As Fidelio conducts Board Evaluations an important component is always the work of the Audit Committee and the oversight of internal controls.
In the UK Audit Reform has been subject to much analysis and consultation and Fidelio has tracked the process. An inflexion point was the 2018 collapse of Carillion but despite the importance of effective Audit for both Board and investors progress has been slow. Recently, however, the responsible Department for Business, Energy and Industrial Strategy (BEIS) has made a proposal following last year’s consultation process. This contains important developments for all Board Directors: here we focus on the implications for the extension of Directors’ duties.
Following indications that controls at Carillion were inadequate, as well as subsequent corporate failures such as Patisserie Valerie, there was strong opinion in government and among regulators, as well as on the part of investors that a new audit framework should include a strengthening of Board responsibility for internal controls. The initial proposal from BEIS was for a statement from Directors concerning internal control effectiveness, and for this to be subject to external audit or assurance.
This would have brought the UK broadly in line with the Sarbanes-Oxley legislation in the US, but consultation feedback on this point identified a number of concerns with this proposal. Some 80% of responses – including a group of Audit Committee chairs – questioned the presumption that controls are generally inadequate, argued that it should be for Audit Committees to decide whether additional assurance is needed, and also expressed concern that the proposed regulation would impose a disproportionate burden on smaller companies.
In response BEIS will now delegate the issue to the Financial Reporting Council (FRC, soon to be reconstituted as the Audit, Reporting and Governance Authority (ARGA)) and plans to:
“Invite the FRC to consult on strengthening the internal control provisions in the UK Corporate Governance Code to provide for an explicit statement from the Board about their view of the effectiveness of the internal control systems (financial, operational and compliance systems) and the basis for that assessment.”
As part of this exercise guidance will also be provided on how the statement should be prepared and this in turn will be based on a review of existing guidance on risk management and internal controls. Guidance will need to cover acceptable standards and the circumstances in which external assurance should be sought.
As such the important issue of Audit Reform will be dealt with in the context of the UK Corporate Governance Code rather than in new legislation. Action is therefore being taken and new provisions are likely to apply on a comply or explain basis for premium listed entities. Questions do remain for example regarding the potential exclusion of private companies. It appears unlikely that the new internal control statement will be required to be audited.
The BEIS paper is entitled “Restoring Trust in Audit and Corporate Governance” and Fidelio fully recognises the importance of public confidence in the Audit process. Clarity regarding the expectations for Directors is an important piece of this puzzle. The Board Evaluation process is also a key component of providing comfort to shareholders and stakeholders, as well as supporting the Board to increase its effectiveness. Trust, at the end of the day, is very much the bedrock for corporate success.
To discuss Fidelio’s approach to Board Evaluation and how it contributes to Board effectiveness and provides comfort, please contact gkarrancumberlege@fideliopartners.com.
