Competition Commission delivers an irreversible truth

THE COMPETITION COMMISSION conclusion that there are adverse effects arising from the lack of competition in the listed company end of the UK audit market will be widely acclaimed as a victory for common sense.

The spotlight now will turn to remedies that might be proposed by the Commission. These need to be sensitive and proportionate, but must also bring about real change to avoid a forced return to the topic the next time a crisis hits. In looking at remedies it is instructive to look at the changes that the market itself is driving, having digested at least the headlines of evidence to the inquiry.

It has been a process that has shone a light into the often arcane relationships between investors, boards and auditors, which many market participants have found uncomfortable.

Investors have reacted with a degree of impatience to being shut out of a relationship between investee and auditor, which is critical in reassuring shareholders about the integrity of their company and which underpins faith in the capital markets more generally. While companies will listen to regulators and the media, they take the views of investors very seriously.

Hitherto shareholders have been content to let companies run the audit relationship without interference. There are signals that this is now a thing of the past, as investors have questioned the expense that companies cite in reviewing audit arrangements. There are suggestions that such cost is exaggerated, particularly in comparison to potential benefits from a fresh pair of eyes reviewing their investee companies’ affairs. Some large companies, such as BG and Schroders, have already responded by tendering their audits.

There will be more tendering amongst competitor firms for audits of listed companies. The Financial Reporting Council, the industry regulator, has already taken steps towards mandating such tenders for the largest UK PLCs, and eventual compromise over currently proposed European legislation will accelerate this. More than this, demand for good corporate governance will require it.

This process is fast extending to other services historically offered by auditors, as concerns mount over the propriety of the audit being offered alongside more commercially acute projects (such as tax structuring), potentially interfering with the independence of the auditor. Companies are establishing ‘panels’ of advisers whose offerings they can compare on a project by project basis, increasingly using procurement advisers to demonstrate the need for both value and impartiality. The fees earned for other services provided to big companies by their auditors have plummeted. EU regulation will keep it at a low absolute level.

The exposure of audit into the spotlight has led to increased questioning of its value as it now stands, particularly in the context of the financial crisis which originally drove events towards the commission’s inquiry. To be fair much of the criticism may be a consequence of wider dissatisfaction with an overly complex reporting framework, for which auditors will be blamed irrespective of their powerlessness to change it.

However, after a long period of inaction, auditors (in this country at least) accept that they must do things differently if they are to make a full, useful contribution to UK PLC. This will mean a more specific and tailored audit report and greater assurance being given outside the narrow confines of the statutory audit. This is not an easy path – it will require companies to disclose more about risks and judgements – but it is a path that needs treading to ensure capital markets feel adequately informed and assured.

The choice of remedies must meet the needs of the market. They needn’t be swingeing, but they must bring some liquidity to what has been a very static market. Mandatory rotation has been shown to increase concentration, and should be discounted. Tendering does not appear to have the same effect, and can be shown to improve audit quality, so should form part of a package of measures. With requirements for greater transparency and more auditor / shareholder engagements, mandatory retendering for listed companies would help make a real change to a market that, in reality, has too few participants. These are all remedies the commission has identified.

The Competition Commission’s inquiry may not result in major regulatory change. There will be no watershed change in the extraordinary level or concentration at the higher end of the company audit market, but the remedies need to start an irreversible process of opening up the market.

James Roberts is audit partner at BDO

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