Splits and joins

Just before Easter, the Competition and Markets Authority (CMA) published the final report of its study of the UK statutory audit market, recommending a shake-up to improve choice and competition in the sector, and the resilience of the industry to the loss of one of the Big Four. 

Truly, it never rains but it pours. Right now, the profession is in the middle of a public consultation on the recommendations of Sir John Kingman’s Review of audit regulation (launched on 11 March), trying to absorb the findings of the BEIS Select Committee’s inquiry into the future of audit (published on 2 April) and considering the probing questions set by Sir Donald Brydon (issued on 10 April) as part of his own review of the quality and effectiveness of audit. But even against this background of pretty constant precipitation, the CMA’s report created a storm.

The response to the CMA’s recommendations has been fierce from all sides - from different parts of the profession, from business, from academia, from politicians and from the media. I hesitate to describe it as a ‘backlash’, but it is fair to say that critics have been louder than supporters.

Some say the changes go too far; Oliver Shah, the Sunday Times' Business Editor, reported that ‘the overwhelming feeling is that [CMA Chairman] Tyrie and friends are shooting from the hip’. While others feel that they do not go far enough; Professor Prem Sikka lamented that ‘meaningful reforms are once again being taken off the agenda’.

The storm has not passed, but perhaps it has abated for now. The Government has three months to consider the report and beyond that there will be a further public consultation. So I thought it might be a good time to share with members my own reflections on what the CMA has said, and the implications for our profession.

Firstly, I believe that greater choice in the statutory audit sector is both necessary and desirable. The Big Four currently audit 97% of FTSE350 companies - that is not a healthily competitive market.

The collapse of Carillion and a number of high-profile business controversies, including BHS and Patisserie Valerie, have undermined public trust in audit. This is a watershed moment and the profession is ready to embrace fundamental change - increasing choice in the market is one of several ways in which we can rebuild confidence.

Operational split

The CMA has proposed that the Big Four firms implement a full split between their UK audit and consultancy operations, in order to prevent potential conflicts of interest.

This means that the audit practices of the Big Four would have their own CEO and Board, accounts and remuneration – completely separate from that of their consultancy arms.

It is also proposed that profit-sharing between audit and consultancy services be banned, and that bonuses be based on the quality of audits.

While I wholeheartedly support the CMA’s focus on reinforcing the independence of auditors, I believe it would be easier and just as effective to strengthen the application of existing safeguards.

Conflicts of interests – whether real or perceived – can undermine trust to a great extent.  Firms and audit committees are already taking measures to limit potential issues arising from the provision of audit and non-audit services, and these can and should be built on further. The proportion of the Big Four’s income resulting from the provision of non-audit services to entities that they audit has been in steady decline and is likely to decline further.

Splitting firms as proposed could also mean restricting access to some of the skills required to undertake the most complex audits – a position which was echoed by the CBI. TheCityUK was also clear that it sees no evidence that an operational split would serve to enhance audit quality.

The CMA stopped short of proposing a full structural split – acknowledging that this would pose problems, not least because these reforms would only be applicable in the UK to what are global companies. However, Andrea Coscelli, CMA Chief Executive, remains open-minded about bolder measures heading forward.

Mandatory joint audit

It is proposed that joint audits – defined as those between a Big Four firm and a challenger firm – be made mandatory, with joint liability.

There will be exceptions for audits of the largest and most complex companies, and audits solely undertaken by challenger firms will be permitted.

As we made clear in our submission to the CMA, I am not convinced that joint audit will serve to make the market more resilient. As proposed, this looks like a very complex intervention, and I believe there’s a high risk that it could both drive out incumbents and discourage new entrants into the market, while also pushing up costs for businesses and consumers. In addition, I question whether some challenger firms have the capability, or the willingness, to take on FTSE350 audits.

ICAEW has long-argued that a segmented market share cap would be a better and faster way of extending competition – challenger firm BDO has also expressed this sentiment.

Other challenger firms, such as Mazars and Crowe UK, strongly support the joint audit proposal – believing that it will improve quality and confidence in audit.

The CBI shares our concern that mandating joint audit could add cost and complexity for business, and the Investment Association stated that it was unconvinced of the value of joint audits.

Moving forward

Like us, many in the profession have broadly welcomed the chance to engage in constructive debate with the CMA and others, recognising the need for significant reform – but hold reservations about the potential for unintended consequences.

On the whole, the report does contain many ideas that are realistic and pragmatic, and go to the heart of rebuilding trust in audit. It also proposes that progress should be reviewed after five years by the regulator - which by that point will be the new Audit, Reporting and Governance Authority (ARGA).

What is crucial is that the government response to these changes fully takes account of Sir John Kingman’s recommendations on regulation and the results from Sir Donald Brydon’s review on the quality and effectiveness of audit, to deliver a comprehensive and coherent programme of reform.

I am confident that the profession will weather this storm of scrutiny and build a brighter future. As ever, we look forward to continuing to work with all parties to produce effective recommendations for regulation and legislation, which will ensure that audit meets the needs of the British economy and wider society.

Please follow me on Twitter @MichaelIzza for further updates on this and my other engagements.

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