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Audit reform plans hit by delays as regulator admits multiple failings

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Challenger firms are baulking at the introduction of shared audits, while the government’s plan to rein in the Big Four with a new regulator has been delayed.

2nd Jun 2021
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The UK government’s ambitious plan to reform the audit sector is in trouble. 

Key facets of the proposals, including the introduction of shared audits, launch of a new regulator, and legislation to clip the wings of the Big Four have all hit snags in recent weeks. 

The two largest challenger firms, BDO and Grant Thornton, are reportedly not pitching for shared audits of FTSE 100 companies in lieu of increasing the number of FTSE 250 businesses they audit solo.

Shared audits were commonplace before the rise of the Big Four skewed the market to ensure the largest public companies had a single auditor large enough to carry out the work.

To increase competition and strengthen the quality of audit, the UK government is legislating to ensure EY, Deloitte, PwC and KPMG hand over a minimum of 30% of a job to a smaller firm that successfully pitches for the work.

Leftovers

But challenger firms believe the balance of power will not alter, leaving the smaller auditors to feed off scraps that may stir competition between each other but not enable them a platform to rival the Big Four.

“If the challenger firm is just going to get what’s left at the bottom of the barrel, that’s not interesting and doesn’t help,” Fiona Baldwin, head of audit at Grant Thornton, told the Financial Times.

BDO head of audit Scott Knight added: “BDO will work with whatever market intervention [the Department for Business, Energy and Industrial Strategy] land upon and try to make it work.

“We think the exemption from managed shared audits if you appoint a challenger firm will have a significant impact, particularly among the FTSE 250,” Knight said.

Critics have pointed out that Grant Thornton’s shared audit refusal aligns with the thinking behind its 2018 decision to stop bidding for audit contracts from Britain’s largest companies. The firm said it was too difficult to compete with the Big Four firms that dominate the market.

Another problem to overcome is the Catch-22 situation whereby challengers can’t demonstrate that they have the experience to bid for larger engagements without first having gained that experience.

“Their demurrer echoes the mordant humour of Abraham Lincoln, who captured the pain and frustration of the American presidency by likening his position to the man tarred and feathered and carried out of town on a rail – who, asked how he liked it, replied that ‘if it were not for the honour of the thing, he would much rather walk’,” said Jim Peterson, lawyer and lecturer at business and law schools in Chicago and Paris.

For the companies themselves, the process would be unmanageable, Peterson said, while the Big Four would gain nothing but “valueless inflation of their costs, effort and liability exposure”, while the smaller firms could never provide the necessary skills, personnel and capability.

Too big to fail

Sir Jon Thompson, chief executive of the Financial Reporting Council (FRC), also poured cold water on hopes shared audits would loosen the grip the Big Four have on the market “in the short term”. 

In remarks made to the Financial Times, Thompson added the Big Four were “too big to fail”, and would remain the dominant force in the market.  

“We cannot expose the smaller firms to the liability of auditing a FTSE 350 company,” said Thompson. “It’s too much for them to take on.” 

Thompson said over time shared audits would give smaller accounting firms experience in scrutinising the accounts of large companies. 

“That’s the way to build up their capacity, but it’s a slow burn, it’s going to take a long time,” he said. 

The government has proposed a cap on the Big Four’s share of the FTSE 350 audit market if competition does not improve, but Thompson said this was “not really an area where I want to go”. 

“I don’t think in [the] short term we’d be looking at using [those powers],” he said.

“We remain confident that managed shared audit will be effective to increase competition in the long term,” a government business department spokesperson said. “It is welcome that some challenger firms already feel able to tender for FTSE 250 contracts as sole auditor – this is the desired effect following proposals set out by government.”

Asleep at the wheel

Another major aspect of the accounting sector shake-up is the creation of a new, independent accounting regulator, the Audit, Reporting and Governance Authority (ARGA). 

However, the launch of ARGA has been beset with delays and it will not be in operation until 2023 at the earliest. 

The hiccup means some legislative aspects of audit reform will not enter force until 2024. 

In announcing the delay, Thompson also said criticism of the current regulatory regime was valid in the shadow of multiple scandals. 

Thompson admitted the FRC was “asleep at the wheel” in regard to collapses including Carillion in 2018 and Patisserie Valerie in 2019.

“Let’s be straight forward about it,” Thompson said. “Were we complicit or in some way responsible for corporate failure? Well, it’s probably arguable that as a regulator we weren’t anywhere near as strong enough, we weren’t big enough, and we weren’t transparent enough to make a difference to the system.”

Thompson’s stark comments were not a surprise for many industry watchers.

“Some of us have said that for years,” said Labour peer Lord Prem Sikka. “It is still dominated by big business and isn't up to the job. Expect more accounting/auditing scandals.”

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