Q&A: Mazars on dissecting the UK’s draft audit reform bill

Last month, following more than three years of reviews, consultations and deliberations, the UK government finally published its long-awaited response to its consultation on audit and corporate governance reform.

However, many were left underwhelmed by the proposals, with UK lawmakers U-turning on plans to create a tighter internal controls framework comparable to the US Sarbanes-Oxley Act, as well as significantly watering down plans to widen the scope for companies subject to the tightest requirements.

But some remain positive, with Mazars partner Bob Neate arguing that proposals will ultimately leave the UK in a stronger economic position.

During a conversation with Accountancy Age, Neate breaks down the best and worst elements of the draft proposals, suggests some alternatives, and explains the potential impact of the reforms on the future of audit.

What is your overall reaction to the government’s response last week?

My first comment would be that, to an extent, I feel frustrated that the Queen’s Speech didn’t include a bill or legislation to be passed this year. It’s been a good 10 years that we’ve been debating audit and corporate governance reform, and four years since the first report came out. It just feels as though we need to move on with it.

But the fact that there is a draft bill is a strong indication that government does intend to proceed with reform, and the response to the whitepaper gives us a clear indication of the direction of government. That’s a positive move.

And in some ways, it’s probably helpful that there is a slight delay, because the profession as a whole is overheated at the moment. The demands on our capacity, given the extra work required as a consequence of covid and changes in regulation, means we’re all fully stretched. So having a little more space to plan for the coming changes will benefit the profession as a whole. Though it is of course still frustrating that we’re not getting there quicker.

And what about some of the specific elements, such as the omission of UK SOX and the narrowing of public interest entity (PIE) criteria?

To start with public interest entities, I understand the logic for expanding the definition. Some of the private companies in the country are very significant employers and have a very important role in the economy and in the market. And to bring that under closer scrutiny makes sense logically.

Where you put the threshold, I think, is just a matter of judgment. The original whitepaper gave two approaches, one of which bought in around 2,000 companies, and the other was around 1,000. Our position as a firm was the softer one was probably enough. And it comes back to this market capacity point – you do have to do more work for anything that falls within the PIE range. So broadly, I think not going over the top makes sense.

In terms of UK SOX, we never felt that moving to full US-style attestation was necessary. The costs of that would have been very significant. We’ve always thought it’s interesting that cost is one of the big objections to moving to something like joint audit, which has been very successful as an audit quality measure in countries like France. And yet nobody on the firms side has ever raised cost as a significant objection to SOX.  A cynic may think this was because I many firms felt it was a good opportunity to sell services.

We’ve always thought that the corporate governance regime isn’t broken. What it needed was some finetuning and some enhancements through the Code, and that’s broadly what the government is suggesting here. The important thing is there needs to be some way that it’s monitored and enforced as part of the process.

But the Code feels a good enough route at this stage. Our preference was always to put more emphasis on joint or managed shared audit as a way to improve audit quality. Something as draconian as US SOX felt a step too far in the UK at this stage.

What elements of the draft bill would you say you’re most positive about?

Broadly I felt it was a good response. There was nothing in there that made me wince too much. The introduction of an audit and assurance policy is a good step. Giving investors more information on business’ approach to audit and assurance and where they’ve asked for additional assurance in particular, is a good thing. The resilience statement, again, made sense. We had a strange combination between going concern and viability statements but drawing that together into something that’s more cohesive and easier to follow feels sensible.

Mazars as a firm have always advocated that the CMA had it right with joint audit, and that’s based off the experience we’ve seen in France where it’s been tried and tested and works very well. Managed shared audit is not as effective in our view, but it is a good step forwards.

The question we’ve always felt is really important to answer is resilience in the market, particularly FTSE 100. I genuinely hope it doesn’t happen but were a big four firm to disappear as Andersons did only 20 years ago, that would be such a market shock, because the FTSE 100 is effectively 100% audited by the big four. So we have to find a way to build the capacity and experience of challenger firms to operate in that FTSE 100 space. Market share cap, which is the fallback option in the government’s response, doesn’t really do that.

