proposals that could deter people from becoming company directors “if the regulatory response is disproportionate”.

“We are calling on the regulator to be proportionate. It should be targeting those who are dangerously reckless as opposed to people who make a genuine mistake when trying to follow rules – mistakes happen.

“So be tough on the bad guys, but be more gentle on those who are trying their best but who may not always get it right.”

Bosses including Sir Martin Sorrell, founder of advertising firm S4 Capital, Wetherspoon’s chairman Tim Martin and Charlie Mullins, head of Pimlico Plumbers, have also hit out at the plan.

Sir Martin said earlier this year that such a move would “strangle initiative” at companies trying to survive the pandemic, while Mazars warned Britain should not “imitate a US Sarbanes-Oxley approach” to audit reform.

Other accountants have been more overtly critical. KPMG says the accounting crackdown would not improve the quality of scrutiny of companies’ financial statements. As part of the reforms, Big Four firms KPMG, EY, PwC and Deloitte must ringfence their audit and consulting arms to reduce conflicts of interest.

Meanwhile BDO, the UK’s fifth largest accounting firm, claims it is broadly supportive of the proposed reforms, but it would prefer to see a cap on the number of companies that any one firm can audit, rather than a planned shared audit regime.

The aim of managed shared audits is to allow smaller firms to audit a proportion of a company’s business such as its subsidiaries and give mid-tier players more experience so that in time they can rival the Big Four.  

But the Institute of Directors (IoD), which represents around 20,000 businesses in the UK says introducing regulations on topics such as shared audies should be gradual. 

“We are particularly worried about the willingness and capacity of smaller ‘challenger’ audit firms to take on major audits in partnership with the Big Four,” says Roger Barker, director of policy and corporate governance at the IoD. 

“This is a step into the unknown, and the concept needs to be properly tested before it is rolled out.”

The changes will be overseen by the UK’s new beefed-up audit watchdog, the Audit, Reporting and Governance Authority, which is not expected to be launched until 2023.

Kwarteng has now been left in the difficult position of needing to force change within the audit industry to prevent future embarrassing corporate collapses, while, at the same time, trying to ensure any reforms don’t put undue strain on British businesses.

In the process, he is having to propose measures that would historically have gone against his free market instincts. But will the criticism lead to any changes to his proposals?

“You will often have the most unhappy voices first out of the blocks and the Department for Business, Energy and Industrial Strategy (Beis) will take everything with a pinch of salt,” says Herbinet. 

“We have a market that really needs to change, but some people just don’t want change.”

A spokesman for Beis said: “Our consultation sets out phased reforms to strengthen company reporting, accountability and audit to reduce the risk of company collapses, safeguard jobs and protect the UK’s reputation as a premier destination for investment.”

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