Audit Reform: The Re-tender Roundabout

THERE has been a marked increase in audit re-tenders for larger companies since the Competition and Markets Authority inquiry into the larger audit market and consequent changes to the UK Corporate Governance Code.

With the introduction of the audit regulation and directive, this level of activity will continue to increase, not only for Public Interest Entities but, as we have seen with so many regulation changes before, what becomes the norm for the largest soon becomes best practice for nearly everyone.

Much has been made of the fact that with all this activity there has been no positive impact on concentration in the market (and indeed even some tendency to increase it) – something that many of us felt would be a longer term game anyway, with the current lack of familiarity of audit committees with the breadth and capabilities of firms other than the very largest.

Time will tell how this plays out.  However, and perhaps rather more interestingly, less has been made of the likely impact of more frequent re-tendering on both companies and the audit firms they appoint.

The Financial Report Council’s review of “Developments in Audit 2015/16” gives some interesting clues. Of the companies they considered, some 17% carried out a tender in 2015/16.  While one acknowledges that there is a certain backlog of companies that have not tendered their audit for some time, this figure in itself suggests that the maximum period prior to a tender of ten years will not hold in practice and that frequency of tendering will come down to intervals of seven or even five years as best practice establishes itself within the revised rule book. Furthermore 75% of those companies that did go out changed their auditor as a result of the tender.  Many reported benefits from doing so, in particular the “fresh pair of eyes” effect having reaped real benefit.

Companies also found it a little easier than they might have imagined to carry out tenders.  Many of the companies (and audit committees chairman or women) will have been carrying out a tender for the first time.  As they do it more often their facility with the process will only increase.

At the same time it is likely that there will be more commonality in approach and process, given the regularity itself and the increased guidance available both from the FRC and from institutional investors.  Expectations of audit committees are now very clear indeed and public reporting by audit committees brings a degree of transparency to the methodologies companies employ and therefore the inevitable scrutiny that will follow.

The early evidence, and admittedly some of it is purely anecdotal, is that this is having a number of effects:

• Tendering is not about price reduction: while companies may have an expectation of competitive pricing, there is as much danger for an audit committee in going for a “low ball” quote as there is in selecting a highly priced audit. Institutions have made it perfectly clear that they want a good and robust audit first of all and that the cost of audit when set beside their investment value and in comparison to the risks companies run is insignificant. If an audit failure follows, a low priced audit tender the audit committee chair will not be thanked for it.

• Competition is, and will remain, fiercely competitive; irrespective of the market concentration argument (and ignoring conflicts) it is quite possible for a small number of market participants to compete fiercely with each other.

• What has changed is the battleground over which firms compete. Whilst historically competitive tendering an audit may have been quite largely related to price, it is now about perceived quality. That quality has a number of different facets. Regulatory inspection scores are clearly relevant, but more and more the territory over which tenders will be fought will be innovation in the audit process, both to enhance the robustness of the audit, but also to give management greater insight into areas such as business processes and their effectiveness, which should ultimately deliver further value to shareholders.  We already see this with the frequency of the firms’ references to data analytics in recent tenders.  While, no doubt, there is still a lot to develop in that area we can expect that sort of effort to be replicated in the development of other tools and techniques.

While these developments should be positive for investors and companies alike, it might be thought that they could represent a zero-sum game for the large firms, given the market itself is unlikely to grow significantly.  This well might be the case, although there will be an expectation that the increased use of technology has a pay back in people savings.

James Roberts is senior audit partner at BDO

Read Audit Reform: The Conflict Minefield