Directors' Knowhow is a monthly article which highlights changes and updates of relevance to small and mid-sized quoted companies.
Throughout April, the audit industry has been subject to increased observation and scrutiny: the CMA published their recommendations on the audit market; the independent review into the quality and effectiveness of audit was launched; and the BEIS Committee report on the Future of Audit was released, which attracted significant attention across the industry.
The first section of this month’s Director’s Knowhow breaks down the key developments that have been made in relation to the audit industry.
CMA recommends shake-up of the UK audit market
On 18 April 2019, the Competition and Markets Authority (CMA) published its final report on the competition issues associated with the UK audit industry following discussions with audit firms, major UK companies and investors. The report recommends the break-up of the Big Four, proposing the separation of their audit services from their consulting services. As well as this, the CMA is recommending ‘joint audit’ to help smaller audit firms outside of the Big Four develop the capacity needed to review the largest UK companies.
The report concludes that auditors should focus exclusively on producing objective audits, rather than being influenced by their much bigger consultancy services. The operational split would see the separation of management, accounts and remuneration, in addition to a separate CEO and board. The CMA believes that making such a move would increase choice and competition for the audits of larger companies, as well as improving the overall quality of auditing.
If you wish to see the report, you may do so here.
Independent Review into the quality and effectiveness of audit
Greg Clark, Secretary of State for Business, Energy and Industrial Strategy, has commissioned Sir Donald Brydon to lead an independent review into the quality and effectiveness of audit. Following recent large-scale company failures, which have come about as a result of shortcomings in audit, the review will seek to address the widening of the ‘audit expectations gap’ – the difference between what audit does and what people think audit should do. To do so, the review will examine what the audit product looks like and what audit should look like in the future.
The review will cover six overarching areas. These include:
- Understanding the needs and expectations of shareholders who make use of company audits;
- The scope of audit;
- How assurance is provided and how that assurance can be made more effective for investors;
- How any change to the current statutory audit model will impact on potential liability of auditors;
- How communication of audit finding to users can be improved to enable that information to be of more use; and
- The potential benefits and opportunities for international engagement and cohesion across the world on auditing standards.
The review will consult and gather evidence from key stakeholders and experts before publishing its report by the end of 2019.
If you wish to see the consultation, please do so here.
Rachel Reeves, BEIS Chair, keynote speech on the Future of Audit report
On 2 April 2019, Rachel Reeves MP, Chair of the Business, Energy and Industrial Strategy Select Committee, delivered a speech on the Committee’s Future of Audit Report at the ICAEW. Within the speech, Reeves outlined the need for audit reform, upholding standards in corporate governance, and restoring faith in UK business.
Reeves explained that the BEIS Committee are recommending three key sets of reforms. These are:
- Competition in the market for audit services;
- The regulation of audit; and
- The audit product itself.
The BEIS Committee have decided to recommend reforms in these three areas following three major inquiries on audit, which included the CMA market study, Sir John Kingman’s review of the FRC, and the Brydon review of audit. Reeves announced that the BEIS Committee endorses the CMA’s proposed operational split of the Big Four, which would segregate the audit and non-audit functions of these companies. However, Reeves declared that in order to ensure audits of the highest quality, a structural break-up may be required.
If you wish to read the speech, please do so here.
Comments on the BEIS Committee report
Shortly after the release of the BEIS Committee report, ICSA: The Governance Institute, expressed its concerns with the report, stating that it was another missed opportunity. They claim that because the report does not reflect the realities of audit work it will not help to improve the situation. They highlight the need for further education and training around the role of audit, as well as the need to develop trust within the audit industry in order to remove the lack of confidence that is currently associated with the audit market.
Concern over the report was also expressed by some of the Big Four, Hermione Hudson, Head of Assurance at PwC, for example, argues that the report’s recommendations to break up the Big Four presents major risks and will be detrimental to the audit market.
In a similar vein, Stephen Griggs, Managing Partner for Audit at Deloitte, expresses concerns over recommendations about initiating a structural split, which he claims would hamper audit quality, rather than improve it, as well as threaten the UK’s position as a leading capital market.
However, the report was welcomed by some within the audit industry who believe the recommendations made are necessary to improve the quality of audit. Scott Knight, Head of Audit at BDO LLP, welcomes the report, highlighting the introduction of a market cap on the number of FTSE 350 audits that a firm can take on, which he believes will help improve choice and competition within the market.
As well as this, Maggie McGhee, Executive Director of Governance at the ACCA, gave a statement which largely endorses the report. McGhee welcomes the recommendation of fixed-term, audit contracts, along with the piloting of joint audits.
FCA sets outs its priorities for 2019/20
On 17 April 2019, the FCA published its Business Plan for 2019/20, which outlines its areas of priority for the coming year. The key priority outlined in the plan is to support an orderly transition following the UK’s withdrawal from the EU. The FCA also declares its intention to remain a leading figure in shaping the global regulatory apparatus through work with other national regulators and international bodies.
The Business Plan sets out four cross-sector priorities. These include:
- The extension of the Senior Managers and Certification Regime;
- Ensuring the fair treatment of firms’ existing customers;
- Developing work on operational resilience; and
- Combatting financial crime and money laundering practices.
