EXCLUSIVE: interview with Mazars UK head of audit

Head of audit at Mazars UK, Bob Neate, has his say on audit reform in the UK – explaining how he expects smaller firms to follow the Big Four in splitting operations and the benefits of more players through joint audit - as ‘everyone accepts that competition enhances quality’, Zak Jakubowski reports

The Big Four face an audit split due to recommendations from the Competition and Markets Authority’s (CMA’s) report, requiring them to submit an implementation plan to the Financial Reporting Council (FRC) by 23 October this year.

But questions remain over whether the consultancy arm of the business could truly be independent from the auditing arm when a big account is at stake, Neate argues.

He says that perhaps joint audit is the solution to lifting audit standards by breaking up the oligopoly, producing  robust  competition to share out the FTSE 100 auditing jobs among the challenger firms, and points out that it works well enough in the French market.

What are your thoughts on the audit split process? Will it change?

The Competition and Markets Authority’s (CMA’s) objective was to enhance competition to improve quality-basically what if one of the Big Four disappeared and you went down to three, because 100% of the top end (FTSE 100) is audited by the top four.

Their version of it was reasonably prescriptive, but there’s been huge delay in moving forward in market reform, the Department for Business, Energy & Industrial Strategy (BEIS) has been rather busy with Brexit and rather busy with Covid, so it’s probably a year behind where it should be in term of implementation.

'I don't think it will enhance audit quality particularly, and it doesn't do very much towards resilience.'

Bob Neate, head of audit, Mazars UK

The FRC, because it did not want the system to be seen doing nothing, has developed out its own version of operation separation. It’s a slightly softened version compared to the CMA's and it needed to be softened because the FRC have no authority to force its implementation – it doesn’t have the powers it needs.

They have laid out separation principles that they’d like the Big Four particularly to implement and given the Big Four until 2024 to bring in operational separation, which feels like a long way away for me.

The Big Four firms are required to submit an implementation plan to the FRC for ring fencing their audit practice from the rest of the firm’s activities by 23 October this year.

The idea is to create a ringfenced business within the bigger business, and the headline I get is that audit partners in the Big Four (once the ring fence is in place) will be remunerated out of the profit produced from audit only, with no crossover from the consulting part of the business.

There are two elements to why the FRC want that:

• This enhances independence because there’s a view that if you’re taking home a very big pay cheque because of a cross subsidy from the consulting bit of the practice, you will always have one eye on non-audit services even though the ethics code largely prohibits these breaches that at the moment. But is your focus in the right place and are you really independent?

• Secondly, they are trying to help the resilience assessment a little bit by making sure that the audit practices are financially strong enough, because as well as ring-fencing you are going to have to produce separate accounts for the audit practices in that ringfence and have those audited.

So it does help a little bit towards the resilience question, but only in the sense that it gives information about the financial viability of the audit practice as a stand-alone.

Does it change much? It’s not going to answer the questions that were set for the CMA, It is not going to bring in more competition to the market. I don’t think it will enhance audit quality particularly, and it doesn’t do very much towards resilience.

Having said that, I think it is a step in the right direction because audit by its very nature requires audit firms to be independent and objectives set that focus on audit quality. The less you are tied up in a sense with the rest of the bigger practice, the more independent you appear.

 Why are joint audits under discussion?

I think joint audit remains the best answer to the questions the CMA were set.

'If you've got an oligopoly, which is where we largely are, that means you probably pay more than you need to. It also means there is no incentive around quality because there's guaranteed work for them.'

Bob Neate, head of audit, Mazars UK

Why was everyone worried about it, they were worried because the FTSE 350 is systemically important to the wealth of the nation. They are significant employers and wealth creators, it's where our pensions and savings are invested. They need robust auditing to make sure they are strong businesses and the information they are producing for investors is of high quality.

The FTSE 100 particularly is the peak, the top 35/36 companies are a really significant amount of our economy and at the moment 100% of the FTSE 100 are audited by the Big Four. If one of the Big Four go bust, you’ve got a system breakdown as auditing is key to that system.

So how can we move to more players? 

