Competition regulator proposes shake-up of audit sector

The Competition and Markets Authority (CMA) is proposing to spilt audit and consultancy services and impose a ‘joint audit’ in a bid to reform the way in which accountancy firms conduct their work.

The CMA has this morning published an update paper which it said outlined “serious competition concerns” and proposed changes to legislation which would “improve the audit sector for the benefit of savers and investors alike.”

Following the launch of its market study in October, the CMA said it had identified a number of reasons why it believed audit quality was falling short.

It said that choice is too limited, with the Big Four audit firms conducting 97% of the audits of the biggest companies; that companies choose their own auditors, and as a result there was too much evidence of them picking those with whom they have the best ‘cultural fit’ or ‘chemistry’ rather than those who offer the toughest scrutiny; and an auditors’ focus on quality appears diluted by the fact that at least 75% of the revenue of the Big Four comes from other services like consulting.

The CMA is proposing legislation to:

  • separate audit from consulting services
  • introduce measures to substantially increase the accountability of those chairing audit committees in firms
  • impose a ‘joint audit’ regime giving firms outside the Big Four a role in auditing the UK’s biggest companies.

CMA Chairman Andrew Tyrie said: “Addressing the deep-seated problems in the audit market is now long overdue. Most people will never read an auditor’s opinion on a company’s accounts. But tens of millions of people depend on robust and high-quality audits. If a company’s books aren’t properly examined, people’s jobs, pensions or savings can be at risk.

“The CMA will now consult on a number of proposals for robust reform. These intractable problems may take some years to sort out. If it turns out that the proposals are not far-reaching enough, the CMA will persist until the problems are addressed.”

CMA Chief Executive Andrea Coscelli added: “We have moved fast to come up with a comprehensive package of proposals for legislation, which we will now consult on. Successful reform of the audit market will require legislation, in combination with planned improvements to regulation as recommended by Sir John Kingman.”

Details of the proposed reform changes, which are now out for public consultation, are:

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.

The CMA’s proposals only address some of the concerns in this sector. Sir John Kingman’s independent review addresses another: issues with current regulation. Today the government has announced a review of the purpose and scope of the audit more widely. It is already clear from the CMA’s work that a robust approach will likely be required here too.