Correspondence

Response to Government consultation restoring trust and confidence in audit and corporate governance

Published 26 July 2021

Applies to England and Wales

Introduction

The Charity Commission England and Wales (the Commission) is a non-ministerial government department and we are the regulator of charities in England and Wales.

The Commission’s purpose is to ensure charity can thrive and inspire trust so that people can improve lives and strengthen society. Our purpose informs everything we do and how we approach our work. Our 5 strategic objectives are:

1. holding charities to account
2. dealing with wrongdoing and harm
3. informing public choice
4. giving charities the understanding and tools they need to succeed
5. keeping charity relevant for today’s world

Under the Charities Act 2011, we are charged with statutory objectives against which we must deliver. These include increasing public trust and confidence in charities, enhancing the accountability of donors, beneficiaries and the general public and promoting the effective use of charitable resources.

This submission sets out the Commission’s response to BEIS consultation dated 18 March on ‘Restoring Trust and Confidence in Audit and Corporate Governance’.

Summary of Commission’s position

The Commission supports the Government’s objective to improve the UK’s audit and corporate governance framework. However, in terms of the charitable sector the Commission’s position is that it does not support extending a framework designed with the interests of shareholders and for-profit commerce in mind to the charity sector where these imperatives simply do not apply. We therefore recommend that charities are not included within the definition of Public Interest Entities ‘PIEs’ and associated corporate reforms.

In arriving at its position, the Commission considered the detail in the consultation against the existing frameworks, summarised later in this submission, that are in place for the charitable sector. The Commission also considered whether there was any evidence to suggest that risks/problems are prominent in the charitable sector that would warrant introducing such extensive additional regulatory burden and financial cost on the sector, which, inclusion within the PIE regime would bring. Having considered the existing charity reporting and governance framework and the absence of comparable failures to those cited in the consultation document, the Commission concluded that the case has not been made for including charities as PIEs.

In carrying out its regulatory function the Commission publishes guidance and policy for charities that is tailored for the charity sector and central to this is the Commission’s statutory duty to increase public trust and confidence in charities. In considering the reforms discussed in the consultation we identified synergies with existing published Commission regulation, guidance and policy already in place for the charitable sector and are of the view, that this already covers much of the intended reforms.

The Secretary of State’s foreword says “It is vital that investors, financial markets and all those who depend on the largest companies in the UK can continue to rely on the information they publish. I am determined to reinforce the UK’s position in the wake of large corporate failures that have led to job losses and uncertainty among small businesses and local communities. I want to ensure investors can get high quality, focused and reliable information on UK companies so they can invest here with even greater confidence.” A strong message throughout the consultation is that many of the reforms are designed with the for-profit commercial sector in mind focusing on shareholder and investor needs with many references being made to the Corporate Governance Code and Listing Rules. The consultation did not refer to the existing regulatory framework and mechanisms that are in place and have been designed for the not-for-profit sector.

Instead of proceeding with the designation of certain charities as PIEs, we invite Government (BEIS) to work with the Commission and the charity sector and stakeholders to establish the extent to which the existing mechanisms that are already in place for the charitable sector could be enhanced to meet the desired outcome of the Government of improved corporate governance and oversight.

Summary of the existing charity governance and reporting framework and existing oversight mechanisms

We have set out below some relevant detail about the existing charity framework as it is relevant to those reforms in the consultation that are intended to encompass PIEs.

The charity framework consists of Charity Law, Charity Commission policy and guidance and in terms of charity reporting and accounting the Charities Statement of Recommended Practice ‘the SORP’. Charitable companies are also subject to provisions of Company law in respect of the duties on directors, accounts preparation and audit. This is supplemented by good practice sector guidance and in particular the Charity Governance Code and the oversight of fundraising by the Fundraising Regulator.

The SORP is applicable to charities preparing their accounts in accordance with the Financial Reporting Standard applicable in the UK (FRS102). The Commission is joint SORP-making body and the SORP-making body is recognised by the Financial Reporting Council. The SORP provides sector specific guidance for charities on how to apply the Financial Reporting Standard (FRS102). Due to the public interest charities present the SORP includes charity specific requirements that are additional to those of FRS102. In particular, additional requirements relating to; the trustees’ annual report and additional disclosures aimed at providing a high level of accountability and transparency to donors, funders, financial supporters and other stakeholders. The next SORP is currently in development and there is an opportunity to feed into this development. Insofar as the proposals look to introduce new reporting requirements, enhancing the SORP would mean that these requirements could be modified to be relevant to charities.

