BEIS: The quality and effectiveness of audit - independent review by Sir Donald Brydon
On December 18, 2019 the Department for Business, Energy & Industrial Strategy (BEIS) published the final report of its independent review into the quality and effectiveness of audit led by Sir Donald Brydon (Review). The Review considered how the audit process and product could be developed to better serve the needs of users and the wider public interest.
The final report makes 64 recommendations which, in accordance with the Review’s terms of reference, are aimed primarily at the audit of Public Interest Entities. The recommendations include, amongst other things:
- A redefinition of audit and its purpose to clarify that “the purpose of an audit is to help establish and maintain deserved confidence in a company, in its directors and in the information for which they have responsibility to report, including the financial statements.”
- A change from the “true and fair” description of financial statements to the term “present fairly, in all material respects.”
- The creation of a new independent corporate auditing profession based on a core set of principles, with the Audit, Reporting and Governance Authority (ARGA) as its statutory supervisory body.
- The extension of audit to new areas, including alternative performance measures and any key performance indicators used for the purpose of calculating executive remuneration.
- Mechanisms intended to encourage greater shareholder interaction with the audit process, including the introduction to AGM agendas of a standing item to permit questioning of the audit committee chair and auditor by shareholders and the introduction of a process by which shareholders can propose any matters they wish to be covered in the audit.
- New reporting requirements for directors including: a requirement for the board to make a resilience statement that incorporates, enhances and builds on the current going concern and viability statements; a requirement for directors to set out in a public interest statement (as part of the strategic report) how they view the company’s legal, financial, social and environmental responsibilities to the public interest; a requirement for directors to report on the actions they have taken to fulfil their obligations to prevent and detect material fraud against the background of their fraud risk assessment; and publication by the audit committee of a three-year rolling audit and assurance policy which would be put to an annual advisory vote at the AGM.
- The inclusion of a new section in the auditor’s report in which the auditor states whether the directors’ section 172 statement in the annual report is based on observed reality, on the basis of the auditor’s knowledge of the company and its processes.
- A mechanism to enable the workforce to raise issues around risk and assurance in the company, with an obligation on the company to respond.
- A requirement for audit committees to publish their minutes with approved redactions to increase audit committee transparency.
- An obligation on auditors to report to both the audit committee and shareholders on the extent to which their work has been influenced and informed (or not) by any external signals which might imply enhanced risk in the company whose financial statements are being audited.
BEIS will need to consult on the detail of the changes proposed in the final report.
The final report also sets out suggestions in the context of capital maintenance/dividends, although it notes that these have not been framed as formal recommendations given work already underway in BEIS on these issues.
(BEIS: The quality and effectiveness of audit - independent review by Sir Donald Brydon, 18.12.19)
(BEIS: Independent Review into the Quality and Effectiveness of Audit - List of recommendations, 18.12.19)
FRC: Practice Aid on audit quality for audit committees updated
On December 19, 2019 the Financial Reporting Council (FRC) issued an update of its Practice Aid to assist audit committees in evaluating audit quality in their assessment of the effectiveness of the external audit process (Practice Aid). The Practice Aid has been updated to reflect developments in the governance and auditing framework since the first edition was issued in 2015 and it takes account of commentary from audit committees suggesting how the Practice Aid could be more practical in focus and more clearly presented.
Parts of the background material in the Practice Aid has been consolidated and shortened and the illustrative considerations for audit committees have been updated and made more practical. New sections have been added addressing the audit tender process, stressing that high-audit quality should be the primary selection criterion, and matters to be covered in audit committee reporting.
The framework set out in the Practice Aid focuses on understanding and challenging how the auditor demonstrates the effectiveness of key professional judgments made throughout the audit and how these might be supported by evidence of critical auditor competencies. The Practice Aid also sets out practical suggestions on how audit committees might tailor their evaluation in the context of the company’s business model and strategy; the business risks it faces, and the perception of the reasonable expectations of the company’s investors and other stakeholders.
Although the Practice Aid is designed for premium listed companies, the FRC suggests that it may assist other companies, including those voluntarily adopting the UK Corporate Governance Code
(FRC: Updated practice aid on audit quality for audit committees, 19.12.19)
ESMA: Report on EU issuers' use of alternative performance measures
On December 20, 2019, the European Securities and Markets Authority (ESMA) published a report on EU issuers' use of alternative performance measures (APMs) and on the state of compliance with its APM Guidelines issued in 2016 (Guidelines).