More players is not just good for the resilience, everyone accepts that competition enhances quality. If you’ve got an oligopoly, which is where we largely are, that means you probably pay more than you need to. It also means there is less commercial incentive around quality because there’s guaranteed work for them.

Get proper competition in there and that will drive innovation and better quality. The audit market is so well established that the only way it’s going it happen is through some form of regulatory change. The CMA were asked to look at that.

Their study included talking to all players internationally as well as in the UK, they recommended joint audit as the solution that would have the quickest impact in changing the marketplace and allowing what they call ‘challenger firms’ into that space.

We have always found there has been barriers to entry mostly because it’s been sewn up so much, audit committee chairs are often ex Big Four, as well as key investment players. There is still perception that only the Big Four will do.

'You look for a Carillion or a Patisserie Valerie in France, they don't seem to exist. There has not been that kind of corporate/audit failure published. To us joint audit demonstrably has a high quality output.'

Bob Neate, head of audit, Mazars UK

There are quality benefits to a joint audit as well, we’ve been very pro joint audit because of the market we’ve seen in France.

France has had joint audit for its major businesses over the last 50 years. If you take the top 100 companies in France, last time I checked, there were 13 firms in addition to the Big Four auditing in that top 100 in a joint audit environment, whereas we just have the four in the UK.

You look for a Carillion or a Patisserie Valerie in France, they don’t seem to exist. There has not been that kind of corporate/audit failure published. To us joint audit demonstrably has a high quality output.

That is because if you have two firms doing the auditing and sharing the work between them, part of what you do is cross review each other’s work. I’ve done some joint audit and there’s a real psychological difference, if you know another firm is going to be reviewing what you do, you make sure you do it extremely well and you don’t cut corners: it’s a pride thing. This cross challenge and cross review means that you’re less likely to miss something and you’re more likely to challenge in the right areas and come to the right solution.

If there’s two of you facing a Chief Financial Officer (CFO) or audit committee chair who is trying to put pressure on you to let something go, you’re stronger because you don’t want to be the one that stands down.

Are audits inside the FTSE 100 totally shut to anyone below the Big Four?

At the moment none of us have been able to break into that place and the Big Four will tell you that’s because were just not big enough.

If you’re auditing HSBC, who is at the very top of the FTSE 100 and is in over a hundred countries, you’re going to need an audit team around the world of a couple thousand people.

'Joint audit recognises that we're not everywhere yet but gives us time to grow everywhere. Without joint audit it's much harder for us to take on the FTSE 100, just because of that scale issue.'

Bob Neate, head of audit, Mazars UK

At the moment none of us as challenger firms could take that on, but we could take on some of the FTSE 100 as joint auditors and build from there.

The joy of a joint audit is you play to the strength of the two firms. So Mazars, who is present in 91 countries, would take the countries we are strong in and a Big Four firm could do the other countries which we are not in. This gives us a period of time to actually build a presence in those countries. 

Joint audit recognises that we’re not everywhere yet but gives us time to grow everywhere. Without joint audit it’s much harder for us to take on the FTSE 100, just because of that scale issue.

Is Mazars going through an audit operational separation split?

I suspect all the challenger firms will have to go that way because we’re looking to compete in the same market as the Big Four.

If I am pitching against a Big Four for a FTSE 350 company and the audit chair of that company says to me ‘well the FRC thinks that to get the strongest independence the audit practice should be separate, why aren’t you?’, this puts me at a disadvantage.

Therefore, the market expects us to go that way and inevitably we all will.

Just one more thing

The indications we are getting from BEIS and FRC is that BEIS will produce its recommendations for market reform before the end of this year, and we are all trying to keep pressure on them to do that.

We were told it might be a Christmas present arriving just before the break so no doubt ruin my chances of a relaxing Christmas as I will want to read it in detail.

By mid-next year we will have a really clear picture on how audit (its scope, regulation and competition) will be changing.

Further reading:

Accountancy Daily article: CMA wants Big Four operational split and mandatory joint audits

CMA final report, Statutory audit services market study, 219pp, issued 18 April 2019t

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