MPs and industry unite in calls to break Big Four stranglehold
An influential group of MPs are the latest to call for a break-up of the Big Four on competition and trust grounds, but with a Brexit headache, resource constraints and a regulator in flux, does Britain have the appetite to see the task through?
In a hard-hitting report released on Monday, the Business, Energy and Industrial Strategy (BEIS) Committee of MPs said it is entirely wrong for Deloitte, EY, KPMG and PricewaterhouseCoopers to conduct 97% of big companies' audits and provide the same firms with multiple other services.
Members of the select committee recommended a forcible break-up of the Big Four accounting firms and set out why separation of their audit and consultancy arms is the only way to boost competition and the quality of auditing.
The BEIS recommends the UK’s antitrust watchdog takes the hardest option possible when it rules on the issue in a couple of weeks, after the completion of its own review into the state of audit.
The Competition and Markets Authority (CMA) has proposed an operational split between audit and non-audit, but the committee members said a structural break-up is necessary to tackle conflicts of interest and “provide the professional scepticism needed to deliver high-quality audits”.
Many in the industry agree the time for talking is over and action, be it self-imposed or via regulatory mandate, is long overdue.
Robert Stell, owner of Teddington-based firm Bradbury Stell, has recently bucked the trend of accounting firms moving away from audit services and launched a separate auditing entity. He believes if audit quality is to improve, things have to change.
“The CMA, the Financial Reporting Council and now a committee in parliament itself have said that something must change,” he told AccountingWEB. “The UK audit market is an oligopoly. That is fact, not opinion, and where oligopolies exist, it is the government’s duty to break them up and stimulate greater competition, particularly at the FTSE end of the market.”
Calls to break up the quartet are nothing new, but the drum-beat has grown steadily louder in recent years following a spate of high-profile accounting blunders at Carillion, BHS and HBOS, that have damaged trust and cost the taxpayer hundreds of millions of pounds.
With almost perfect timing, the BEIS report was put out on the same day the soon-to-be-defunct Financial Reporting Council announced it had opened an investigation into KPMG's audit of Carillion.
Consistent to the last, the FRC has appointed a former KPMG accountant to head the “independent review” of KPMG’s entire audit practice.
“One thing is clear – the auditing industry is incapable of putting its own house in order and that task will need to be performed by others,” said Prem Sikka, emeritus professor of accounting at the University of Essex.
“Auditing is simply a means of securing timely and reliable financial accountability of corporations”, he said, “and if big firms are unwilling to do that then governments need to develop alternative institutional structures.
“The status quo is untenable and reforms would need to be imposed in the teeth of opposition from the auditing industry,” concluded Sikka.
The FRC is being disbanded due to its ineffectiveness and will be replaced by another regulator, the Auditing, Reporting and Governance Authority (ARGA), which is set to be given a new mandate, new leadership and stronger legal powers.
Industry watchers will be hoping the new body does not follow the path of another regulator which emerged from the ashes of a previous failed incarnation: the Financial Conduct Authority (FCA).
The FCA was created in 2014 following the financial crisis and a series of banking scandals that tarnished the reputation of the sector. In a flurry of publicity, it launched an accountability scheme for finance professionals but is now fighting off claims of being toothless.
The regulator is now facing a review into its handling of the collapse of savings firm London & Capital Finance (LCF), which went under in January carrying £237m of investments. It has since emerged that LCF went through three auditors in three years.
EY was external auditor for LCF in 2016/2017, after it picked up the reins from PwC, which audited the accounts for the 2015/2016 financial year.
Prior to PwC, Oliver Clive & Co had audited the company’s accounts for the previous year, according to Companies House filings, yet none of the auditors flagged up anything untoward until administrators Smith & Williamson said they had found “a number of highly suspicious transactions by a small group of connected people which have led to large sums of bondholders’ money ending up in their personal possession or control”.
BEIS members recommend a segmented market cap and the use of joint audits, on a pilot basis, for the most complex audits to enable challenger firms to step up.
“The ideal scenario is for all FTSE audits to be spread amongst the top eight,” said Robert Stell. “The problem is that the barriers to entry are so high. I have heard that £250,000 is not unusual for a FTSE audit bid cost. You can quite understand why many accountancy firms would shy away from that.”
BEIS members also want to increase the frequency of audit rotations to seven-year non-renewable terms and (should the CMA go ahead with an operational split) a cooling off period of three years, in which non-audit services cannot be offered to a former audit client.
Given the Brexit paralysis currently affecting the UK’s parliament, a very real possibility of a resource black hole stymieing the plan, and even the possibility of a change in government, how much of this will be possible to execute is uncertain.
Experts said the Brexit resource black hole and undefined timeframe could put a spanner in the works, and that accelerating the creation of the new regulator would be a major step forward.
“There seems considerable agreement on the need for this change, which would bring about greater supervision of audits,” said Professor of Accounting and Public Management at Kent Business School, Robert Jupe. “However, finding time for the legislation may be the problem.”
He felt the select committee calling on the CMA to at least stick with its proposal for an operational split between audit and non-audit work within firms meant this outcome was more likely than the full structural break-up occurring.
“Nonetheless, after many years of debate about the quality of audits in the UK, and the continuing accounting scandals, it now seems time to adopt radical change in the form of the break-up proposal,” Jupe said. “This should ensure that the audit arms of the Big Four firms improve the delivery of their audits, as they would be reliant on audit fees and no longer able to use audits to gain consultancy business.”
Unsurprisingly, the Big Four rejected the findings and said the move will weaken resilience, increase costs and damage the UK’s global competitiveness.
“We recognise the need for reforms which will enhance audit quality; however, the report’s recommendation to break up the largest firms risks hampering, rather than enhancing it,” said Hemione Hudson, PwC head of assurance. “Arguing for ‘break-up’ sounds like action, but actually it will reduce quality, weaken resilience and distract attention from more practical steps to ensure auditing keeps pace with society’s expectations.”