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March 29, 2011

House of Lords unveils recommendations

Audit market competition needs to be tackled starting with an investigation into the role of auditors by the Office of Fair Trading (OFT) and with changes including a five year retendering process and mandatory audit committee reports, the UK Lords inquiry into the audit market has found.

In its final report, the UK House of Lords economics affairs committee said that attempts to introduce greater competition in the audit market have failed and the current approach by the government to increase transparency and disclosure has been disappointing and passive.

The committee said that measures presented by the minister at the department of business, innovation and skills Edward Davey that echoed the ones of the FRC’s Markets Participants Group have failed.

“We were disappointed that the minister is not more ambitious,” the committee said.

When speaking as a witness at the enquiry, Davey said the government was looking to improve transparency and disclosure of audit committees, but he dismissed any radical measures.

The committee does not share the view of the minister and said that one of the first steps forward is an investigation by the OFT to examine restrictions of competition, conduct a market study of restrictive bank covenants and several other issues such as additional auditor assurance to investors.

“We recommend that the OFT should conduct such an investigation into the audit market in the UK, with a view to a possible referral to the Competition Commission. Its findings would need to take full account of the international dimension, but the UK could give a lead internationally by undertaking such a review.”

One of the main recommendations by the committee is for FTSE 350 companies to carry out a mandatory tender of their audit contracts every five years.

“A regular tender, with a non Big Four auditor invited to participate, should promote greater competition to the benefit of both cost and quality,” said the committee.

During the inquiry, the committee heard that some of the banks and FTSE companies retender on average every 48 years, prompting serious cause for concern.

In line with the recommendations already heard by some market participants the committee recommends a mandatory report by the audit committee which includes significant financial reporting issues raised during the course of the audit, an explanation of the basis of the decision on audit tendering and auditor choice.

“The FRC’s UK Corporate Governance and Stewardship Codes should be amended accordingly,” added the committee.

One of the recommendations for increasing tendering to the non-Big Four firms is for governments to make a greater effort, within EU procurement rules, to enable non-Big Four firms to win public sector work.

The committee also suggests the government considers the emergence of a new competitor from the scrapped Audit Commission as suggested by FRC’s chairman Baroness Hogg.

One of the main issues addressed by the European Commission Green Paper on audit is the conflict of interest when offering audit client’s non-audit services.

The HoL committee said that scraping such services would not be justifiable. However they recommend that a firm’s external auditors should be banned from providing internal audit, tax advisory services and advice to the risk committee for that firm.

The UK regulatory environment is also too fragmented and unwieldy with manifold overlapping organisations and functions, according to the Committee.

“This is neither productive nor necessary. The wider powers sought by the FRC would go some way to simplifying and streamlining matters for audit. But further impetus needs to be given to rationalisation and reform,” said the committee.

Most of the recommendations by the report are in line those put forward by the EC, but some could potentially be met with widespread disagreement.

One of the issues pointed out by the report is the use of IFRS and the recommendation that its application should not be extended beyond the large listed companies where it is already mandatory.

“IFRS is more rules-based than UK GAAP. IFRS might be limiting auditors’ scope to exercise prudent judgment,” said the committee.

The committee also recommends the government introduces living wills for the Big Four auditors, in order to lay out all the information the authorities need. This will ensure  both good and failing parts of an audit firm are separate so disruption to the financial system from a collapse can be minimised.


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