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CMA final report calls for mandatory joint audit and operational split

The UK’s Competition and Markets Authority (CMA) has called for mandatory joint audits and an operational split of the Big Four in its final report on the UK audit market.

The CMA said legislation is needed to ‘address both the vulnerability of the industry to the loss of one of the Big Four, and the current inadequate choice and competition’.

Operational Split

In its update paper published in December 2018, the CMA acknowledged the difficulties of introducing an immediate global structural split so has therefore suggested an operational split in the UK.

The operational split would require:

  • Separate management, accounts and remuneration
  • A separate CEO and board for the audit arm
  • Separate financial statements for the audit practice
  • An end to profit-sharing between audit and consultancy
  • Promotions and bonuses based on the quality of the audits

The CMA said this would allow for auditors to exclusively focus on ‘producing the most challenging and objective audits’.

Some have argued that an operational split would not go far enough to address some of the problems. In the BEIS report, UK MPs called for a full legal split, however, they also noted some of the difficulties in achieving this.

Mandatory Joint Audits

The CMA said mandatory joint audits would increase the ‘capacity of challengers, to increase choice in the market and thereby drive up audit quality’.

The report said: “Challenger firms should work alongside the Big Four in these joint audits and should be jointly liable for the results. There should be initial limited expectations to the requirement, based on criteria set by the regulator, focused on the largest and most complex companies.”

An exemption to this will be if a company choses a sole ‘challenger’ firm to be its auditor.

However, the introduction of joint audits is not due to become permanent. The CMA said it should ‘remain in place until the regulator determines that choice and competition have improved enough to address the vulnerability of the market to the loss of one of the Big Four’.

Regulation of Audit Committees

The CMA recommended that the regulator should hold audit committees to account ‘more vigorously’, which could include ensuring committees report their decisions as they hire and supervise auditors, and that the regulator issues public reprimands to companies whose committees fall short of adequate scrutiny of their auditors.

Five-year review

The CMA has recommended that the regulator should review the effects of these changes periodically, ‘in the first instance five years from full implementation’.

The review of the changes should consider:

  • The merits of moving to independent appointment for auditors
  • Whether to go beyond the operational split already proposed
  • How to ‘fine-tune’ the joint audit remedy to adapt to market developments

 

The recommendations follows the December update paper and has taken account of the report published by the Business, Energy and Industrial Strategy select committee on the future of audit and the Kingman review which called for the UK’s Financial Reporting council to be replaced by the Audit, Reporting and Governance Authority (ARGA).

CMA chairman Andrew Tyrie said: “People’s livelihoods, savings and pensions all depend on the auditors’ job being done to a high standard. But too many fall short – more than a quarter of big company audits are considered sub-standard by the regulator. This cannot be allowed to continue.

“The Government now has three reports to hand. In large part, they come to similar conclusions. Conflicts of interest cannot be allowed to persist; nor can the UK afford to rely on only four firms to audit Britain’s biggest companies any longer. Early action will require legislation – hence the CMA’s proposals.”

CMA chief executive Andrea Coscelli said: The UK is recognised as having a strong history in the fields of corporate governance and accounting.

“Our recommendations, along with improvements to regulation and clarifying the purpose and scope of audits, will ensure the UK strengthens its position.

“We look forward to supporting the Government as it considers how best to take forward these changes through legislation, alongside Sir John Kingman’s recommendations on regulation and the results from Sir Donald Brydon’s review on the quality and effectiveness of audit.”

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