The UK’s Competition Commission yesterday (15 October) published a report on the competitiveness of the audit market broadly chiming with changes currently under debate at European level.
In a summary of its final report on the supply of audit services in the UK, the watchdog confirmed that competition is restricted in the audit market due to factors which inhibit companies from switching auditors. Partly as a result of this, auditors tend to focus on satisfying management rather than shareholders, it says.
The Commission's proposed measures include an obligation for the UK’s 350 largest companies to put their statutory audit out to tender at least every 10 years, a dilution of earlier proposals favoured by the watchdog for five-yearly tenders.
No company would be able to delay audits beyond ten years. The Competition Commission said that many companies would benefit from putting their audits out to tender more frequently.
Beefed up audit committee role
Loan agreements binding companies to choose auditors from a pre-selected list or category, which sometimes benefit the largest audit firms – the so-called “big-4” comprising Deloitte, Ernst & Young, KPMG and PwC – will be banned.
The report also proposes beefing up the role of the audit committee and reducing the influence of management, including a stipulation that only the audit committee is permitted to negotiate audit fees and influence the scope of audit work, initiate tender processes, make recommendations for the appointment of auditors and authorise external audit firms to carry out non-audit services.
The Competition Commission will work towards drawing up an order for elements of the remedy package within its purview, and make recommendations for the others. These are expected to come into force from the last quarter of 2014.
The UK watchdog says it will be able to make any necessary amendments to tally with forthcoming EU measures.
EU proposals cap non-audit services
In a qualified majority decision last week (7 October), ambassadors of the EU states backed proposals including a 15-year limit on keeping the same auditor for banks and 'systemically important' companies, and a 20-year limit for other public interest entities.
They also agreed to cap non-audit services at 70%.
The decision opens the way for trilogue negotiations on reform of the audit market between the Council of Ministers, the European Commission and the European Parliament.
The UK argued against mandatory rotation of auditors, opting instead for the tendering process that the Competition Commission has now proposed.
But the European Commission’s original package of proposals for audit reform backed rotation every six years unless there was a joint audit in place in which case the limit would be nine years, and the issue remains a subject for discussion in the trilogue negotiations.
“Our measures will deliver lasting change in a market where currently a major company putting its audit out to tender remains unusual enough to be a news story. Instead, all this business will be open to competition on a regular basis. The introduction of regular and predictable tenders will benefit shareholders, who will also have a much greater say and knowledge of whether their needs as customers are being met,” according to Laura Carstensen, chairman of the UK Competition Commission’s audit market investigation group.
“Instead of long unchallenged tenures which can reduce the appearance of objectivity and scepticism essential to an effective audit, there will now be far greater transparency and scrutiny,” Carstensen added.
“We do not think that five-yearly mandatory tendering would have increased choice. Instead what is required is for those that buy audit services to recognise that real quality as well as niche expertise exist outside the largest professional service firms. We would urge businesses to do a broader survey of firms and the capabilities available before determining which their preferred suppliers are for audit and non-audit services,” said Michael Izza, the chief executive of the Institute of Chartered Accountants in England and Wales, the UK professional membership organisation.
“[The report’s] real importance lies not in the legislative changes that that it will bring about but in the focus it will cast on some of the darker recesses of governance,” said James Roberts, a partner with audit firm BDO.
“By giving this oxygen it has changed people’s thinking, and the market has now begun to see the need for change. There is a missed opportunity, however, insofar as the UK watchdog has not come to a decision about whether the competition provided by the “big-four” auditors [Deloite, Ernst & Young, KPMG and PwC] – especially if one of these left the market – is sufficient,” Roberts added.
“The measures it [the report] proposes such as more frequent tendering for PIE audits, a more transparent auditor appointment process and prohibition on the so-called ‘big 4 only’ clauses in loan agreements, are welcome in that they will play a part, over time, in changing mindsets and behaviour among those charged with making auditor appointments. This is significant and in line with the thrust of the audit reform proposals coming from the parallel EU process,” commented BDO Global Head of Regulatory & Public Policy Affairs, Noel Clehane.
“However an interesting situation will arise if, as appears likely, certain measures rejected by the UK Competition Commission, are adopted at European Union level, notably mandatory audit firm rotation, as the EU measures would override those decided upon by the UK authority,” Clehane added.
Sue Almond, ACCA technical director, said: “These proposals from the UK Competition Commission provide an opportunity to strengthen the Financial Reporting Council’s existing recommendation for the biggest companies to put their audits out to tender on a 10 year basis, and with mandatory rotation likely to come from the European Union in the next few years anyway, introducing a five year requirement to tender right now (as the Commission had earlier proposed) would have caused a burden and confusion for businesses at a time when they need to be concentrating on their core business activities. It would have meant, potentially, the audit rules changing three times over a few years," said Sue Almond, the technical director of the Association of Chartered Certified Accountants (ACCA).
“The auditor appointment should be the primary responsibility of the Audit Committee, who should make an informed decision based on the particular circumstances, but that should be a transparent process. However, public perception should not be overlooked here. An auditor in place for a very long time could be seen as no longer independent. The European Council's Committee of Permanent Representatives’ (COREPER) proposals for a 20 year rotation could be more beneficial for the business community,” Almond concluded.
The European Commission tabled a draft regulation in November 2011, requiring that audit firms rotate their work regularly and spin off consultancy work, measures that would favour smaller audit outfits.
The European Union adopted a directive in 2006 which aimed to restore confidence in capital markets by strengthening the quality and independence of auditing of company accounts.
The directive came in the aftermath of international accounting scandals involving US firm Enron and which brought to collapse one of the top global auditing firms, Arthur Andersen.
- 2013: Ongoing trilogue negotiations between European Parliament, Commission and member states in relation to EU proposals for audit reform