EuropeanIssuers meet with DG Fisma's Head of Capital Markets Union Unit
On 10 April 2019, a EuropeanIssuers delegation, consisting of Tim Ward, Florence Bindelle and Frederico de Santos Martins met with DG Fisma’s Head of Capital Markets Union Unit. The delegation discussed the outcome of the SME Growth Markets proposal and exchanged views on the challenges that small and mid-caps are experiencing across Europe.
The delegation first discussed the current state of markets across Europe, which included the decreasing amount of IPOs, the impact of MiFID II on research providers, and the lack of new listings throughout Europe. Following this, the delegation considered certain potential solutions, such as introducing an EU definition of small and mid-caps in EU law, allowing a variable voting rights structure, the provision of more capital to small-caps and supporting proportionate measures to corporate governance.
ESMA publish Q&As on Prospectuses and the Transparency Directive
On 11 April 2019, ESMA issued updated Questions and Answers documents for both the Prospectus Directive and the Transparency Directive. Both documents intend to foster supervisory consolidation through the promotion of common supervisory approaches and practices to implementing their regulations. ESMA has collated questions posed by the general public, competent authorities and other relevant stakeholders in relation to the application of the Directive’s and provided responses to them.
The two documents are especially useful for issuers as they give indications and guidance about the implications of each Directive’s provisions.
If you would like to see the Q&A document for the Prospectus Directive, please do so here.
If you would like to see the Q&A document for the Transparency Directive, please do so here.
EuropeanIssuers position on the review of MAR
The QCA’s European counterpart, EuropeanIssuers, has this month published a position paper on the Review of Market Abuse Regulation. Despite acknowledging that the process of implementation is not yet at an end, the position paper outlines some of the critical issues associated with MAR that have been reported thus far. As well as this, EuropeanIssuers propose solutions to the issues raised.
The key issues raised, include the following areas:
- Scope of application;
- Notion of inside information and delay;
- Insider lists;
- Manager transactions;
- Exempt companies from drawing up and keeping lists of persons associated to PDMRs;
- Exempt non-financial companies from the application of the rules on prevention and detection of market abuse; and
- Adjusting the amount of sanctions.
If you wish to see the position paper, please do so here.
BEIS/DEFRA update of environmental reporting guidelines
At the end of March 2019, the Department for Business Energy and Industrial Strategy and the Department for the Environment, Food and Rural Affairs jointly published updated guidance on environmental reporting. The guidance is intended to help companies comply with the Streamlined Energy and Carbon Reporting regulations, including greenhouse gas reporting. The guidance includes information on the changes which took effect on 1 April 2019.
The changes require companies listed on the Main Market of the London Stock Exchange and large Limited Liability Partnerships to report on their energy use and greenhouse gas emissions in their annual Directors’ report. Whilst it is predominantly for companies on the Main Market, the document can also be used to help smaller companies and organisations with voluntary reporting on a range of environmental issues.
If you would like to view the report, please do so here.
Investment Association report on closing the gender pay gap
Early in April, the Investment Association launched its report, ‘Closing the Gap’, which looks into the make-up of the gender pay gap in the asset management sector. The report also collates and analyses fifteen initiatives that the industry is introducing in order to help narrow the gender pay gap and make the industry more inclusive, as well as providing recommendations for benchmarks and the monitoring of progress.
The report finds that many senior positions are held by men, with just 1 in 10 of their survey respondents having a female CEO or Chair despite there being roughly 38% of women who work in the asset management industry.
QCA meet with FCA to discuss the impact of MiFID II
On 16 April 2019, the QCA, along with several of its member companies, met with the FCA to discuss the supervisory work they are conducting to assess the impact of the MiFID II reforms on the market for research. The FCA mentioned that they had been engaging with buy-side firms and brokers, as well as independent research providers, an, broadly speaking, found that research had remained relatively stable and that there had been good levels of compliance. The findings from their engagements with these firms and brokers is in the process of being reviewed and should be published within the next few months.
Following this, the QCA/Peel Hunt Mid and Small-cap Investor Survey was discussed, before the QCA’s members were able to raise any concerns they had over the impact MiFID II was having on the extent and quality of research being produced on their companies. Generally speaking, there were concerns over the disproportional impact that MiFID II was having on research for smaller companies, as well as the considerable costs of research. Not only this, but it was explained that the overall quality of research being produced had been in decline for years, and the extent of independent research being produced had taken a further hit since the introduction of the reforms.
Policy consultation responses
At the end of March 2019, the QCA’s Corporate Governance Expert Group contributed to the response to the FRC’s consultation on the Proposed Revision to the UK Stewardship Code. See the response here.
Additionally, the QCA is currently seeking member input on the following consultations:
- FRC: Business Reporting of Intangibles: Realistic Proposals
- ICAEW: Consultation on guidance for preparers of prospective financial information
- FCA+FRC: Building a Regulatory Framework for Effective Stewardship
- FRC: Consultation on stronger Going Concern standard for auditors
- BEIS: Independent Review of the Financial Reporting Council: Initial consultation on the recommendations
- Independent Review into the Quality and Effectiveness of Audit
If you have any comments you wish to contribute on any of these consultations, please get in touch with Jack Marshall, Policy Adviser, email@example.com.