The ripple effect of audit and governance reform in the boardroom

Indeed, there is a high likelihood the measures could alter key relationships, not just between audit committees and boards, but also between those who lead them. It’s also possible they will amplify the difficulties of securing boards with the right skills. The looming repercussions could be significant and will demand careful management by both board and audit committee chairs alike.

Variations

The White Paper published in March, Restoring trust in Audit and Corporate Governance, contains 230 pages of analysis and reform proposals aimed at rebuilding public faith in the audit sector following a series of high-profile corporate failures.

The headline measures—managed shared audits, an operational split between audit and other services and the introduction of a new regulator—naturally, bring an unprecedented focus on the role of auditors and the functioning of the audit market.

But the paper is also unsparing in its attention to audit committees and their work. Its recommendations build upon a study by the Competition and Markets Authority, published in 2019, which says there is “significant variation in the performance of audit committees within FTSE 350 companies”. The CMA concludes this means existing rules are “insufficient”.

The White Paper backs the CMA’s ideas for change, among them are a new set of requirements for audit committee members making them responsible for continuous monitoring of audit quality and the “scepticism” auditors should apply to their work.

There’s more. The new regulator, ARGA (the Audit, Reporting and Governance Authority) will have a duty to oversee the compliance and performance of audit committees against the new requirements. This will come with an ability to demand information from committees and potentially place an observer at meetings if considered necessary.

Powers to sanction audit committees are also included. These include the ability to reprimand audit committees using “public notices”, or making inspection reports publicly available. The government says its intention is that powers should be used “proportionately” and only after a committee has had the “opportunity to address any issues”. Nevertheless, the new rules herald the creation of a regulatory environment audit committees have never known before.

An adjustment is likely. One likely outcome is for audit committees to intensify their focus on compliance, a shift that could prompt increasing levels of costly documentation and an increase in assurance - both internal audit and external assurance by the statutory auditor and possibly others - driven by an effort to stay on the right side of regulators.

But that change in priority could come at the expense of the “enterprise” portion of boardroom responsibilities. In other words, independent directors who are on audit committees could find themselves with less time and reduced incentive to focus on the strategic direction of their companies.  And that, in turn, may undermine the way membership of the audit committee is viewed. Indeed, the perception might also develop that audit committees are forbiddingly unattractive places for non-experts, in effect evolving into zones only for directors with either auditing or accounting together with regulatory expertise on their CVs.

That could have reverberations in the boardroom. Compelled to fill audit committee seats with former accountants or auditors, a board’s roster of skills could become dramatically limited especially if it has a relatively small number of independent directors. There is a risk both boards and audit committees will be forced to operate with a lack of generalists, an unappealing prospect for any company chair concerned about their boards possessing the right broad knowledge base.

There are further worries. Chairing an audit committee is usually attractive to sitting finance directors because it is considered a stepping stone to roles as a boardroom chair. But with the risk of increased regulatory burden, FDs may wonder whether the job is worth it. Boards could then be pushed to seek experienced personnel at the big audit and accounting firms, a move that might reduce the pool of talent available for improving boardroom diversity. Once again, an unattractive possibility in the current era.

Relationships

The personnel issues are tricky, but audit committee regulation could also complicate boardroom relationships.

An audit committee chair subject to the risk of public sanctions could, as already noted, become more compliance-focused, risk averse and, as a result, more questioning of the board. That sets up a potential conflict with the board chair which will demand care and awareness if the relationship is to remain positive and productive.

Chairs will need to be alert to other issues too. With a newly-minted supervisory regime will come an entirely different relationship between audit committees and the regulator, one which will undoubtedly assume major importance, especially if there is friction during troubled times. A thoughtful board chair will need to maintain good lines of communication with an audit committee chair in case an intervention is required to manage the regulatory relationship, should it turn sour.

For audit committees the regulatory landscape is being reshaped. Boards as a whole will need to accept and recognise that audit committees will come under greater scrutiny and this may change their approach to key issues, potentially forcing them to challenge the board more often. All sides should respond to this with calm heads and understanding that this is a new era for governance and recognise that all board members of leading companies will have additional responsibilities and may be held to account by the regulator for how they have exercised them.

That said, the route to managing the transition is “get your house in order”. Adapting well to the White Paper’s new reporting requirements and regulatory proposals will pay off.

The White Paper is still under consultation but it promises a significant break from the past for audit committees and directors more generally. One that will demand significant dexterity and a willingness to adapt.