The UK’s Business, Energy and Industrial Strategy Committee (BEIS) has called for a full structural break-up of the Big Four, which would entail a full legal separation between the firms’ audit and non-audit service lines.

In its Future of Audit report, BEIS endorsed the Competition and Market’s Authority’s proposal of an organisational split between audit and non-audit but argued that going further with a structural break-up would prove more effective in tackling conflicts of interest and providing the professional scepticism needed to deliver high-quality audits.

The report expressed the view that a strong audit culture of independence and challenge is one of the most important factors of audit quality and noted that it was concerned about audit representing a ‘small and shrinking’ part of the firms.

The report said: “As the relative size of audit declines, there is inevitably a point at which audit can no longer be regarded as core to the firm. It is perhaps a sign of the status of audit in these firms that none of the Big Four in the UK is headed by an auditor. Indeed, in their evidence to us, the non-audit heads of these multidisciplinary firms revealed an at times shocking lack of knowledge about the purpose and nature of audit.”

The report explained that there could be three models of separation between audit and non-audit services: “Governance separation is the shallowest and easiest to implement. Structural separation is the fullest and most disruptive. Operational separation is a compromise. A fuller separation delivers more benefits and with greater certainty, but also entails higher costs and risks.”

The report argued that a ‘full, clean legal separation’ would address problems such as cultural tensions and conflicts and concerns over the financial independence of audit services.

While supporting a full structural split, BEIS recognised that it would involve ‘significantly greater’ costs and risks than an operational split.

One of the arguments from the Big Four firms was that the quality of audit depends on specialist skills and technology which is facilitated by the nature of a multidisciplinary firm. The report noted that the ‘resourcing of specialists would no doubt be costlier and less seamless after legal separation’ but expressed the view that developing some of these skills in-house would ensure that ‘these specialists share the culture, values and goals of audit’.

Expectations gap

In responses to the numerous inquiries into the UK’s audit market, a recurring theme has been the expectations gap, which in part has prompted the Brydon review to assess whether or not auditing standards are still fit for purpose in the 21st century.

However, the report noted: “We do not accept the attempts of auditors—particularly the Big Four and Grant Thornton—to underplay the role or scope of audit, nor to implicitly blame the public for failing to understand the purpose of audit. Rather, the firms should focus on the poor quality of their audits, and on how they are falling short of what audits are for within the current framework.”

It also said, in reference to failings at café-chain Patisserie Valerie, that the detection of material fraud must continue to be a priority and recommends that audits must state how they have investigated potential fraud, including by directors.

BEIS chair Rachel Reeves said: “Change in the audit market is long overdue. The reviews from the CMA and Kingman highlight the failings; now we need action. The Big Four’s dominance has fostered a precarious market which shuts out challengers and delivers audits which investors and the public cannot rely on.

“Our report proposes a range of measures to boost competition, improve the audit product, and ensure that the UK continues to be a world leader in corporate governance. A segmented market-cap and the piloting of joint audits would help to break the stranglehold of the Big 4 and deliver a healthier and more resilient audit market.

“For the big firms, audits seem too often to be the route to milking the cash-cow of consultancy business. The client relationship, and the conflicts of interest which abound, undermine the professional scepticism needed to deliver reliable, high-quality audits. Splitting audit from non-audit business would be a big step to boosting the culture of challenge needed to deliver high-quality audits.

 “Change is needed to deliver for investors, workers and the public. The Big Four may not like it, they may seek to undermine the case for reform, but vested interests should not be allowed to get in the way of positive change. We must not wait for the next corporate collapse. Government and regulators need to get on and legislate to deliver these reforms and ensure that audits deliver what businesses, investors, pension-holders and the public expect.”

The report called for a range of improvements to be made to the audit product and encouraged the Brydon review to look into how audits could be made to be ‘forward-looking’.

In the future, the report suggested that audits could provide a better picture of a company’s overall corporate governance, including assessments on areas such as pay policy, the gender pay gap, payment practices to suppliers, and on environmental sustainability.

Industry reactions

As expected, the Big Four on the whole have reaffirmed their opinion that they should not be split up.

EY UK said they believe that the ‘vision’ outlined in the report can be best delivered by a multidisciplinary model of services. A spokesperson said: “A multidisciplinary model provides the structure, breadth and depth of technical skills and industry expertise necessary to deliver high-quality audits for large and complex companies, both for today and the scope that the committee envisages for the future.

“We, therefore, disagree with the proposals that call for an operational or structural split in the UK as this would undermine the multidisciplinary model and risk unintended consequences to audit quality.”

PwC UK head of assurance Hermione Hudson said: “We recognise the need for reforms which will enhance audit quality; however, the report’s recommendation to break up the largest firms risks hampering, rather than enhancing it. 

“Arguing for ‘break-up’ sounds like action, but actually it will reduce quality, weaken resilience and distract attention from more practical steps to ensure auditing keeps pace with society’s expectations.

“There are likely to be significant unintended consequences from breaking up the large professional services firms, with increased cost and disruption to the economy and businesses which would be damaging to the UK’s competitiveness. As business secretary Greg Clark MP told the BEIS select committee, ‘audit and other professional services in this country are widely admired around the world’, and it is important that the UK remains an attractive place to do business.”

Despite being critical of the proposal to break up the Big Four, Hudson did agree that the scope of audit needs to be investigated: “We agree that audit firms and the regulator must focus on increasing trust in audit and the consistency of audit quality. We believe it is also necessary to focus on the changing needs and expectations from audit.

“We support the report’s recommendation that Sir Donald Brydon should consider extending the scope of audit. This is backed up by our own Future of Audit initiative, in which we have consulted a wide range of stakeholders, including business and investors. Our consultation has revealed a desire for audits to be more forward looking and have a broader scope to cover other areas of reporting beyond the historical financial statements.”

Deloitte UK managing partner for audit Stephen Griggs said: “We welcome many of the recommendations, including extending the scope of the audit and better regulation of audit, but we have concerns about a potential structural split. This will be detrimental to audit quality and could materially damage the UK’s competitive position as a leading capital market.”

While KPMG UK did not openly resist calls for a structural breakup, a spokesperson explained the firm’s efforts to reduce concerns about possible conflicts of interest: “We have already stopped undertaking non-audit work for companies we audit in the FTSE 350. We are not accepting any new non-audit work for these companies, and we anticipate that the vast majority of existing projects will have concluded by the end of 2019.”

A spokesperson for Grant Thornton UK said: "The audit market requires systemic change to deliver for clients, their shareholders, pensioners and the public. We’ll continue to press for industry-wide change while improving our own practices wherever necessary.”

“Across the industry we must improve current practices now, but the statutory practice of audit must also change to ensure it is fit for purpose in future.”