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. 

S

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
.