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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.

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“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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