The report builds on a desktop review of the 2018 annual financial reports and ad hoc disclosures regarding annual earnings results of 123 issuers and a qualitative analysis of the application of the Guidelines in prospectuses. It addresses the use of APMs in management reports, ad-hoc disclosures and primary financial statements, and compliance by issuers with the Guidelines in such reports and documents, and suggests that there is significant room for improvement as only a minority of issuers comply with all principles of the Guidelines.
ESMA reports that:
- The use of APMs is widespread in all sectors and across all sizes of issuer and types of regulated document. The most commonly used APMs are Earnings before Interest and Tax (EBIT), Earnings before Interest, Taxes, Depreciation and Amortisation (EBITDA), net debt and operating results.
- Only a minority of issuers sampled complied with all principles of the Guidelines in their annual earnings results, management reports and prospectuses. ESMA calls on issuers to improve their disclosures regarding APMs and encourages issuers to enhance their reconciliations, definitions and explanations in relation to all APMs. ESMA highlights that ratios and subtotals included inside financial statements may also fall within the definition of an APM and therefore should comply with the Guidelines.
ESMA expects issuers to consider the findings of the report when preparing their future communications to the market containing APMs and makes a series of detailed recommendations. ESMA and National Competent Authorities will continue to monitor the application of the Guidelines and take appropriate actions in case of infringements.
(ESMA: Report on EU issuers' use of alternative performance measures, 20.12.19)
Council of the European Union: Regulation as regards the promotion of the use of SME growth markets
On December 12, 2019, Regulation (EU) 2019/2115 amending Directive 2014/65/EU and Regulations (EU) No 596/2014 (MAR) and (EU) 2017/1129 as regards the promotion of the use of SME growth markets was published in the Official Journal.
The text of the Regulation is in substantially the same form as that adopted by the Council of the EU in November.
The Regulation will enter into force on December 31, 2019, save for the amendments to MAR, which will apply from January 1, 2021.
(Council of the European Union: Regulation as regards the promotion of the use of SME growth markets, 12.12.19)
FCA: Primary Market Bulletin No. 26
On December 17, 2019, the Financial Conduct Authority (FCA) published its 26th Primary Market Bulletin (PMB 26). PMB 26 updates a number of the technical and procedural notes in the Knowledge Base to reflect changes driven by the Prospectus Regulation (PR), which came fully into effect on July 21, 2019.
Updates to the Knowledge Base required to reflect the PR will be completed in stages. PMB 26 contains the first stage of updates which are minor changes, such as updates to terminology and rule references which do not materially affect the substance of the guidance. The amended notes are:
- Eligibility process (Primary Market/PN/901.4)
- Circulation and publication of unapproved documents (Primary Market/TN/205.2)
- Refinancing and reconstructions (Primary Market/TN/301.2)
- Open-ended investment companies (Primary Market/TN/423.2)
- Disclosure of 'lock-up' agreements (Primary Market/TN/522.3)
- Public offers (Primary Market/TN/601.2)
- Public offers - the six-day rule (Primary Market/TN/603.2)
- Collective investment undertaking prospectuses - portfolio disclosure (Primary Market/TN/622.2)
- Zero coupon notes (Primary Market/TN/631.2)
- Financial information on guarantors in debt prospectuses and requests for omission (Primary Market/TN/634.2)
The FCA is also deleting three technical notes that it no longer considers relevant. These are:
- Incorporation by reference (UKLA/TN/620.1)
- Risk factors (UKLA/TN/621.3)
- Non-equity prospectuses aimed at retail investors (UKLA/TN/632.1)
The FCA plans to update the remaining notes in future Primary Market Bulletins as these either require more substantive changes and/or reference European Securities and Markets Authority publications which are being updated. The FCA reiterates that in the meantime the existing guidance should be applied to the extent it is compatible with the PR.
(FCA: Primary Market Bulletin, 17.12.19)
FCA: Handbook Notice No 72
On December 13, 2019, the Financial Conduct Authority (FCA) published Handbook Notice No 72 (Notice) and associated instruments. The Notice contains, amongst other things, feedback on the FCA’s quarterly consultation CP19/27 (Consultation) published in September 2019.
