Audit reform is to be resurrected after the government announced that it will push ahead with legislation to create a brand new regulator with strengthened powers to oversee audit, governance and financial reporting.

The news came in the King’s Speech—a declaration of the UK government’s legislative intentions—which said it would bring forward a draft audit reform and corporate governance bill during the current Parliament.

The bill will form the largest tranche of the audit reform process that has been underway since 2018 following the collapse of construction giant Carillion.

Richard Moriarty, chief executive of the Financial Reporting Council (FRC)—the body set to be transformed by the new reforms—said the FRC had already done much to change but said “serious gaps” remained in the watchdog’s regulatory “toolkit”.

“Without these changes, we are the regulatory equivalent of being a sheriff for only half the county and with weaker powers than are needed,” said Moriarty.

‘Positive direction of travel’

“This positive direction of travel recognises our important role in supporting the UK’s reputation for good corporate governance, financial reporting and audit.”

Intentions for audit reform, including a new regulator, were set out by the then Conservative government in 2022 but it was then largely overlooked. A mention in the King’s Speech last year did not result in any legislation coming forward.

Some much-lauded reforms were even jettisoned. In October last year, the government U-turned on a high-profile segment of the audit reform agenda. It cancelled planned new reporting requirements that would have seen boards report on their risk and resilience positions, audit and assurance policies and anti-fraud measures.

Once the new bill is passed, the FRC will likely become the Audit, Reporting and Governance Authority (ARGA). The previous government suggested ARGA would have wider investigatory powers, as well as the right to sanction company directors for failures in corporate reporting.

The FRC has already drafted new minimum standards for audit committee members to cover their responsibilities for “appointment and monitoring” of auditors.

Powers for the regulator to place observers on audit committees were rejected by the Conservative government.

However, it is possible that new legislation could include measures that would set a path to powers for ARGA to appoint auditors to troubled companies.

One part of the planned audit reforms did go ahead when the FRC included greater responsibilities for boards on internal controls in a revised corporate governance code. Though welcomed by many, the development disappointed some who had called for the measures to have the force of legislation.

Overseeing audit

Briefing notes to the King’s Speech also highlighted work for the new regulator overseeing audit firms, “protect against conflicts of interest at audit firms and build resilience so quality audit is available to all companies that need it”.

It remains unclear whether the government will push ahead with “managed shared audit” for FTSE 350 companies, an intention declared in 2022 by the then government in response to consultation. Managed shared audit would see a smaller, so-called “challenger” firm join a Big Four firm on large audit projects.

The governement said at the time it would legislate to make the reform possible and give ARGA power’s to potentially limit the dominance of audit work by big firms through a “market share cap”. There were also expectations watchdogs would receive powers needed to “monitor the health of audit firms”.

Big Four firms were additionally told the government preferred “operational separation” of audit departments from other service lines, for example tax or consulting. Since the 2022 report, and despite no legislation, firms are understood to have largely made those changes voluntarily.

Good for governance

There was welcome elsewhere in the governance sector for the King’s Speech announcement. Mike Suffield  a former audit regulator with the FRC and now director of professional insights with accountancy body ACCA, said: “Audit reform has been severely overdue in the UK, yet repeated delays have sidelined it despite the importance of promoting the UK as a great place to do business.”

He added: “The shift of the FRC to ARGA as a clear independent watchdog will strengthen the oversight of audit quality so that audit firms can be held properly to account, introducing changes that have been needed since the collapse of Carillion in 2018.”

Gavin Hayes, head of communications at the Institute of Internal Auditors, said: “Ensuring the audit regulator has the legal powers it needs to do its job effectively is vital to restore trust in the audit and corporate governance system which underpins our economic stability.”

A debate has been raging over governance in the City and Westminster for some time. On one side are the London Stock Exchange and the Capital Markets Industry Taskforce (CMIT), a lobby group, who have argued in favour of a “reset” to reduce the burden of UK governance on companies. It was CMIT chair and LSE chief executive Julia Hoggett who played a significant role in persuading government to perform its U-turn last year.

Hoggett has also argued for higher levels of chief executive pay, a campaign that appears to have garnered some support.

LSE and CMIT have also backed listings reforms which have attracted significant criticism from investor groups.