There are two forms of external scrutiny that can be carried out on charity reports and accounts, being, audit and independent examination. Both are tailored to the charity sector and the professionals providing the services to charities are subject to a legal duty to report certain matters of material significance directly to the Commission. The thresholds for audit are significantly lower in the charitable sector due to the public interest, this in turn brings more oversight and assurance.

The Commission requires trustees to report serious incidents to the Commission. This is a legal requirement in submitting their annual return and there is guidance detailing what such matters should be reported.

Both the auditor and examiner reporting regime and the serious incident reporting enables the Commission to be sighted on risks and issues and this enables the Commission to assess issues and engage with Charities as necessary. This reporting is over and above what is required in the private sector and the powers intended for the new Auditing Reporting and Governance Authority (ARGA).

In terms of internal financial controls, the Commission issues sector specific guidance. This guidance is also considered by both the auditor and independent examiner when they conduct their external scrutiny.

The Commission has published guidance in relation to risk and reserves and would highlight that charities are already currently subject to additional reporting requirements under the Charities SORP in terms of financial review, risk reporting and reserves reporting. This reporting is over and above what is required in the private sector. Insofar as the reforms envisage a discussion of distributable reserves, the Commission’s guidance already covers this matter.

The Commission has regulatory powers in place that are provided in the Charities Act. The powers include but are not limited to trustee disqualification, trustee suspension, trustee removal, official warning, appointment of interim managers, directing orders and information gathering powers. These powers are far reaching, effective and are used to deal with wrong-doing and harm. Although the new ARGA will be expert in corporate reporting, it lacks the required knowledge of the duties of trusteeship, charity law and the experience of the sector to effectively oversee charities, such is expertise already found in the charity regulators in the UK.

The Commission believes that the existing framework is fit for purpose for the charity sector and in many areas has been developed in consultation with the sector. To introduce a new framework for charities will increase the regulatory burden for the sector with cost implications that will impact the sector without any assurance that the framework will deliver the enhanced assurance desired.

Detailed response to relevant questions

Question 1 - Should large private companies be included within the definition of a Public Interest Entity (PIE)? Please give your reasons.

The Commission would not recommend that charities be included within the definition of a Public Interest Entity (PIE).

In framing our response, we note that the reforms set out in the consultation reference the interests of shareholders and the issues facing for-profit corporations. The resulting proposals have been developed with the for-profit sector at its heart and as such are not, in our view, readily transferrable to the charity sector. In keeping with the tenor of for-profit corporations as the primary focus we note that although examples are given of corporate failures that necessitate reform no evidence or examples are provided demonstrating similar failures in the charity sector.

Charities registered in England and Wales are already regulated by the Commission and are already subject to a robust and enhanced regulatory framework because of the public interest they present. In considering whether larger charitable companies should be included within the PIE definition the Commission considered the current regulatory framework relevant for charities and the proposed framework that would apply to larger charities if included within the PIE definition. The Commission concluded that in many areas there is an existing framework in place that deals with the issues that this reform seeks to address.

The Commission would recommend that consideration be given to looking at ways of enhancing the existing mechanisms, which have been designed for the charity sector and have evolved over time taking into account risk and proportionality. The Commission acknowledges and appreciates that recent corporate failures in large businesses has impacted on confidence in audit and corporate reporting but is not aware of any comparable larger charity failings and so it is difficult to understand the driver for this reform in the charity sector.

Question 2 - What large private companies would you include in the PIE definition: Option 1, Option 2 or another? Please give your reasons.

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1.

Question 6 - Should the Government seek to include large third sector entities as PIEs beyond those that would already be included in the definitions proposed for large companies? If so, what types of third sector entities do you believe should be included and why?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1.

Question 7 - What threshold for ‘incoming resources’ would you propose for the definition of ‘large’ for third sector entities? Is exceeding £100m too high, too low or, just right?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1.

