The UK is likely to adopt some form of Sarbanes-Oxley-style safeguards on financial reporting, Sir Jon Thompson, chief executive of the Financial Reporting Council (FRC), told delegates at ICAEW’s virtual Financial Reporting, Audit and Assurance Conference on Monday. 

Thompson also discussed the possibility of market share caps for FTSE 350 audits, to encourage the growth of challenger firms and change the behaviour of audit committees. “I think it's by that experience, that we're going to remove that stigma around the challenge difference.”

Responses to the BEIS White Paper on audit and corporate reform showed considerable support for changes in the oversight of audit committees and the introduction of the audit insurance statement, he said. “But I also believe that ministers will consider very carefully the assessed administrative costs of reporting on internal controls against the benefit of the reforms.”

The white paper stimulated many audit committee chairs to consider the level of assurance they currently get, said Thompson. The role of internal audit has been prominent in many conversations with the FRC, as have general questions about the state of internal controls and assurances that can currently be given by management. 

“The Institute of Internal Auditors' new standard published earlier this year was a helpful reminder of the impact of a quality internal audit function which we very much support, whether ministers push ahead with the legislative change on UK SOX or not. It will be relatively easy for us to raise the bar further with revisions to the corporate governance code, or for us to include reporting on internal controls in minimum standards for audit committees.”

Thompson reiterated that high-quality audit is essential to maintaining trust and confidence in the UK financial markets. If the UK is to retain its position as a world-leading professional services marketplace, he said, outstanding audit quality and rigorous professionalism is needed. The FRC is issuing guidance and a framework on what classifies as a ‘good’ audit later this Autumn.

The FRC’s annual review in July showed some improvement on last year's audit results, but that improvement was marginal, Thompson said. Significant change needs to happen across the market to meaningfully improve audit quality. “We saw the improvement programmes of some firms, beginning to make a difference much faster than others, meaning that the spread of results was very wide across the seven largest firms.” 

Over the last 12 months, the FRC has initiated its own programme of measures in response to Kingman, such as operational separation of the Big Four firms prior to legislation. This is being done through “excellent” cooperation and negotiation with the firms, said Thompson. 

We’re now beginning to see the audit practice being put at arm's length from the rest of the firm. We've introduced enhanced audit standards in relation to ethics and fraud, and we have built our supervisory capacity considerably in the last 12 months. This was designed to understand much more about what the seven largest firms were doing to drive our audit quality.”

Thompson’s expectation is that ministers will move to implement many of the changes of the white paper, including strengthening the regulator's oversight of audit firms, giving legislative backing to operational separation, and raising the bar further on fraud obligations on auditors, in addition to changes in the reporting framework. 

“It’s our belief that higher standards in companies flow through to higher quality audit, and we should see the connection between reporting and audit.”

In response to Thompson’s remarks, Iain Wright, ICAEW’s Managing Director, Reputation & Influence, said that a strong and proportionate system of Sarbanes-Oxley style internal controls will act as a spur for improved financial reporting, reduce the risk of fraud and failure, and boost audit quality. 

“It would also focus the minds of directors on the controls in running their companies and, crucially, hold them to account, which will in turn reassure investors, leading to more investment, more innovation, greater competitiveness and productivity and more jobs. Failure to put this on the statute book would be a real missed opportunity.”