In their responses to the Competition and Markets Authority (CMA) study of the audit market, both professional bodies stress the need to focus on audit quality.

ICAEW stated: ‘Despite several high-profile corporate collapses and audit failures in recent years, we are sceptical that the number of competitors - as such - available in the market for large corporate and public interest entity (PIE) audits has a direct causal link to auditor performance.’

However, the institute goes on say it is confident that a consensus now exists across the accountancy profession that increased choice in the market for large corporate and public interest entities (PIE) audits is necessary and desirable.

ICAEW counsels against any expectation that major changes will happen quickly, saying it will take time for potential challengers to gain the experience and capacity to be regarded as viable competitors to the Big Four. A graduated approach to implementation will also mitigate the possibility of causing one or more of the Big Four to withdraw from the market or significantly reduce their commitment to it.

In its response, ICAEW notes: ‘One of the issues which runs directly contrary to any attempt to encourage new entrants to the audits of the largest companies, is the deep concern of firms outside of the Big Four regarding the potentially significant reputational and financial damage which they could suffer under the current regulatory regime for performing a poor audit.

‘Indeed, firms outside of the Big Four view multi-million-pound penalties, such as those imposed recently for a breach of the independence rules where there was no underlying issue with the quality of the audit, as being far too high a price to bear for entering this market.

‘ICAEW believes that firms outside of the Big Four will be seeking assurances that the current FRC sanctions regime will be amended to be much more proportionate by, for example, tying any potential sanction to a multiple of audit fees rather than basing the financial sanction on the total revenues of the firm for its last financial year so that the firms can understand the extent of the financial risk that they would be taking in entering this market.’

This point is echoed in the ICAS submission, which states: ‘The current auditor liability regime concentrates the audit of the most complex PIE companies within a very small group of firms who have the capacity to invest in the training and technology required to manage this risk and who have the diversification and scale to absorb liability for failings should these arise.

‘We believe the CMA will need to engage with the FRC to address this particular challenge. Consideration may need to be given to whether or not the existing auditor liability regime should be adapted.’

Remedies

As regards remedies, ICAEW describes a collective market share cap on the Big Four in the FTSE 350 as difficult but worth investigating further. Any such cap will need to offer the Big Four the prospect of enough business to keep them in the market, while encouraging their challengers to invest in the capacity and resources required to operate at this level. If this route is pursued, ICAEW believes that the cap should be set at the lower, tighter end of the options under discussion.

It also suggests that the option of a market cap of around 65 clients for any single firm is a practicable alternative approach to a collective cap. In either case, ICAEW says it sees the setting of a market share cap in the listed market beyond the FTSE 350 as necessary, to limit the extent to which Big Four firms simply displace downwards. It strongly recommends that any capping mechanism is subject to a regular review of its impact, initially after three-to-five years.

ICAEW stated: ‘For several reasons, we do not see that breaking up the Big Four would be helpful, although we believe that ring-fencing within the largest firms to separate audit and non-audit services is an option worth investigating.’

It is also not in favour of the idea of an independent public body to appoint auditors in the market for large corporate and PIEs, which it says its ‘problematic’, but believes there may be a role for joint and shared audits as a way of helping challenger firms acquire experience and credibility.

ICAS

For its part, ICAS stated: ‘If audit quality is the prevailing issue, then the optimum outcome is likely to be a combination of several initiatives, including a review of corporate reporting, scope of audit, enhanced corporate governance, and creating opportunities for increased choice. Therefore, the CMA needs to contribute to this wider programme of reform.’

The Scottish institute is in favour of implementing a government supported multi-stakeholder review into the UK corporate governance and corporate reporting frameworks including assurance. 

Its response also gives backing to a separation of audit and non-audit services, stating: ‘We would support a complete prohibition on audit firms providing non-audit services to their PIE audit clients (at least the FTSE 350), subject to a small agreed list of permitted assurance related services.

‘The assurance and audit related services that could be allowed to be provided to PIE audit clients should be reviewed and clarified, and a list of permitted services prepared accordingly.’

ICAS says this proposal would help address the perception that management is ‘too close’ to the audit firm.  However, the institute notes that a complete prohibition on audit firms supplying non-audit services to a large company or PIE would be a severe restriction of choice for the companies concerned.

Likewise, it says the split of UK arms of major accounting firms into audit only and non-audit service practices, ‘would require overcoming considerable challenges’.

It also wants to see increased transparency of the audit committee tender process. In particular, this should include disclosure of the audit committee’s key criteria for assessing the qualities they expect of their statutory auditors.

ICAS stated: ‘This should be at a sufficiently detailed level to enable all firms including those outside of the Big Four to assess their own capabilities to audit a particular PIE company and if necessary to close any gaps in capability.’

ICAS also warns that the FRC and CMA need to ensure their respective objectives are aligned. The FRC has an established KPI that 90% of FTSE 350 audits should not require more than limited improvements. If this KPI is met through existing audit arrangements this acts as a constraint to making a change given that the risk of audit quality falling below the FRC threshold may be elevated in the period of transition from one auditor to another. The regulator would need to find ways to support the audit market through this process, if enhanced choice is to be a realised outcome, ICAS argues.

ICAEW response to CMA is here

ICAS response to CMA is here

Report by Pat Sweet