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April 30, 2008

Non-audit work drives Scottish revenue

Non-audit work drives Scottish revenue

Corporate finance and tax work are helping to drive growth for firms in Scotland, leading many groups to report double-digit fee income growth of up to 20 percent. But Paul Rogerson reports that the market may soon slow as the business environment changes.

In Scotland, the Big Four have boasted annualised increases in revenue and profits of 15 percent to 20 percent in the past two years. They have exploited what Frank Blin, head of UK regions at PricewaterhouseCoopers (PwC), has described as a “regulatory dividend” arising from a mass of new compliance requirements including global accounting canon IFRS and the US Sarbanes-Oxley Act. Professional advisers have also benefited as Scotland has embraced the London Government’s Public Private Partnerships (PPP)/ Private Finance Initiative (PFI).

This fee boon has coincided with a buoyant market for mergers and acquisitions, including locally seismic one-off events like the July 2006 flotation of Edinburgh insurer Standard Life, which netted professional services firms an estimated £200 million in fees. Corporate finance and tax work have been, and continue to be, the dominant growth drivers.

Runaway corporate consolidation can have its downside, as the Scots firms find themselves at the mercy of global market forces. One case in point is this year’s £11.6 billion takeover of giant utility ScottishPower by Iberdrola of Spain, which removed one of Scotland’s few world-class listed companies from the stock market. This was particularly irksome for Deloitte, which had scored an impressive coup just a few months previously by snatching the ScottishPower audit from PwC in a competitive tender battle that also included Ernst & Young (E&Y). It was a pyrrhic victory. E&Y – Iberdrola’s auditors – ended up auditing ScottishPower anyway.

It is unarguable that deals such as this will reduce the high-level fee quantum across Scotland’s relatively small, 70-strong quoted sector. Scottish & Southern Energy, one of the UK’s two remaining energy powerhouses, is also expected to fall prey to an overseas buyout and there are no more companies of a comparable stature close to joining the FTSE north of the border.

Royal Bank of Scotland (RBS), currently engaged in a tug of war with Barclays for Dutch bank ABN Amro, remains the ‘jewel in the crown’, having handed auditor Deloitte £50 million in fees in the past two years alone.

There seems to be an emerging consensus in any case that the money-earning potential of the top echelon is probably peaking. The “credit crunch” has slowed a vigorous appetite for deal making.

There is also some uncertainty over the future flow of PPP/PFI fees following the installation of a Scottish National Party administration in the devolved parliament. New First Minister Alex Salmond cancelled a £100 million prison to be built and run by the private sector. 


Both the leading players and the mid-tier firms are also constrained by capacity issues as they go head-to-head with Scotland’s vigorous financial services sector for scarce talent. This is their own fault to some extent – the recruitment of trainee accountants dipped sharply in the wake of the dotcom crash and 9/11, and the firms’ conservatism has proved ill-judged. As the talent pool has drained, salaries have inflated, with newly qualified accountants now commanding £40,000 or more.

Currently awash with cash, the banks and finance houses have no qualms about paying up for the best. One mid-tier accounting firm in Scotland last year lost five of its six recently qualified accountants to HBOS, Sainsbury’s Bank, Standard Life and fund manager Baillie Gifford.

So what of the mid-tier? As is evident on the broader UK canvas, firms are engaged on a quest for scale, both to compete with the Big Four for non-audit work and boost their capacity for specialisation. This has led to a steady stream of mergers, including Baker Tilly’s March takeover of ten-partner Edinburgh independent Scott & Paterson, understood to be the biggest tie-up in Scotland since the 1999 merger of Deloitte with Edinburgh-based Rutherford Manson Dowds.

Other recent deals have seen Grant Thornton align with RSM Robson Rhodes, while Glasgow-headquartered Campbell Dallas has made progress toward its goal of establishing a base in each major business centre through mergers with smaller firms in Aberdeen and Stirling.

Whatever the synergies of these deals, the oft-quoted ambition of the mid-tier to break the Big Four’s dominance of the public company audit market still appears forlorn. There is one ray of hope, according to Robert Kerr, managing partner of French Duncan. If the UK Financial Reporting Council (FRC) forces the elite quartet to disclose their profits on audit work, he believes clients would be a little more wary about jumping into bed with them. Current rules state that accounting firms must only state their revenues.

Kerr is perhaps too optimistic about the likely scale of any action the FRC might take to open up the market. Yet even if it does force disclosure of profits, one problem remains, as he admits: Who will audit the profits calculated by the auditors?

Paul Rogerson is city editor of The Herald newspaper.

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