Audit industry stalemate shows signs of shifting

Audit industry stalemate shows signs of shifting

Signs that the UK’s audit industry would reform had slowed in the New Year, but with Brexit almost over the line and an impending cabinet reshuffle, we could begin to see more plans put in motion

Audit industry stalemate shows signs of shifting
  • Reports: Big Four holding private talks to separate audit from consulting
  • CMA calls on the Government to legislate to break up the Big Four
  • Rachel Reeves, long-term critic of the Big Four and advocate for a break-up, re-elected Chair of the Business, Energy and Industrial Strategy (BEIS) Select Committee

Last year was a big year for audit in the UK, with scandals and reports into the industry driving the appetite for reform. In January, however, momentum seemingly slowed with parties in a stalemate over how to advance.

With Brexit almost over the line and a cabinet reshuffle expected in its wake, there’s a sense audit reform momentum could once again pick up.

Reports in The Times claim that the Big Four firms – Deloitte, PwC, EY and KPMG – are in talks with the Financial Reporting Council (FRC) over a self-imposed breakup, pre-empting any legislative changes that could be forced upon them.

The FRC, which will soon be replaced by the  Audit, Reporting and Governance Authority (ARGA), are reportedly drawing up guidelines on how firms should separate their consulting and audit operations, which when combined has resulted in historical accusations of conflicts of interest.

Changes to “governance, leadership, financials and remuneration” at firms’ audit and consulting arms have been proposed, as has the establishment of ‘common principles’, according to The Times’ source close to the discussions.

The FRC would oversee the implementation of such changes, while holding firms to account if they fail to adapt.

According to Sky News, the new regime would involve “mandatory shared audits”, with all but the largest FTSE350 firms required to include at least one challenger firm in their audit tender processes.

A spokesman for the regulator said: “The FRC is in early discussions with the audit firms to understand their thinking on operational separation with a view to establishing some common principles to which we might hold them accountable.

“Our objectives are that the audit practices should be focused first and foremost on audit quality; and that they should be financially self-standing, with no structural cross-subsidies.”

CMA refreshes call for legislation

Following the news, the Competition and Market Authority (CMA), which published its report into the statutory audit market in April 2019, renewed its calls on the Government to legislate to break up the Big Four.

A spokeswoman for the CMA said: “What is clear is that change is now vital in the audit industry. It remains our view that legislation is needed so that the regulator has the power to design and enforce an effective split between audit and consultancy services.

“Any proposals from the industry or elsewhere should be judged against the criteria we set out in our report. For the split between audit and non-audit services, these criteria include an end to cross-subsidies and profit sharing.”

The CMA’s report established four key recommendations to “address serious competition problems in the UK audit industry”: an operational split,  mandatory joint audit, saying more choice would “increase resilience”, regulation of UK companies’ audit committees, a 5-year review of progress by the regulator.

“Conflicts of interest cannot be allowed to persist; nor can the UK afford to rely on only 4 firms to audit Britain’s biggest companies any longer. Early action will require legislation – hence the CMA’s proposals,” siad in CMA Chairman Andrew Tyrie in a public statement at the time.

Sky News reported that the system being worked on by FRC and the Big Four is seen as a compromise to the CMA’s recommendations, which are widely regarded to have been discarded by ministers.

The key difference between the mandatory joint audits proposed by the CMA and the mandatory shared audits being discussed by the FRC and the Big Four is that a joint system would hand responsibility to two or more auditors, requiring sign-off from both.

A shared audit system involves more than one auditor, but the principle auditor would retain the responsibility of signing off the accounts.

The CMA directly addressed its concerns with a shared system in paragraph 6.3 its report: “Several firms pointed us towards shared audits rather than joint audits as a way to achieve the same objective.

“We remain of the view we expressed in our update paper. Shared audit would result in the smaller firm being very clearly subsidiary to the bigger; it would be less effective in achieving resilience and choice in the market.

“It would also present a risk to audit quality because the second auditor would not sign the audit report, and would not be jointly liable, as with joint audit.”

Since the CMA’s report was released, an independent review into the quality and effectiveness of audit by Sir Donald Brydon was also released on 18 December 2019. Read our reporting on this here.

Rachel Reeves re-elected as BEIS Chair

One of the Big Four’s staunchest critics, MP for Leeds West Rachel Reeves, has been re-elected unopposed as the Chair of the Business, Energy and Industrial Strategy (BEIS) select committee.

The BEIS committee released its own audit report in April 2019 which recommended the breakup of the Big Four, with Reeves leading the calls.

She has also chaired in enquiries in the collapse of large companies, such as Carillion and Thomas Cook, which have been at the centre of the UK’s audit scandals.

In a series of tweets following her re-election, Reeves reaffirmed her commitment to “holding those responsible to account, whether fault lies in government or business” when things go wrong.

“With the inquiry into the collapse of Carillion I shone a light on the corporate malpractice which is now subject to criminal proceedings, and while doing so uncovered systemic failings in the ‘big four’ accounting and audit firms,” she wrote

“Holding the powerful to account is a key job of Select Committees and I’ve always seen it as the responsibility of Chair to do it unrelentingly with professionalism and rigour.”

A spokesperson for the BEIS emphasised the importance of a strong audit market, saying: “A competitive audit market is crucial to confidence in business. Work has begun to reform and bolster the FRC, with a strong new leadership team recently taking up position.

“We are committed to taking action on the findings of the CMA’s audit investigation, have consulted on its recommendations and will respond in due course.”

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