In respect of the suggested £100m incoming resources threshold, it is not clear from the consultation why the incoming resources threshold for charities of £100m has been suggested. This is a much lower threshold than the thresholds suggested for larger companies and does not take into account the balance sheet or employee numbers like the options for larger companies do. If the reforms are intended to mitigate economic impact, then the case for a lower threshold for charities was not made in the consultation.

Question 9 - How would an increase in the number of PIEs impact on the number of auditors operating in the PIE audit market?

Charity audit is recognised by the FRC as a specialism and has its own individual application of International Standards of Auditing in auditing Practice Note, PN11. If charities were to be included as PIEs the Commission would have concerns that there would be insufficient audit resource and experience to deliver the service to charities which would be detrimental to the charity sector and stakeholders.

Question 9 - Do you agree that the Government should provide time for companies to prepare for the introduction of a new definition of PIE?

Given the substantial changes it would be important to allow companies time to prepare for the introduction of a new PIE definition. This will allow companies to better plan for the regime. Should the proposals be implemented for charities then timing these reforms to coincide with other planned changes to accounting standards would be desirable. See our answer to question 1 as to why charities should not be included.

Question 12 - Is there a case for strengthening the internal control framework for UK companies? What would you see as the principal benefits and disbenefits of stronger regulation of internal controls?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1. The Commission acknowledges that strengthening the internal control framework for UK companies would bring benefits and more assurance.

In terms of charities there is already a framework in place which the external scrutiny needs to pay regard to and this framework is regularly reviewed. Insofar as the reforms look to enhance the Board oversight of internal financial controls beyond the existing guidance, these adaptations can be readily accommodated in a future update to our guidance.

Question 13 - If the control framework were to be strengthened, would you support the Government’s initial preferred option (Table 2)? Are there other options that you think Government should consider? Should external audit and assurance of the internal controls be mandatory?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1.

In respect of the existing framework for charities, there is published Commission guidance on charity internal financial controls, CC8 Internal financial Controls ^{[footnote 1]} which is sector specific and includes a checklist for charities to use.

In relation to the external scrutiny of charity reports and accounts both forms of external scrutiny (audit and independent examination) take account of the internal control framework in place for charities. For charity audit the relevant practice note PN11 ^{[footnote 2]} requires auditors to take account of guidance issued by the Commission when obtaining an understanding of the control activities relevant to the audit. For charity independent examination, Commission guidance ^{[footnote 3]} states the examiner is recommended to consider whether there is evidence that the financial controls are either not present or not operating as they should.

There is also a legal duty ^{[footnote 4]} for the auditor or examiner to report matters of material significance to the Commission. In terms of reporting such matters to the Commission this is a legal requirement under sections 156 and 159 of the Charities Act 2011. There is a published list of matters and one of the reportable matters relates to ‘Internal Controls and Governance’. In particular it states that auditors and examiners should report matters of ‘failure(s) of internal controls, including failure(s) in charity governance that resulted in, or could give rise to, a material loss or misappropriation of charitable funds, or which leads to significant charitable funds being put at major risk.’ There is also the requirement to report matters relating to Dishonesty and Fraud, Money Laundering and Criminal Activity, Support of Terrorism, Risk to charity’s beneficiaries, Breaches of law or the charity’s trusts, Breach of an order or direction made by the charity regulator, Modified auditor opinion or qualified independent examiner report and Conflicts of interest and related party transactions. This framework has been designed for the charity sector and is applicable to charities subject to external scrutiny irrespective of size.

The Commission collects data from charities using the Annual Return form. As part of the Annual Return questions, charities are asked the following question in relation to financial controls “During the financial period for this annual return, did your charity review its financial controls?” This is over and above what the for-profit sector are required to do.

In terms of serious incidence reporting Charities are required to self-report to the Charity Commission and reportable incidents do link to internal controls. The Commission has published guidance ^{[footnote 5]} for trustees in this area.

The consultation omits any reference to the existing charity framework, so it is not clear from the consultation whether the existing charity framework has been considered in developing the consultation proposals. The Commission would suggest that the current charity framework for internal controls be reviewed to establish what enhancements, if any, would be needed. This approach would ensure that the regime is fit for the charity sector and would also build on the existing work in this area that has been developed by the Commission.

