Last week, the Competition and Markets Authority (CMA) published 72 responses to its 18 December proposals to reform the U.K. audit market. The CMA review is runs alongside three other concurrent reviews of the audit industry—one by Sir John Kingman that takes in the Financial Reporting Council (FRC), another from Sir Donald Brydon, the outgoing chair of the London Stock Exchange, which offers a government-sponsored review examining the scope of audit more widely, and the last from the Business, Energy and Industrial Strategy (BEIS) Select Committee. The BEIS probe aims to ensure the findings of Kingman and the CMA are “not left to gather dust,” according to Chair Rachel Reeves.
These reviews were instituted not just because of the Big Four dominance of the market, but also because of high-profile audit failures at BHS, Carillion, and—most recently—Patisserie Valerie.
A response from the Institute for Chartered Accountants of England and Wales (ICAEW) supports a market share cap (a cap on the amount of the market that any one audit firm can audit), but is against splitting up the audit firms themselves and is also against a mandatory joint audit—two of the other reforms put forward. The Association of British Insurers (ABI) does not support the mandatory joint audit either; and it is not in favour of subsidies of challenger audit forms. It voices tentative support for the market share cap and argues that the new “measures to safeguard audit quality [that] have been in operation for a relatively short time” should be given time to settle in.
Audit companies need to learn the recent lessons from high profile audit failures and reform to regain public confidence, or they will be forced to do it.
Business secretary Greg Clark
The responses of the Big Four themselves, whom all the fuss is about, are of course the most relevant here. PwC, for example, begins by saying that the CMA should have conducted a full market review and consulted the other enquiries before making any recommendations, because key stakeholders—audit committees and investors—fear a wave of unintended consequences. The firm also says that competition works well and that most clients find audits to be of excellent quality. Mandatory auditor rotation has required more than half of FTSE 350 companies having tendered their external audit since 1 January 2013; but this fails to recognise that the tenders were filled with one of the three other members of the Big Four.
The remedies proposed by the CMA are:
Remedy 1: Regulatory scrutiny of Audit Committee
Remedy 2: Mandatory joint audit
Remedy 2A: Market share cap
Remedy 3: Additional measures to support challenger firms that we propose to consider further
Remedy 4: Market resilience
Remedy 5: Full structural or operational split between audit and non-audit services
Remedy 6: Peer review
A split between audit and advisory businesses
To get higher quality, auditors should focus exclusively on audit – not on also selling consulting services. One way of achieving this could be a structural break-up. But the international networks these firms belong to and the extent to which audit firms draw on expertise of those advising businesses would make this protracted and complex. A more immediate solution would be for audit and non-audit businesses to be split into separate operating entities. To be effective this will also require separate management, accounts and remuneration. That way auditors will only be rewarded for scrutinising an organisation’s accounts but will still be able to draw on expertise from other parts of the firm.
Regulatory scrutiny of auditor appointment and management
Audits are a legal requirement, to ensure that companies act in the interests of their owners rather than their managers. Given the relative lack of engagement by investors and owners of some of Britain’s largest companies, these companies should not be left to appoint their own auditors alone. The CMA proposes close scrutiny of audit appointment and management to make sure those appointing auditors are held to account and independent enough to choose the most challenging audit firm, rather than – for example – the cheapest.
Encouraging more choice
At present, many of the UK’s largest companies have little choice, given that one or more of the Big Four may be conflicted. Competition is weak. The CMA proposes that audits of the UK’s biggest companies (FTSE 350) should be carried out by at least 2 firms, at least one of which would be from outside the Big Four. This will give mid-tier firms access to the largest clients, allowing them to develop their experience and credibility, while also ensuring a cross-check on quality. A possible alternative is a market share cap – ensuring that some major audit contracts are only available to non-Big Four firms.
PwC does support more regulatory oversight of audit committees and the selection process. It is also “supportive of the introduction of a temporary market share cap for the FTSE 350 audit market,” but it argues against mandatory joint audits on the grounds of increased costs and decreased quality, and it does not believe those audits will increase choice. The firm vehemently opposes either a structural or operational split up of the Big Four, although it—along with the other three—has agreed not to sell non-audit work to audit clients.
KPMG feels that regulatory oversight and intervention in audit committees’ choice of an auditor should be an exception, not the rule, agreeing with the ICAEW that recent regulatory changes have not had time to have their full effect. In regard to competition, a market share cap is the firms preferred option. The concept of joint audits also remains on the table; it is just a more difficult option to implement. Further, in order to improve competition, KPMG says: “We have previously indicated our willingness to consider removing the existing restrictions we have in place for audit partners leaving to join non-Big Four networks.” Like PwC, it is fully opposed to any kind of split.
Deloitte takes a different approach, signaling its opposition to most of the reforms early, particularly joint audit and a break up of the firms. Instead, it puts forward its own recommendations to increase challenger firms’ participation. It suggest a combination of market share cap and shared audits, a model it says that would give them an additional 25 percent market share of FTSE 250 companies by 2024, alongside a meaningful share of audit work of the largest and most complex FTSE 100 companies. But those firms would need to take on another 1,000 audit partners to accomplish this. Instead of a split Deloitte suggests a governance and performance management split, hiving off the audit part of the business in terms of oversight and profit centres.
Finally, EY addresses each remedy one by one. Yes, to regulatory scrutiny; no to mandatory joint audits; temporary market caps are a novel remedy that could work; no to support for challenger firms; no to separation; and, lastly, no to peer review. EY’s only other positive suggestion is: “We note that several firms proposed alternative measures in discussions with the CMA in August 2018 that could assist challenger firms in reducing barriers to entry; we recommend these now be re-examined to make the market attractive to new entrants.”
All four firms ask that the findings from each of the four reviews be published before any kind of decision on actual reform, regulations, or legislation is made; but, as before, there is little agreement among the firms as to a way forward.