UK: To Tender Or Not To Tender

Amendments To The Corporate Governance Code And Guidance On Audit Committees
Last Updated: 26 November 2012
Article by Mark Howard

In April 2012, the Financial Reporting Council (FRC) published a consultation paper seeking feedback on proposals to amend the provisions of the UK Corporate Governance Code (the Code) and the Guidance on Audit Committees (the Guidance). Following a period of public consultation, the FRC has now published a feedback statement (dated 28 September 2012) and new editions of both the Code and the Guidance. We have provided a summary of the key amendments, as they appear in the new editions, for you below.

Statement of the Board

The Code has been amended so that the board must include in its annual report and accounts a statement confirming that the report and accounts, taken as a whole, are fair, balanced and understandable and provide the information needed for shareholders to assess the company's performance, business model and strategy.

The FRC's initial proposals had required the board to set out the reasons why it considered the annual report and accounts, to be fair, balanced and understandable. However, there was concern from commentators that this did not set out clearly and explicitly what was required of the board. It was also suggested that disclosures regarding the basis of the board's consideration could simply lead to a generic description of the process cluttering the annual report.1 The final drafting has been revised to provide further clarification on this point and aims to express the FRC's intentions more distinctly.

Going forward, a new supporting principle will also require boards to establish procedures or arrangements that will enable them to make an appropriate assessment prior to committing to the requisite statement. It has been left up to the board to decide what, if any, role the audit committee should have in this procedure.


In order to address the dominance of the Big Four, and a perceived impairment of the auditor's independence and the quality of the audit due to extended tenure, the Code and Guidance has been amended to require all FTSE 350 companies to put their external audit contract out to tender at least every ten years.

The FRC has made it clear that tendering is on a "comply or explain" basis and is not intended to amount to mandatory rotation by another name. Therefore, where a company does not think it is in the best interests of its business or shareholders, it has some flexibility as to when it chooses to put its contract out to tender. It has also been made clear that a company is free to award the audit contract to its existing auditors, if this is the decision of the board on conclusion of the tender process.

The FRC had initially proposed that the tenders should be conducted on an open book basis. However, this was seen as undermining the FRC's objective as it is anticompetitive to allow competing firms access to the audit files, and therefore the intellectual property, of the existing auditors. In any event, as the Code is applicable to the companies themselves and not binding on their auditors, it would be impractical and inappropriate, for the Code to require that access be granted to an audit firm's working papers.2 Therefore, the final wording was replaced with a requirement that all tendering firms should have such access as is necessary to information and individuals during the tendering process.

The timing of implementation of these amendments has attracted criticism, including from a number of the accounting firms themselves, in view of the ongoing debates concerning audit policy in the UK and Europe. In October 2011, the Office of Fair Trading (OFT) made a reference to the Competition Commission (Commissions) following its identification of features of the UK statutory audit market for large companies which the OFT considered it had reasonable grounds to suspect prevents, restricts or distorts competition. In particular, it highlighted that the market is highly concentrated (with the majority of the market engaging the Big Four), with substantial barriers to entry and switching (an example frequently put forward is that on average a FTSE 100 company only changes its auditor every 48 years).

The Commission has been engaged in a year long investigation into the issue. Masses of working papers have been released which give some insight into the Commissions findings so far. The Commission has identified its "theories of harm", which could be present in the market, as (1) suboptimal audit quality and levels of innovation; (2) higher prices and costs; and (3) less competition in non-auditing markets. The Commission went on to state that its initial view is that there are barriers to entry and expansion in the market. The Commission is due to release its provisional findings in January 2013 and we expect that at that time it will announce its proposals for further policy change.

Concurrently, the European Commission (EC) has also been addressing the issue of audit policy. It issued its proposals for a draft Directive (requiring national implementing measures) and Regulation (which has direct effect) in November 2011. Its proposals include mandatory rotation of audit firms (with a maximum engagement of 6 years and a cooling off period of 4 years, during which the previous firm cannot be re-engaged), mandatory tendering and prohibition on providing non-audit services to audit clients. If implemented, the EC's proposed measures would be a radical shake up of the statutory audit market, not just in the UK but across the European Union.

Other Provisions

There are a number of other amendments to the Code and Guidance which have been incorporated into the new editions. In accordance with the FRC's intention to assist companies manage regulatory change, some of these amendments though addressed in previous consultations will come into effect at the same time.

We briefly, summarise these amendments below.

  • Further clarification of what is required as an explanation under the "comply or explain" principle. In providing an explanation, the company should "set out the background, provide a clear rationale for the action it is taking, and describe any mitigating actions taken to address any additional risk and maintain conformity with the relevant principle. Where deviation from a particular provision is intended to be limited in time, the explanation should indicate when the company expects to conform with the provision." In respect of the last sentence of this additional wording, the FRC has made it clear that this wording in no way infers that any deviation from the Code must be temporary
  • The public reporting requirements in the Code are extended by new provision C.3.8, which provides more prescriptive guidance as to the content of the audit committee's report, so as to encourage more informative reporting. It requires that the audit committee's report should include "(1) the significant issues that it considered in relation to the financial statements, and how these issues were addressed; (2) an explanation of how it has assessed the effectiveness of the external audit process and the approach taken to the appointment or reappointment of the external auditor, and information on the length of tenure of the current audit firm and when the tender was last conducted; and (3) if the external auditor provides non-audit services, an explanation of how auditor objectivity and independence is safeguarded."
  • As we reported in our November 2011 update, principle B.2.4 of the Code will be amended to require listed companies to report annually on their boardroom diversity policy, including gender diversity, and on any measurable objectives that the board has set for implementing its policy and the progress it has made in achieving such objectives.
  • A new supporting principle B.6 will be introduced. It states that "evaluation of the board should consider the balance of skills, experience, independence and knowledge of the company on the board, its diversity, including gender, how the board works together as a unit, and other factors to its effectiveness".

We note that the new editions of the Code and Guidance will apply to reporting periods beginning on or after 1 October 2012.


1 Memorandum of comments dated July 2012 by ICAEW

2 PWC's response to the FRC's Consultation Paper dated 6 July 2012

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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