Charities producing ‘true and fair’ accrual accounts are required to produce their report and accounts in accordance with the Charities Statement of Recommended Practice (SORP). The SORP is currently going through a development process and suggested improvements to the reporting on internal controls could potentially be fed into the SORP development process. If changes to SORP were made in this area then this would result in earlier changes in reporting for the sector as the next SORP is timetable for publication in 2024, which would likely to be in advance of the implementation of the reform in the consultation.

Question 14 - If the framework were to be strengthened, which types of company should be within scope of the new requirements?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1

As explained above charities already have a framework in place that is relevant for the charity sector. We would suggest that reforms might be better achieved by strengthening the existing framework and oversight mechanisms.

Question 19 - Do you agree that the above matters should be included by all companies in the Resilience Statement? If so, should they be addressed in the short or medium term sections of the Statement, or both? Should any other matters be addressed by all companies in the short and medium term sections of the Resilience Statement?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1.

The Commission would highlight that charities are already currently subject to additional reporting requirements under the Charities SORP in terms of financial review, risk reporting and reserves reporting that is relevant to resilience reporting. In addition to the SORP reporting requirements the Commission produces sector specific guidance on Charity reserves building resilience ^{[footnote 6]} and Charities and risk management ^{[footnote 7]}.

The SORP making body is considering charity reserves reporting in the current SORP development work. Enhancing the reporting of the trustees’ conclusions as to the financial resilience of their charity might better be considered in the review of the existing going concern disclosures that the SORP requires.

Question 20 - Should the Resilience Statement be a vehicle for TCFD reporting in whole or part?

There is a concern that the directors and trustees’ reports grow in length due to additional disclosures thereby making it harder for stakeholders to find the information they are seeking. It is desirable to take a more holistic view of corporate reporting into account, including climate change and carbon reporting. The review of the SORP is already looking at climate change reporting in the context of sustainability reporting and this framework offers a better solution for charities than imposing forms of reporting not designed with the charity sector in mind.

Question 21 - Are there any other arrangements the Government should consider to ensure that overlapping powers are managed effectively?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1. The Commission is the UK regulator of charities in England and Wales and has powers under the Charities Act. Were the proposals to proceed to include certain charities as PIEs then it would be essential for ARGA to work closely with the Commission.

Question 33 - Should the Government’s proposed enforcement powers be made available to the regulator in respect of breaches of directors’ duties?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1

The Commission has regulatory powers in place that are provided in the Charities Act. The powers include but are not limited to trustee disqualification, trustee suspension, trustee removal, official warning and appointment of interim managers. These powers are far reaching and effective and are used to deal with wrongdoing and harm.

If ARGA was to be able to investigate and sanction this would introduce dual regulation and would be confusing for the sector and stakeholders and so a process would need to be in place to ensure ARGA collaborates closely with the Commission.

Question 94 - Are there others matters which PIE auditors should have to report to the regulator? Could this duty otherwise be improved to ensure that viability and other serious concerns are disclosed to the regulator in a timely way?

The Commission would not recommend that charities be included within the definition of a Public Interest Entity. See our answer to question 1

There is an existing regime in place for charity auditors and examiners which is tailored for the charity sector ^{[footnote 8]} with reporting to the charity regulator. Introducing separate requirements to report certain matters to ARGA adds to regulatory cost without necessarily delivering any enhanced oversight of charities.

1. Internal financial controls for charities (CC8) - GOV.UK (www.gov.uk) ↩

2. PN11 1..90 (frc.org.uk) ↩

3. Independent examination of charity accounts: examiners (CC32) - GOV.UK (www.gov.uk) ↩

4. Charities Act 2011 (legislation.gov.uk) ↩

5. How to report a serious incident in your charity - GOV.UK (www.gov.uk) ↩

6. Charity reserves: building resilience (CC19) - GOV.UK (www.gov.uk) ↩

7. Charities and risk management (CC26) - GOV.UK (www.gov.uk) ↩

8. Charities Act 2011 (legislation.gov.uk) ↩