Lords probe of audit market
Some of you will have noticed that the House of Lords has decided it should look at the audit market. they want to know if the Big Four dominance is detrimental and whether anything should be done about it. They also want to investigate whether banks auditors could have done more in the run up to the financial crisis.
It’s a mystery to me why these two issues have been brought together in this way.
The audit market has an issue – the Big Four dominates large and public company audit and there’s little sign of anyone finding a way into this market from outside the Big Four.
But the issue here is banking covenants/credit agreements which restrict many companies to using only a Big Four auditor. Not until we know the true extent of this practice will we know what really underpins Big Four domination. The regulators have anecdotal evidence that the restrictive covenants are used, but have little or no information about the scope of their use. The regulators should, therefore, be working out how they get their hands on that information. In the US public companies disclose their credit agreements to the regulator – time the same thing happened here.
But that’s different from whether auditors should have done more on bank audits ahead of the crisis (though we are speaking about the same group of auditors). And the reason it is different is that in this area – international banking – the Big Four really are the only source of capability. It’s not entirely clear how a conclusion about the audit market would lead to any insight about auditors’ behaviour while dealing with the banks. Even if the Lords concluded that the market needs opening up and produced a foolproof method prising it open, it’s not entirely clear that new entrants would want to bother with big bank audits – the demands are just too great. What smaller audit firms are really concerned about is Big Four domination of public company audits where an auditor structured on a vast international scale is not a necessity. That’s most of the FTSE350 outside the 100.
Incidentally, the Financial Services Authority already believes the auditors did not do enough before the crisis and has written publicly of auditors being swayed by management bias.
Far better for the Lords to have concentrated on one of these issues at a time. And the regulators appear to need more help dealing with the audit market.