Challenger firms find FTSE 350-adjacent niches before CMA rule changes

Challenger firms find FTSE 350-adjacent niches before CMA rule changes

Amid scandals, fee increases and legislation change, challenger firms have begun to reap the benefits of an audit industry shift.

Challenger firms find FTSE 350-adjacent niches before CMA rule changes

After a year fraught with large-scale auditing difficulties, challenger firms are reporting an increase in business interest from companies both inside and outside of the FTSE 350.

While the government is still considering different measures to help level the audit playing field, some companies are changing audit firms on their own time.

According to the Financial Reporting Council’s 2019 audit report, the Big Four still hold nearly 97% of the FTSE 350’s audit accounts, leaving six accounts to Grant Thornton and five accounts to BDO, respectively.

However, it seems that companies on the Alternative Investment Market (AIM) are much more willing to embrace a smaller audit firm. The Big Four only holds 32.6% of AIM audit accounts, while non-Big Four companies hold a majority 67.4% of the market.

Curiously, one FTSE 350 company, Ferrexpo, even left Deloitte in favour of the small firm MHA MacIntyre Hudson, the only company of its stature to do so.

On the whole, these account shifts may demonstrate the beginnings of a perspective change within the industry, coming on the heels of a potential market overhaul.

An emerging niche for top-tier firms

As audit fees across the Big Four rise and big names create the wrong headlines, companies are beginning to look to larger firms outside of the Big Four, called challenger firms, for efficiently priced and comprehensive audit solutions.

Scott Knight, head of audit at BDO LLP, said that challenger firms are seeing an unprecedented demand for service.

“Many FTSE 350 companies tell us they want more choice and are actively seeking auditors which are free from conflicts of interest,” Knight said. “It’s too early to hail a market transformation, but with listed companies moving at a faster pace than regulatory reform, the signs are certainly promising.”

Even below the FTSE 350 company cut-off, mid-to-large firms have found an ever-expanding audit niche, thanks to their typically lower-price points.

However, Bob Neate, the UK head of audit at Mazars, believes that these audit fees are too low, particularly for challenger firms who may feel the need to price-match old fees.

As more opportunities become available to challenger firms, Neate warns that companies should be mindful of their own financial requirements before agreeing to take on an audit, particularly for high-risk and low-profile clients.

“I think that has been a bit of a factor in what’s out there,” Neate said. “Not so much in the 350, but below the 350, where we’ve seen many more opportunities than we’ve seen for a very long time in the listed market.”

Despite these additional opportunities, Neate believes that intervention is necessary to guarantee future success.

“We are absolutely convinced about the need for market reform, for a variety of reasons,” Neate said. “One of my key reasons, personally, is bringing more resilience and competition. The resilience piece being related to, ‘what if a Big Four did disappear?’

“That end of the market is an oligopoly at the moment, it’s only the Big Four, and without other players, that would be devastating for the economy.”

Although the Big Four are the powerhouses of the industry, Neate recalled the collapse of Arthur Andersen in 2002, saying, “It does happen, it has happened, and it could still happen.”

Saving the profession’s reputation

Following a wave of auditing scandals like the Carillion collapse, in April 2019, the Competition and Markets Authority (CMA) proposed new measures to keep accountancy firms in line.

One recommendation, focused on keeping lucrative non-audit work from influencing the behaviour of an auditing team, would keep audit and consultancy service operations separate.

Another option, which aimed to keep the shortcomings of each firm in check, would require a mandatory joint audit partnered with at least one non-Big Four firm.

However, both recommendations have been criticised by both the Big Four and mid-tier firms for being potentially ineffective and costly.

Part of the initial problem is the fact that, on the whole, audit is not extremely lucrative when compared to functions like consultancy. Capitalising on this fact, firms of all sizes have used audit as a bargaining tool to providing clients with other accountancy services, rather than pricing it at a fair value.

“Collectively, I think we need to be careful to make sure audit fees are sufficient to perform a high-quality audit,” Neate said.

The CMA’s suggestions echo this belief, citing that idea that low fees may impair the quality of work undertaken by a firm and encourage firms to cut corners.

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