A missed opportunity to reform UK governance
News that the UK is finalising an overhaul of corporate governance, audit controls and oversight is welcome. The process, which will lead to the replacement of the current regulator, has already dragged on too long.
Less welcome is the direction of travel. Details are not yet confirmed, but the government seems to be bowing to business pressure, opting for softer reforms. It will not use legislation to require directors to sign off on companies’ internal controls over financial reporting, along the lines of the US Sarbanes-Oxley Act, and it will extend the remit of the new regulator to fewer companies than it could have done.
The government has to strike a difficult balance at a time when businesses are coping with post-pandemic volatility. Proposals for tighter controls to prevent corporate scandals potentially clash with efforts to make UK markets more attractive following Brexit. The government has to ensure one does not cancel out the other. These new reforms will have the net effect of strengthening the UK governance regime. Just not by enough.
It is regrettable that the government will shun an approach modelled on Sarbanes-Oxley. Such a step would add more legal teeth to its attempts to improve internal controls and risk management. Instead of legislating, it looks likely to push provisions to ensure directors make an annual statement about the effectiveness of their controls into the UK’s corporate governance code. Those guidelines are much admired, and copied in other jurisdictions, but they are harder to enforce and companies can decide not to comply, provided they explain why.
What is more, only companies with a premium listing in the UK are required to follow the code. They are exactly the enterprises that tend to have strong controls already. Outside that group are many small and medium-sized listed companies, as well as an entire swath of privately held businesses. From Patisserie Valerie to BHS, this is where some of the biggest recent corporate scandals have erupted.
Confidence in UK plc is critical to making the City more alluring to investors. Some of the larger private companies will be supervised by the new regulator, the Audit Reporting and Governance Authority, though the government will not extend its scope as much as it should have. With most directors largely untroubled by the reforms, ARGA and external auditors will now face even more pressure to do the job of oversight and control. A rare opportunity to spur a wider range of companies to improve their governance now risks being missed.
“Business opposes more regulation” is as obvious a headline as “dog bites man”, but experience does not always support doom-mongering executives and directors. After initial turbulence, Sarbanes-Oxley settled down to become a useful element of the US regulatory toolbox. In the UK, bankers fretted about the senior manager certification regime introduced in 2016, warning it would blunt risk-taking, hinder decision-making, and blight director recruitment. Few if any of those predictions came true.
Meanwhile, this government needs to take care about the signals it sends, and not only because it is embroiled in separate allegations of “sleaze”. The business department’s intention to go for a looser approach to governance reform and the Treasury’s parallel proposals that UK financial watchdogs should consider the implications of their work for “growth and competitiveness” are faintly reminiscent of the early 2000s. The then government unwisely celebrated “light touch” regulation. We all know how that ended.