Can the next tier pick up Big Four audit baton?

BDO’S SENIOR PARTNER believes there is “once in a generation” opportunity to shatter the Big Four‘s dominance of the FTSE 350 audit market as political pressure increases.

Simon Michaels (pictured) called for change – “no matter how modest” – to be enforced as current probes being run by The House of Lords and European mandarins strengthen the mid-tier’s long-running lobby for an overhaul.

When Big Four chiefs were grilled by the House of Lords recently about audit concentration, they stressed the “scale and reach” firms needed to audit multinationals.

Some 80% of the FTSE 100’s revenues are generated outside of the UK, and in this backdrop, the demands on a mid-tier firm to service clients with complex businesses across a range of global territories would be significant.

To reinforce the point, Ian Powell, chairman of PwC, said it had cost PwC’s UK arm close to approximately £40m to roll out the firm’s revised “audit approach” project, in response to the changing needs of its clients. The overhaul cost PwC’s firms around the world $400m.

To invest in a similar project at a time when revenues are remaining steady at best and falling at worst, would be a huge financial outlay for Grant Thornton and BDO – the fifth and six biggest UK firms respectively – let alone the practices beneath them.

It also takes significant investment to put together a tender for a multinational audit job, increasing potential costs even further.

If the audit market is opened up, then the mid-tier will also have threat of lawsuits potentially costing hundreds of millions of hanging over their heads.

A claim from a major multinational could “wipe out” a smaller firm, Deloitte chief John Connolly told the Lords.

For example, the liquidators of collapsed company Independent Insurance filed a law suit against KPMG for £300m.

The case was settled, but the amounts involved almost equal BDO’s annual revenues of £312.2m. Grant Thornton posted revenues of £380m, which gives an indication of the dangers to a potential mid-tier auditor when a big company fails.

John Connolly made the shrewd observation that “market extension” to the mid-tier could be achieved by limiting firms’ liability to litigation – of course, this move would clearly benefit the Big Four as well.

Michaels and BDO support the view that investors should be more involved in audit appointments because it would result in a more competitive environment.

But this idea relies upon factors that can’t be guaranteed:

Firstly that banks will remove Big Four-only clauses from many loan agreements with FTSE 350-sized companies and secondly that the UK’s largest companies actually want to change their auditors.

An FD once told Accountancy Age that “you’ve got to walk the walk” – in terms of having a Big Four auditor signing off the books – to assure investors that the highest book-keeping standards were being maintained.

Firms in the mid-tier would counter that they also maintain the highest auditing standards.

But it is this perception issue of the mid-tier having less strength and depth of the Big Four that will form the major obstacle in convincing the largest companies to engage a smaller firm.

Until this stigma is lifted, the mid-tier will find itself no better off than before.