Managed shared audit gives you the opportunity to get your feet under the carpet in those businesses, get known by the audit committee who can see your capability and help you to understand those businesses. The important thing with managed shared audit in BEIS response is that the option is there for international work to be included as part of the ‘meaningful proportion’ as well. So, it does give the scope for helping challengers get the right experience and to build capacity globally. It’s going to be a relatively slow burn compared to joint audit, but it’s better than ignoring the resilience issue.

Can you explain a bit more about why you think joint audit is a better option that managed shared audit?

With a joint audit, you jointly sign the opinion on the group accounts, and therefore you are demonstrating your technical ability and your ability to make the right judgments as well. With managed shared audit, the group accounts are still signed solely by a big four firm. And as a shared auditor, whilst you’re making key judgments around the elements of the group that you are auditing, you’re not there at the top table. That means you’re not getting that experience and exposure to an Audit Committee in the same way as you do on a joint audit.

There are other benefits to joint audit from an audit quality perspective. In a joint audit, you are both responsible for signing the group opinion so you plan the audit together bringing cross firm challenge and review each other’s work. this means that there is a quality check that you do not get in the same way with a solo audit.

And as much as anything it’s cultural, because if you know another firm is reviewing your work, you make sure it’s really good!

What do you perceive as being the general long-term benefits of this package of reforms for the UK?

What markets like is strong governance, they like certainty, and they like to know the regulatory environment is effective. When you look at this package as a whole, the creation of ARGA will be important because it will give the regulator more teeth and authority in performing its role, and an expectation of building capability and capacity. So that has to bring some certainty to the markets, which is a good thing.

Having a greater equity in terms of accountability between boards, auditors and regulators is a good piece. We are all very conscious that some directors probably were not very comfortable that the BEIS response brings greater accountability for boards as a whole, and that ARGA will have some enforcement powers to take action where this is not met. That seems balanced and I believe investors will have more certainty and comfort that it’s a tough, well-regulated market.

Overall, I do see it as positive benefit to the economy. The government has listened, and it hasn’t gone over the top in regulation. I think their positioning on UK SOX is partly driven by that, because that would have created significant additional compliance work for businesses and boards. Once the bill is through, and we’ve got clarity and certainty, we’re probably going to be in a stronger position as an ecosystem which should be attractive to investors.

You mentioned that the profession as a whole is overheated right now – what do you mean by that, and how can they prepare for this new audit regime?

I do not know of a major firm that is not feeling capacity constrained at the moment. Every firm is struggling to resource and perform the work being requested of us. And we are all having to turn away work that, a few years ago, we would have loved to do.

Putting significant additional burden, at this point in time, on audit firms who are still working through the legacy of covid related delays and the inefficiencies of remote working creates challenges and potentially quality risk.

Our teams, in truth, are tired, because we’ve been working incredibly hard for a very long time. And that’s what I mean by we’re overheated at the moment. There’s more audit work being required than the profession has the capacity to deal with.

With that in mind, if you bought in a lot of additional burden in the next year or so, something could break or companies will not find an auditor. And that’s the risk. Having a little more time to continue to build resource is helpful. However, that shouldn’t be a reason for not moving forward, because it’s important to the whole ecosystem that the reform packages come through.

Is there a specific area you could put that down to? Talent, for instance?

A core issue is actually that people just aren’t there to recruit, or at least not in the numbers we all collectively need. Our audit business grew 30% last year, and that means our headcount needs to grow at 30%. Finding those additional heads in this market is very difficult. As a global firm, we’ve done that by drawing upon our resources from around the world, and that works okay, but it’s not the ideal long-term solution.

I have to say, Brexit hasn’t helped. We’ve got a very significant European presence as a firm, and it’s not as easy to bring people across anymore – there’s a whole new level of bureaucracy and cost attached now.

The volume of work as a whole has grown, but the number of people that exists as qualified, experienced accountants hasn’t grown at the same pace. We’re all trying to remedy that by taking on significantly more trainees. We’re looking to take 350 this year. But of course, it takes three years to train to qualification and we need experienced talent now. It is that conundrum of getting enough heads to cope with the growth opportunity, but also being conscious of not growing too fast because you need to bring people in and train them to our ways, and that takes time.