The Competition and Markets Authority (CMA) has announced the launch of its anticipated study of the audit sector, designed to examine concerns that it is not working well for the economy or investors because of the dominance of the Big Four and a lack of competition
The competition authority said the move comes amid growing concerns about statutory audits, in particular following the collapse of construction firm Carillion, as well as recent poor results from the Financial Reporting Council (FRC) reviews of audit quality.
The CMA market study will focus on three main areas: choice and switching; the long-term resilience of the sector; and the incentives between audited companies, audit firms and investors.
The CMA stated: ‘Unlike in some markets where there are concerns over whether the market is working well, there seem to be few complaints here that prices are too high.
‘Indeed quite the opposite; we have heard views that there might be merit in prices being higher in order to secure higher quality.
‘Separately we have heard from some mid-tier firms that the links between audit and non-audit services of the Big Four firms may make it difficult for mid-tier auditors to win audit contracts with FTSE 350 clients if the Big Four price their statutory audit offer relatively low.’
In its outline of the work, the CMA said that while the changes put in place by its predecessor, the Competition Commission, appear to have strengthened competition between the Big Four, the largest UK companies still turn almost exclusively to one of them when selecting an auditor.
The CMA said: ‘The key question for us is whether a lack of competition and choice means that there is not enough pressure on auditors to provide a good service, leading to worse outcomes in terms of quality, price or lack of innovation.’
The market study will also examine what the role of the Big Four firms means for resilience, and the risk that each being ‘too big to fail’ is potentially threatening long-term competition.
In addition, the CMA says its work will examine concerns that the fact that companies, rather than their investors, select their auditor might result in a lack of incentive to produce challenging performance reviews.
The CMA said it will be assessing the effectiveness of previous reforms in addressing this misalignment, and will also consider ‘whether the wider public interest in ensuring high quality audit might diverge from shareholders’ interests, and what implication this might have for possible market reforms.’
The competition authority said it will be looking at the ‘expectation gap’: the difference between what the public and financial statement users believe auditors are responsible for and what auditors’ actual responsibilities are.
The CMA said: ‘We will examine the existing scope of UK and international standards of statutory audit and we will gather views from stakeholders on whether the regulatory scope is delivering or hindering the outcomes that customers and stakeholders in the wider economy expect.’
The study will focus on what the CMA calls ‘the most effective and proportionate remedies’. These will include particular consideration of ideas to improve incentives; further separating audit and non-audit services; and reducing barriers to entry and expansion of non-Big Four firms.
The CMA has indicated it will consider three groups of measures which it has identified as likely to hold the most promise in addressing the issues.
The first is increasing competition between the Big Four, for instance by creating audit only firms. The second option is increasing competition from non-Big Four audit firms, for instance through a market share cap and/or introducing joint or shared audits. The third possibility is addressing the incentives arising in audits, for instance by moving responsibility for appointing auditors away from audited companies, in certain circumstances, to an independent body.
However, the CMA notes that preliminary discussion of the option of splitting the audit practices of the Big Four in the UK into separate businesses ‘would pose significant and potentially insurmountable challenges’.
Andrew Tyrie, CMA chairman, said: ‘If the many critics of the audit process are right, it is not just the companies which buy audits that lose out; it is the millions of people dependent on savings, pension funds and other investments in those companies whose audits may be defective.
‘Sir John Kingman’s independent review of the regulator is a big step in the right direction. And the CMA will now examine the market carefully to establish what contribution more effective competition could make to improving audit quality.’
The CMA says it has written to the government about its market study and the possible need for legislation to implement its findings and those of the independent review of the FRC led by Sir John Kingman.
The competition authority intends to consult on provisional views by the end of the year and complete its work as soon as possible thereafter.
An FRC spokesperson said: 'We have expressed concern about concentration at the top of the audit market so we welcome this announcement.
'We will work closely with the CMS as they carry out this study. It is essential that there is widespread confidence in the quality of company audit in the UK.'
Responding to the CMA’s market review of the audit sector, Scott Knight, Head of Audit at BDO, said: 'The CMA’s market review is welcome news but it is absolutely vital that any remedy to improve competition works hand-in-glove with reform of the FRC so that quality and competition are dealt with together.
'By only having powers over chartered accountants and not financial directors or CEOs, the FRC is currently like the director of a play who doesn’t have control over all the actors on the stage. This must change. To help address competition we would like to see an 80% cap on market share of the number of FTSE and public interest companies that the Big Four can audit. This is both a positive and practicable step towards improving competition and, unlike other versions of a cap we have seen, we would like to see this proposal implemented within a two to three year period and to include big private companies as well as the FTSE 350.
'Today there is real appetite for change within the audit market. These changes, taken in tandem, would put the right structures in place to ensure trust, transparency and competition in the audit of the UK’s 2000 UK public interest entities whilst ensuring that there is no regulatory drag on the UK’s four and a half million entrepreneurially spirited businesses.'
The deadline for written submissions on the market study is 30 October.
Statutory audit market study is here.
Report by Pat Sweet