Amongst other things, changes have been made to the FCA Handbook to:
- Update references to the UK Corporate Governance Code (Code) to refer to the latest edition of the Code published in July 2018. These changes came into effect on December 13, 2019 but (for issuers with an accounting period beginning before January 1, 2019) certain transitional provisions apply until June 30, 2019.
- Implement requirements for annual corporate reporting in the European single electronic format (ESEF) under the Transparency Directive. These changes also came into effect on December 13, 2019 but are subject to transitional provisions which mean they apply in relation to financial years beginning on or after January 1, 2020.
The above changes are set out in the Listing Rules and Disclosure Guidance and Transparency Rules (Miscellaneous Amendments No 2) Instrument 2019 and are in substantively in the form proposed in the Consultation.
Other areas covered in the Notice and associated instruments include inter alia changes to the supervision manual proposed in the Consultation to reflect minor amendments to certain forms relating to the Alternative Investment Fund Managers Directive and other changes to the FCA Handbook following on from CP19/12 (Consultation on Investment Platforms including a discussion chapter on Exit Fees) and CP19/24 (Recovering the costs of the Office for Professional Body Anti-Money-laundering Supervision).
(FCA: Handbook Notice No 72, 13.12.19)
(Conduct Of Business (Speculative Illiquid Securities) Instrument 2019 (FCA 2019/99), 21.11.19)
(Conduct Of Business Sourcebook (Platform Switching) Instrument 2019 (FCA 2019/103), 12.12.19)
(Alternative Investment Fund Managers Directive (Miscellaneous Amendments) Instrument 2019 (FCA 2019/104), 12.12.19)
(listing Rules And Disclosure Guidance And Transparency Rules (Miscellaneous Amendments No 2) Instrument 2019 (FCA 2019/105), 12.12.19)
(Fees (Office For Professional Body Anti-Money Laundering Supervision) (No 3) Instrument 2019 (FCA 2019/100), 12.12.19)
Technical Expert Group on Sustainable Finance: Handbook on climate benchmarks and ESG disclosures
On December 20, 2019, the Technical Expert Group on Sustainable Finance (TEG) published its handbook on climate transition benchmarks and benchmarks for environmental, social and governance disclosures (Handbook).
The Handbook follows the TEG’s final report on climate benchmarks which was published on September 30, 2019 and aims to clarify the recommendations put forward by TEG and to respond to frequently asked questions from the market.
(TEG: Handbook on climate benchmarks and ESG disclosures, 20.12.19)
European Commission: Commission Delegated Regulation (EU) 2019/2100 published in Official Journal
On December 16, 2019, Commission Delegated Regulation (EU) 2019/2100 amending Delegated Regulation (EU) 2019/815 with regard to updates of the taxonomy to be used for the European single electronic reporting format (ESEF) was published in the Official Journal.
Delegated Regulation (EU) 2019/2100 updates the ESEF regulatory technical standards Delegated Regulation to account for these changes to the IFRS taxonomy, which is updated annually. It will enter into force on January 5, 2020, and will apply to annual financial reports containing financial statements for financial years beginning on or after January 1, 2020.
(European Commission: Commission Delegated Regulation (EU) 2019/2100 published in Official Journal, 16.12.19)
HM Treasury: Money Laundering and Terrorist Financing (Amendment) Regulations 2019
On December 20, 2019, the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (Regulations) were published. These Regulations update the UK’s existing anti-money laundering legislation to implement changes in the EU’s anti-money laundering framework.
The Regulations amend the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (2017 Money Laundering Regulations) to implement amendments made by the Fifth Money Laundering Directive in the UK before the implementation deadline of January 10, 2020.
Regulation 5 of the Regulations amends the 2017 Money Laundering Regulations in relation to customer due diligence measures to be taken by relevant persons.
New Regulation 30A will, when in force:
- Impose a requirement on relevant persons to check beneficial ownership registers of legal entities in scope of the persons with significant control (PSC) requirements before establishing a business relationship. Relevant persons who find a discrepancy between the beneficial ownership information on the registers and the information which becomes available to them in the course of carrying out customer due diligence will be required to report these discrepancies to Companies House. There is a legal professional privilege exception.
- Require the Registrar of Companies to take appropriate actions to investigate and, if necessary, resolve the discrepancy in a timely manner.
