Audit and Corporate Governance: New UK Proposals for Directors

On Thursday, 18 March the UK’s Department of Business, Energy, and Industrial Strategy released its long awaited proposals for audit reform and corporate governance, entitled “Restoring trust in audit and corporate governance.”

The white paper states that “responsible behaviour by directors is the fundamental starting point for high quality and reliable corporate governance and reporting”. So what does this effort to restore trust and encourage greater transparency mean for directors of large UK companies?

Increased director accountability for internal controls, dividends, and capital maintenance

The consultation contains numerous proposals around reporting and attestation requirements for internal controls, risk management, dividend and capital maintenance decisions, and resilience planning. If implemented, the proposals could directly affect directors’ responsibilities, reporting requirements, and remuneration. There also would be more significant fines and suspensions for any accountability failures.

For internal control reporting, Sir John Kingman’s independent review on the Financial Reporting Council recommended that the UK consider a system similar to that of the United States under the Sarbanes-Oxley (SOX) regime. The Government does not recommend a full import of the SOX framework, but instead proposes an option where directors would be required to carry out an annual review of the effectiveness of their company’s internal controls and to make a statement, as part of their annual report, as to whether they consider them to have operated effectively.

The white paper also makes the following proposals and recommendations:

•  A mechanism to sanction individual directors when they have failed to maintain and establish an adequate internal control structure and procedures for financial reporting.
• Requirements for companies to disclose the amount of distributable reserves. In addition, when proposing a dividend, directors should be required to make a statement that the dividend is within known distributable reserves and payment will not threaten solvency over the next two years.
• Strengthening of malus and clawback provisions in director remuneration agreements by suggesting a minimum clawback period of two years and expanding triggers for clawbacks to material failure of risk management controls, misconduct, reputational damage, and failure to protect the interests of employees and customers.

New supervision of corporate reporting

Proposals regarding additional reporting requirements, including reporting on payment practices and an audit and assurance policy, affirm the Government’s desire for greater accountability. Of note is the recommendation that directors publish a “resilience statement” that includes an assessment of short- and long-term risks. As part of the consultation, the Government is asking if this should be the vehicle for reporting climate-related financial disclosures, underlining the seriousness with which directors need to take such issues.

The Government also proposes to strengthen the regulator’s powers with regard to corporate reporting. This includes a proposal to grant audit, reporting, and governance authority powers to direct changes to annual reports (removing the current necessity for a court order) and to publish their correspondence and summary findings to increase transparency. It also includes a proposal to expand the regulator’s power to perform a corporate reporting review of the contents of the entire annual report, so that the entire report is subject to oversight.

Looking to the future

While still at proposal and consultation stage, it is clear that the Government is taking a serious approach to audit and corporate governance reform. Increased rigour, in what is already considered by many to be the gold standard, looks set to be the future.

While awaiting the release of final standards, directors should take account of the potential risks and consequences of the proposed reforms, continue with regular reviews of policies and processes in place, and seek to implement best practices.

We will shortly be releasing a comprehensive review and summary of the full Department of Business, Energy, and Industrial proposals, including their insurance and risk management implications.