U.K. Government Looks to Limit Dominance of Big Four Audit Firms

Tuesday’s proposal confirmed plans to replace the Financial Reporting Council, which currently oversees audit and accounting in the U.K., with the Audit, Reporting and Governance Authority, a newly created regulator. Moreover, ARGA will be given the authority to require audit firms to keep their audit and nonaudit functions operationally separate.

The FRC in 2020 told the Big Four that it expected this separation by June 2024. EY is currently weighing a split of its audit and advisory functions, though the plan is in the beginning stages and requires approval of the firm’s partners across the globe.

The government on Tuesday noted a prior commitment to publish a draft of the U.K. audit revamp bill this parliamentary session, which opened in May and ends in April 2023. The proposal would then follow normal parliamentary procedure, requiring a vote.

James Barbour, director of technical policy at the Institute of Chartered Accountants of Scotland—a professional body of chartered accountants—said the government looks to fast-track the process, though that still puts it at two years at the earliest before a law is on the books.

Under the proposed changes, regulators would have the power to penalize board members of large companies who breach their legal duties around reporting and audit, a departure from rules in which only directors who are also accountants face potential sanctions. However, the government dropped an earlier proposal to hold board members personally liable for failed oversight of internal controls over financial reporting similar to the Sarbanes-Oxley Act in the U.S. Instead, directors from large listed companies will have to state why they think internal controls are sufficient, per a provision that is expected to be added to the U.K. corporate governance code, a guidebook for companies’ conduct that directors can comply with or explain reasons for why companies aren’t.

Even with the so-called “comply or explain” option, though, Mr. Barbour said there are teeth to the changes that companies and directors will have to take notice of, as investors and other stakeholders won’t likely take well to attempts to explain away noncompliance. “We do think that there’s a lot in this and companies will really need to focus minds to make sure they have the internal controls,” he said.

The U.K. government watered down certain elements of previous proposals, including giving the country’s audit watchdog authority over the audits of private companies with more than £500 million in annual revenue, equivalent to roughly $630 million, and more than 500 employees. Instead, the regulator will have oversight over private businesses with more than £750 million in annual revenue and more than 750 employees, in addition to publicly traded companies.

The revisions have been years in the making, with pressure building to overhaul the audit sector following a series of scandals involving companies including construction company Carillion PLC, which collapsed in 2018. Due to lax accounting standards, the company was able to hide hundreds of millions of pounds in liabilities.

PwC didn’t immediately respond to a request for comment.

Stephen Griggs, U.K. managing partner at Deloitte, described the revisions as a “key step forward” to enhance the reporting system in the U.K. Deloitte is an advertising partner of CFO Journal.

KPMG and EY said the changes were welcome but didn’t go far enough in certain areas. “The apparent decision not to include a U.K. version of Sarbanes-Oxley in primary legislation leaves corporate Britain with no clearly defined framework for internal controls, and risks a pick’n’mix approach to reporting and measurement,” said Jon Holt, chief executive of KPMG in the U.K.

The decision not to implement rules akin to Sarbanes-Oxley amounts to a “missed opportunity” to improve controls in the U.K., said Jon Thompson, chief executive of the FRC.

The Institute of Chartered Accountants in England and Wales, an accounting industry organization, called the changes halfhearted. “Lessons from Carillion and other recent company failures have been ignored, with little emphasis now on tightening internal controls and modernizing corporate governance,” said Michael Izza, chief executive of the ICAEW.

Write to Jennifer Williams-Alvarez at jennifer.williams-alvarez@wsj.com