Industry responds to CMA calls for shake-up of audit market

The Competition and Markets Authority has called for a shake-up in the UK audit market to address “serious competition problems” in the industry. It says the legislation is needed to address both the vulnerability of the industry to the loss of one of the Big Four, and current inadequate choice and competition.

The CMA is recommending the separation of audit from consulting services, mandatory ‘joint audit’ to enable firms outside the Big 4 to develop the capacity needed to review the UK’s biggest companies, and the introduction of statutory regulatory powers to increase accountability of companies’ audit committees.

Chairman of the CMA, Andrew Tyrie said people’s livelihoods, savings and pensions all depend on the auditors’ job being done to a high standard, but too many fall short. “More than a quarter of big company audits are considered sub-standard by the regulator. This cannot be allowed to continue.

“The government now has three reports to hand. In large part, they come to similar conclusions. Conflicts of interest cannot be allowed to persist; nor can the UK afford to rely on only four firms to audit Britain’s biggest companies any longer. Early action will require legislation – hence the CMA’s proposals.”

Having repeatedly called for the separation of audit from non-audit services, the proposals were largely welcomed by the Chartered Institute of Internal Auditors, but with a caveat.

Chief executive of the CIIA, Dr Ian Peters said: “We welcome the proposal to separate external audit from non-audit services to raise standards, eliminate potential conflicts of interest and ensure the independence of external auditors to reduce the risk of another Carillion-style collapse.

“We are unconvinced about the CMA’s proposal for joint audits which risk becoming burdensome for business and there are big unanswered questions about how they would work. Joint audit is a sledgehammer to crack a nut and there are far better ways to raise external audit standards.”

CBI president, John Allan had further notions about ways to tackle the problem. “The UK’s position as a world leader on corporate governance is highly-prized. But with the eyes of the world on the UK, some CMA proposals risk damaging that reputation. Other ideas, such as greater scrutiny of audit committees by the regulator have merit and could help guard against high-profile corporate failures, which have rightly prompted searching questions," he said.

“Improving the quality of audit to enhance public trust and investor confidence must be paramount. But the guiding star for any reforms must be a focus on what works.”

Mandating joint audits, he warned, would add cost and complexity for business with no guarantee of better outcomes; with operational splits possibly restricting access to the skills required to carry out complex audits.

The recommendations (Source: Competition & Markets Authority)

The recommendations are:

Operational split
Auditors should focus exclusively on producing the most challenging and objective audits, rather than being influenced by their much larger consultancy businesses. Given the difficulties with an immediate global structural split, the CMA is – at this stage – recommending an operational split of the Big Four’s UK audit work. This will require separate management, accounts and remuneration: a separate CEO and board for the audit arm; separate financial statements for the audit practice; an end to profit-sharing between audit and consultancy, and promotions and bonuses based on the quality of the audits.

More choice to increase resilience: mandatory joint audit
More choice and competition for the audits of big businesses can and should drive up their quality, but the barriers to entry for ‘challenger’ audit firms are currently large. The CMA recommends mandatory joint audit, to increase the capacity of challengers, to increase choice in the market and thereby drive up audit quality. Challenger firms should work alongside the Big Four in these joint audits and should be jointly liable for the results. There should be initial limited exceptions to the requirement, based on criteria set by the regulator, focused on the largest and most complex companies. In addition, any company choosing a sole ‘challenger’ auditor should be exempt. Audits of exempt companies may be subject to rigorous, real-time peer reviews commissioned by and reporting to the regulator. The joint audit requirement should remain in place until the regulator determines that choice and competition have improved enough to address the vulnerability of the market to the loss of one of the Big Four.

Regulation of UK companies’ audit committees
It is essential that audit committees choose auditors by seeking those likely to provide the most robust and constructive challenge to the accounting practices of their companies. The CMA recommends that the regulator should hold audit committees more vigorously to account. This may include ensuring that committees report their decisions as they hire and supervise auditors, and that the regulator issues public reprimands to companies whose committees fall short of adequate scrutiny of their auditors.

A five-year review of progress by the regulator
The regulator should review the effects of these changes periodically, in the first instance five years from full implementation.This should consider in particular: the merits of moving to independent appointment for auditors; whether to go beyond the operational split already proposed; and how to fine-tune the joint audit remedy to adapt to market developments.

The Big Four audit firms in the UK are Ernst & Young (EY), Deloitte, KPMG and PricewaterhouseCoopers (PwC).

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