The Regulations further amend the Terrorism Act 2000 and the Proceeds of Crime Act 2002 in order to align the definitions of the ‘regulated sector’ in those Acts with the amendments made by the Fifth Money Laundering Directive.
The Regulations also make amendments to the Companies Act 2006 and other companies legislation in order to implement requirements in the Fifth Money Laundering Directive relating to companies.
The Regulations come into force on January 10, 2020.
(HM Treasury: Money Laundering and Terrorist Financing (Amendment) Regulations 2019, 20.12.19)
(HM Treasury: Money Laundering and Terrorist Financing (Amendment) Regulations 2019 – explanatory memorandum, 20.12.19)
FRC: Revised ethical and auditing standards
On December 17, 2019 the Financial Reporting Council (FRC) published its Feedback Statement and Impact Assessment: Revisions to the UK’s Auditing and Ethical Standards, in relation to the final amended versions of certain of its Ethical and Auditing Standards (Revised Standards), changes to which were proposed in July 2019.
The Revised Standards are largely in the form previously consulted on, although certain amendments have been made including, amongst other things:
- Clarifying that the ‘objective, reasonable and informed third party’ (ORTIP) test applies to reporting accountants as well as auditors.
- Certain clarifications relating to the list of permitted services.
- The provision of additional guidance on the definition of a ‘contingent fee.’
- Changing the effective date for the revised Ethical Standards – this was originally proposed to be December 15, 2019 but has been amended to refer to periods commencing on or after March 15, 2020 (subject to certain transitional provisions). The effective date for the revised Auditing Standards remains December 15, 2019.
The FRC also notes that it will monitor the outcome of the Brydon review into the quality and effectiveness of statutory audit in the UK and consider whether further changes are necessary when the recommendations are implemented.
(FRC: Revised ethical and auditing standards, 17.12.19)
ESMA: Undue short-term pressure on corporations report published
On December 18, 2019, the European Securities and Markets Authority (ESMA) published a report on undue short-term pressure on corporations in securities markets (Report). The Report follows a consultation published by ESMA in June 2019 and makes recommendations to the European Commission (Commission) for action in key areas, such as environmental, social and governance (ESG) disclosures, and institutional investor engagement.
On ESG disclosures, ESMA recommends:
- That issuers’ ESG disclosures (which should respect a minimum level of comparability, relevance and reliability) be improved.
- That the Commission considers appropriate amendments to the Non-Financial Reporting Directive (NFRD) to establish principles for high quality non-financial information along with a limited set of specific disclosure requirements.
- Promoting a single set of ESG disclosure standards.
- Requiring the inclusion of the non-financial statements in issuers' annual financial reports and mandating assurance on its content and consistency with other information in the annual financial report.
- Establishing consistency between the NFRD and the Transparency Directive.
On institutional investor engagement, ESMA recommends:
- Reviewing the Public Statement on Information on shareholder cooperation and acting in concert under the Takeover Bids Directive (the White List), and in particular whether the White List should include coordination activities among institutional investors in the area of ESG risks.
- That the Commission considers the effectiveness of a shareholder vote on the non-financial statement to allow investors to express their views on how investee companies address sustainability risks.
- Monitoring the broader application of the Shareholder Rights Directive to assess whether it effectively encourages long-term engagement.
ESMA also recommends that the Commission considers requiring member states to have an adequate independent monitoring framework in relation to the remuneration of listed company directors to ensure the quality of information disclosed in the remuneration reports of listed companies.
The Report has been sent to the Commission which will decide whether to initiate legislative changes to address the Report’s recommendations and monitor the effect of certain legislative acts to assess whether there is a need for further action.
(ESMA: Undue short-term pressure on corporations report published, 18.12.19)
Council of the European Union: Amending Directive as regards cross-border conversions, mergers and divisions published in the Official Journal
On December 12, 2019, Directive (EU) 2019/2121 of the European Parliament and of the Council of November 27, 2019 amending Directive (EU) 2017/1132 as regards cross-border conversions, mergers and divisions, was published in the Official Journal.
The text of the Directive is in substantially the same form as that adopted by the European Council in November.
The Directive will enter into force on January 1, 2020 and member states are required to bring into force the laws, regulations and administrative provisions necessary to comply with it by January 31, 2023.
(Council of the European Union: Amending Directive as regards cross-border conversions, mergers and divisions published in the Official Journal, 12.12.19)