The Financial Reporting Council (FRC) has written to the U.K.’s largest audit firms setting out the regulator’s expectations for how they should achieve “operational separation”—essentially, splitting external audit from consultancy work—in an effort to bring about improvements in audit quality, as well as stimulate greater competition in a market the Big Four overwhelmingly dominate.
The FRC has told EY, Deloitte, KPMG, and PwC they must create separate boards—with a majority of independent directors sitting on them—for their audit practices and that they must be led by independent chairmen.
The change is meant to put audit firms in line with the U.K.’s corporate governance code that applies to the quoted companies whose accounts they oversee.
The FRC has also sent a similar letter to a number of challenger firms outside the Big Four, including BDO, Grant Thornton, and Mazars.
In a statement, Claire Lindridge, the FRC’s director of audit firm monitoring and supervision, said: “The FRC’s focus is to ensure audit firms put audit quality front and centre, with new independence and financial transparency guidelines to support this.
“We expect the firms to put in place independent governance for the audit practice and ensure that the audit practice is appropriately ring fenced from the rest of the firm so that financial results are clear and transparent.”
The Big Four have faced repeated calls for a wholesale split following the FRC’s own findings of a drop-off in audit quality and a series of accounting scandals where “at risk” companies were given clean bills of health. The high-profile collapses of the construction company Carillion, the retailer BHS and, more recently, at the travel company Thomas Cook, have led to calls from British lawmakers for a shake-up of the audit market to spot problems earlier and avoid thousands of job losses.
Last December the government-commissioned Brydon Review into the shortcomings of the external audit profession found that “audit is not broken but it has lost its way.” The report made a raft of recommendations to improve audit quality, including redefining audit and its purpose, extending the concept of auditing to areas beyond financial statements to “external signs of concern” (including fraud), and making more (and better) use of technology to provide greater assurance and audit reporting.
Last April the United Kingdom’s competition regulator, the Competition and Markets Authority (CMA), recommended auditing and consultancy services should be entirely separate to improve competition and prevent “cozy relationships” and conflicts of interest, but stopped short of calling for the Big Four accountancy firms to be broken up.