The long-awaited provisional findings of the UK Competition Commission (CC) have generally pleased mid-tier networks and caused concern among the Big Four, as it has declared that factors inhibiting companies switching auditors are restricting competition in the audit market, and proposed bolder remedies than preliminary reports had led the industry to expect.
So far the CC has only published a summary of its findings and suggested remedies, with a full report expected sometime next week explaining the rationale behind today’s release.
On the list of actions flagged for consideration by the CC are mandatory tendering and rotation, increased transparency with more frequent audit reviews and extended reporting requirements, and the strengthening accountability and independence by giving audit committees and shareholders greater control of external auditors.
The first to respond to the CC’s provisional findings was PwC UK’s head of reputation and public policy Richard Sexton, who told International Accounting Bulletin that this morning’s report lacked the details that, "we would have expected so far, and the rationale behind the comments the CC are making".
Nevertheless, Sexton continued: "We find some of their comments odd given the evidence we have given, and a bit surprising as a result. We had no indication from the working documents published that the CC had this level of concern. We believe that the CC has grossly underestimated the critical role that audit committees play in protecting the interests of shareholders and governance. We are, under the law, not allowed to speak to shareholders about anything, and that is why audit committees are there. But that seems to have completely bypassed the CC."
Ernst & Young UK and Ireland head of assurance Hywel Ball said the firm strongly disagrees with the CC’s statement that the audit market is not serving shareholders.
" We note that much of the summary is on aspects of corporate governance and regulation, and in that context we are surprised that there are important omissions from the description of how that framework operates," he said.
"For example, there is no mention of the role of the Chair of boards and the senior independent directors in representing and safeguarding shareholder interests, nor of the importance of unitary boards themselves. We think the somewhat stark description in black and white terms of the role and power of the finance directors and their motives does not represent the real world as we experience it."
One of the most controversial remedies offered by the CC regards mandatory tendering, which the CC believes should take place more frequently than every 10 years, as currently suggested by the Financial Reporting Council.
"We do not support their suggestions as regards mandatory tendering or rotation" commented KPMG UK chairman and senior partner Simon Collins. "After long deliberation and consultation, the FRC has only just introduced tendering every ten years on a "comply or explain" basis, and this is already having a significant impact. We supported this measure as we believe it fits with the corporate governance framework in the UK and reinforces audit committee oversight of the external auditor. Arbitrary pre-set periods will do the reverse and potentially damage audit quality, and forced rotation will undermine audit committees and actually reduce shareholder choice. It is premature, therefore, to disregard the FRC measures as an effective remedy."
Collins also said KPMG UK does not agree with what it sees as the CC’s conclusion that, effectively, audit committees are not doing their jobs properly. "In our experience, audit committees in the UK generally take their responsibilities seriously, both for oversight of the external auditor and financial reporting more generally. Indeed if audit committees were not functioning properly, it would have much more fundamental ramifications for UK corporate governance," he said.
Mid-tier firms have been more welcoming of the CC’s provisional findings, with Mazars’ UK head of public interest markets David Herbinet saying: "We applaud the CC’s findings and, in particular, the emphasis on the primacy of the auditors’ duty to shareholders. We’ve been active in this debate for the best part of the last decade and the CC deserves praise for its study: it’s the most thorough and independent inquiry ever into the FTSE 350 audit market in the UK and reflects the situation of most other national audit markets. It’s clearly going to make a significant contribution in Brussels as the European institutions decide the way forward on the future shape of the EU audit market."
Herbinet continued: "No one can deny now that a major programme of reform is required as an urgent matter of public interest. The status quo is not an option. The key objective of reform must be to create a level playing field amongst the various firms with the capability to audit FTSE 100 and FTSE 250 companies. It is vital that all the key players – investors, boards and audit firms – work together to come up with viable and forward looking solutions."
A spokesperson representing Grant Thornton UK also welcomed the CC’s "recognition that there are barriers to entry which prevent capable and credible audit service providers from effectively competing in this market", as well as its intention £to consult on a range of possible remedies to address the issues which it has identified".
The spokesperson continued: "We support the creation of a diverse market for the supply of audit and non-audit services to the FTSE 350 with increased competition bringing benefits through improved pricing, service, innovation and overall audit product. The implementation by the CC of an appropriately balanced package of remedies will improve the diversity of the market and assist firms such as Grant Thornton to accelerate their expansion in this market".
BDO UK’s managing partner Simon Michaels also welcomed the CC’s announcement and said: "The CC has identified a challenge to the audit profession in demonstrating that it is, and appears to be, independent from client management. This is a challenge we acknowledge and which requires careful thought prior to selection of remedies. The CC has until October of this year to finalise its report and, in particular, to select remedies to correct the market defects. The remedies selected by the CC need to be effective and comprehensive. No one solution will achieve market correction, but rather a combination of tendering requirements, encouragement of transparency and dialogue between auditors, companies and investors, and reform of outdated exclusionary practices should provide a backdrop for a healthier FTSE 350 audit market."
Professional bodies join the debate
ACCA technical director Sue Almond said that the whole point of this investigation has been about the audit market’s structure.
"While the audit market is static, it must be remembered that auditors act as society’s eyes and ears to report fraud, bribery and money laundering activities; they also assist the assessment and collection of both direct and indirect taxation, so the future of audit services need to be assured and supported," she said.
Looking at the remedies ACCA said it does not believe that there is evidence that mandatory rotation increases audit quality.
"Given the complexity of modern business, it can take two years plus before a new auditor is up to speed, and losing that long-held knowledge could be potentially disruptive for a company. ACCA would prefer to see an emphasis on competitive tendering."
ACCA also echoed the comments made on tendering by backing the current suggestion by the FRC.
"Tendering takes a lot of effort and resources; it would be better to have the audit committee explain why they suggest to maintain an auditor without tendering after 10 years, as proposed by the FRC," ACCA said.
Institute of Chartered Accountants for England and Wales (ICEAW) chief executive Michael Izza warned that it is important to see the CC’s report in context.
"The UK audit and accounting sector is a significant success story which not only contributes over 1% of GDP in its own right but helps support businesses of all sizes across every economic sector driving employment and growth. The accountancy profession is also the biggest single employer of graduates in the UK and a great British export. It is therefore critical when looking at how these measures are implemented, that they do not undermine or destabilise what is such an important sector for the UK economy. They also need to be seen in an international context and be consistent with proposals currently being considered in Europe," he said.
"Increasing market choice will only be possible if audit committees – who are responsible for appointing auditors – recognise that there is huge quality and talent to be had outside the Big Four accounting firms," Izza added.
The Institute of Chartered Accountants of Scotland (ICAS) also warned against remedies such as mandatory rotation and tendering saying such measures is unlikely to increase the level of choice in the market.
Responding to provisional recommendations by the CC that companies should change audit firms every 7, 10 or 14 years, ICAS director of technical policy James Barbour questioned the reasoning behind this proposed remedy to increase choice and whether it would merely result in the work being reallocated amongst the Big Four firms.
"We are concerned that today’s proposals may not achieve their central aim. It remains to be seen how exactly they would expand the pool of audit firms being engaged. Additionally, there is anecdotal evidence that the FRC’s introduction of retendering of audits every 10 years on a comply or explain basis is already having a positive impact," he said.