Company directors will not face a legal requirement to report on internal controls, but they will face a new enforcement regime and sanctions for failure in their company reporting and audit committee duties, according to the latest government update on audit reform.

Audit committee members will also face a new set of “minimum standards” to be imposed by the governance watchdog once it has new powers. The government has held back from granting powers for the regulator to place an observer in audit committee meetings—a proposal that was floated last year.

The news comes in the government’s response to a white paper published last year containing proposals for reforming audit and corporate governance in the UK. That white paper was itself a response to three government reviews looking into audit, audit regulation, the audit market and the role of company directors in financial reporting and audit.

A response to the white paper has been much anticipated, and reveals that directors must brace for more disclosures and a new corporate governance regime overseeing their work.

The proposals follow a slew of corporate scandals involving concerns about the integrity of audit including those at Carillion and the former high-street retailer BHS.

New audit regulator

The government says it is pushing ahead with a new corporate governance watchdog, the Audit, Reporting and Governance Authority (ARGA)  to take over from the Financial Reporting Council (FRC).

ARGA will have new powers to “investigate and sanction” failure to maintain corporate reporting and audit committee duties. The sanctions are not detailed in government documents published today, but the white paper made mention of reprimands, fines, orders to take mitigating action and naming directors found guilty of non-compliance.

There are new transparency measures for directors so they will be required to publish an audit and assurance policy, a statement on how they tackle fraud, a resilience statement and information on a company’s distributable reserves.

But there will be no legal duty for directors to sign off their internal controls regimes as practised in the US under the Sarbanes-Oxley Act. The current head of the FRC, Sir Jon Thompson, has previously lent his support to a UK version of the US rules.

Instead, the government has chosen watered-down requirements that the UK’s corporate governance code be amended with “strengthened” provisions for boards to issue statements on the “effectiveness” of their internal controls regime. However, this will be on a “comply or explain” basis, far from the legislative duty thought necessary by many. Mention of mandatory assurance of the statement appears to have been dropped too.

The government said in its report that the white paper had convinced many that inrenal controls proposals would deter companies from listing in London and increase costs significantly. There were also concerns whether there is enough assurance capacity in the UK to cope with mandatory measures. The government said around 80% of consultation respondents opposed mandatory assurance.

Internal controls

The reining back on internal control measures immediately attracted attention from experts.

Mike Suffield, director of professional insights at accountancy body ACCA, said the absence of a legislative requirement for directors to report on internal controls was an “omission”. “We saw this option as an important element of a reform programme that should look across the corporate reporting ecosystem as a whole, and not just the auditors,” he says.

Andrew Harding, chief executive of CIMA, a professional body for management accountants, had similar concerns. “When it comes to the adoption of internal controls, which we have strongly advocated for in the past, we want to see such reforms applied consistently by the largest companies rather than on a comply-or-explain basis, as it seems to be proposed.”

There are other headline measures. Big companies will also have to disclose how they assure the quality of information they publish on non-financial topics such as climate risk.

Large unlisted companies, those with with 750 employees or more than £750m in turnover, will fall within the scope of the new regulator and there will be more work on how transparency can be improved on executive bonus “clawback” policies. This is also likely to mean further amendment to the governance code.

And there is much to consider on audit. FTSE 350 companies will be required to either appoint an auditor from outside the four big global firms, or “allocate a certain portion” of their audit to a smaller firm.

There had been proposals to change the purpose and scope of audit. On purpose, the government appears to have left it up to the new regulator to “deliver change in this area through ongoing improvements” to audit standards and guidance. On scope, the matter is left to the “market—companies, directors, investors—to shape the development of an enhanced wider assurance services market in the coming years”.

But there will be a new statutory regime for the oversight of accountancy and a new enforcement regime for the profession covering all members of relevant professional bodies.

Directors’ duties

One measure absent from the government’s paper is any mention of reforming section 172 of the Companies Act which sets out directors’ duties. A push has been underway for reform by the Better Business Act campaign, looking for more recognition of stakeholders in the legal duties. Sources close to the campaign had believed their proposals had gained traction with policy makers.

Roger Barker, director of policy and governance at the Institute of Directors, said the reforms could have adopted the campaign objectives by “emphasising the need for a more balanced stakeholder approach to business decision-making rather than prioritising the interests of shareholders”.

The minister for corporate responsibility, Lord Callanan, said: “Collapses like Carillion have made it clear that audit needs to improve and these reforms will ensure the UK sets a global standard.

“By restoring confidence in audit and corporate reporting we will strengthen the foundation of UK plc, so it can drive growth and job creation across the country.”