Major audit overhaul to break up Big Four dominance
The government’s long-awaited overhaul of the audit regime includes proposals to break up the Big Four dominance, increase competition from smaller ‘challenger’ firms, and new reporting obligations for directors.
Business secretary Kwasi Kwarteng has announced today major new reforms to the audit regime to “restore business confidence” following the large-scale corporate collapses and accounting scandals like Thomas Cook, Carillion and BHS.
The government’s plans include a new regulator to oversee quality and standards in the audit market. Meanwhile, directors of large businesses could face fines and suspensions under the new reforms if they have been found to be negligent.
The BEISS proposals take on board the findings from the independent reviews from Sir John Kingman, Sir Donald Brydon and the Competition and Markets Authority. “When big companies go bust, the effects are felt far and wide with job losses and the British taxpayer picking up the tab,” said Kwarteng.
“It’s clear from large-scale collapses that Britain’s audit regime needs to be modernised with a package of sensible, proportionate reforms.”
Sir John Kingman recognised that “much has already been done to strengthen regulation of UK audit” since his 2018 report. But the critical missing piece is “to fix the regulator’s legal status and powers”, which is why he wants the consultation followed through “with legislative action as soon as possible”.
End of the Big Four’s audit dominance
Under the new proposals, PwC, Deloitte, KPMG and EY's stranglehold of the audit market would be watered down as large companies would be required to use smaller ‘challenger’ firms.
“It is not healthy for audit quality that the UK audit market is so concentrated, with 97% of FTSE 350 audits undertaken by just four audit firms,” said the report “This concentration is not helped by the fact that those firms also compete to provide a wide range of other business services to the largest companies.”
Also of concern is that almost a third of FTSE 350 audits last year were found to be in need of improvement.
The government is therefore proposing new measures to increase competition and boost smaller audit firms, such as the Big Four facing a cap on their market share of FTSE 350 audits if the sector doesn’t improve.
The Audit, Reporting and Governance Authority (ARGA) would be given powers to impose an operational split between the audit and non-audit functions of accountancy firms. This intervention is expected to reduce the risk of any conflicts of interest.
Replacing the Financial Reporting Council, the new regulator will also have powers to direct changes to company reports and accounts. Currently, the regulator would have to seek a court order.
The powers given to ARGA will be backed by legislation and funded by a mandatory levy on industry,
Investor and public confidence in audit
Recent problems with corporate reporting highlight that this is an area the government must address. The executive summary even uses the belated discovery of a major fraud at German payments processor Wirecard as an example of the need for a fundamental reform of the framework underpinning audit and corporate reporting.
The proposals would enforce new reporting obligations for auditors and directors around detecting and preventing fraud. This would require boards to set out what controls they have in place and auditors would be expected to look out for problems.
Audits would also extend beyond a company’s financial results and take into account their wider performance on metrics like climate targets. The consultation explains that this would ensure investors and other interested parties are fully informed and can hold companies to account.
Holding directors to account
One of the biggest headlines from the consultation is plans to make directors more accountable.
The consultation recognises that responsible behaviour by directors is “the fundamental starting point for high quality and reliable corporate governance and reporting” but acknowledges that the current framework is “inadequate in holding the directors of such companies to account”.
Under the proposals, directors of large businesses could face fines for negligence such as significant errors with accounts, hiding crucial information from auditors, or leaving the door open to fraud.
The consultation also wants businesses to clamp down on ‘rewards for failure’. Directors of a failed business could also see their bonuses reclaimed in the event of a collapse or failing up to two years after the pay award is made. Dividends and bonuses could also be stopped if a business is facing insolvency, under plans to make large businesses more transparent.
Another measure to increase transparency would require directors to release annual ‘resilience statements’ which explains how their organisation is mitigating short and long-term risks.
Big Four react
Statements from the Big Four firms all backed the idea of “leading the world on corporate governance” and used phrases such as “opportunity” in reaction to the consultation.
Kevin Ellis, chairman at PwC UK, welcomed the consultation and recognised the need for a “coherent set of measures”.
“We’ve said for some time that we support measures that promote high quality audits, increase resilience of the audit market and maintain the attractiveness of audit as a profession. We have already taken a series of steps following the independent reviews, and will be carefully analysing the proposals and their implications.”
Stephen Griggs, Deloitte’s managing partner, called the government’s white paper a key milestone in moving ahead with reform of the audit market.
He added: “It is important that changes in audit are complemented by reforms to the governance of the UK’s largest and most complex businesses and those with a significant impact on public interest. Defining which entities are captured by new reforms is key to ensuring they are focused where they are most needed, not on smaller entrepreneurial businesses.”
AccountingWEB community reacts
AccountingWEB readers response to the consultation was nicely summarised by contributor Jason Croke who said that he’d “wish they’d just get on and do it”.
Looking more closely at the proposals Croke was sceptical about the potential to open the world of audit up to the mid-tier top 15 accountancy firms. “[I’m] not sure if even the top 15 would have the capacity to take on multinational audits at the same pricing level that the big 4 can churn it out for,” he said.
Meanwhile he questioned the reality of making audits “more rigorous”. “If they mean being able to spot a £250m blackhole in Tesco's accounts then that's not really 'more rigorous' to me, they mean ‘do it properly’.”
For AccountingWEB member Birdman, the main issue is independence. “[Audits] start with the premise that everything is correct, then look for evidence to support that theory. Until they become truly independent (imposed by a third party rather than appointed by the company being audited) I can't see anything changing.”