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The UK big four face an operational split between audit and consulting services following the CMA’s report.
Legislation is needed to address both the vulnerability of the industry to the loss of one of the big four, and the current inadequate choice and competition, the Competition and Markets Authority (CMA) said following the publication of its final report.
The CMA is recommending the separation of audit from consulting services, mandatory ‘joint audit’ to enable firms outside the big four to develop the capacity needed to review the UK’s biggest companies, and the introduction of statutory regulatory powers to increase accountability of companies’ audit committees.
The CMA’s recommendations, outlined in its final report, follow extensive discussions with audit firms, investors and major UK companies on its update paper – published in December.
They also take account of the recommendations of a major report from the Business Select Committee, and the inquiry into regulation led by Sir John Kingman.
The recommendations are:
The CMA recommended that auditors should focus exclusively on producing the most challenging and objective audits, rather than being influenced by their much larger consultancy businesses. Given the difficulties with an immediate global structural split, the CMA is – at this stage – recommending an operational split of the big four’s UK audit work.
This will require separate management, accounts and remuneration: a separate CEO and board for the audit arm; separate financial statements for the audit practice; an end to profit-sharing between audit and consultancy, and promotions and bonuses based on the quality of the audits.
More choice and competition for the audits of big businesses can and should drive up their quality, the CMA judged, but the barriers to entry for ‘challenger’ audit firms are currently large.
The CMA recommends mandatory joint audit, to increase the capacity of challengers, to increase choice in the market and thereby drive up audit quality.
"Challenger firms should work alongside the big four in these joint audits and should be jointly liable for the results. There should be initial limited exceptions to the requirement, based on criteria set by the regulator, focused on the largest and most complex companies," CMA noted.
In addition, it said, any company choosing a sole ‘challenger’ auditor should be exempt. However, audits of exempt companies may be subject to rigorous, real-time peer reviews commissioned by and reporting to the regulator.
The CMA noted that it is essential that audit committees choose auditors by seeking those likely to provide the most robust and constructive challenge to the accounting practices of their companies. It recommended that the regulator should hold audit committees more vigorously to account. This may include ensuring that committees report their decisions as they hire and supervise auditors, and that the regulator issues public reprimands to companies whose committees fall short of adequate scrutiny of their auditors.
The CMA said the regulator should review the effects of these changes periodically, in the first instance five years from full implementation. This should consider in particular: the merits of moving to independent appointment for auditors; whether to go beyond the operational split already proposed; and how to fine-tune the joint audit remedy to adapt to market developments.
Conflicts of interest must end
"People’s livelihoods, savings and pensions all depend on the auditors’ job being done to a high standard. But too many fall short – more than a quarter of big company audits are considered sub-standard by the regulator. This cannot be allowed to continue," CMA chairman Andrew Tyrie said.
He explained that the government now has three reports to hand, which come to similar conclusions.
"Conflicts of interest cannot be allowed to persist; nor can the UK afford to rely on only four firms to audit Britain’s biggest companies any longer. Early action will require legislation – hence the CMA’s proposals," Mr Tyrie said.
CMA chief executive Andrea Coscelli also commented that the CMA's recommendations would ensure the UK strengthens its position in relation to corporate governance and accounting.
"We look forward to supporting the government as it considers how best to take forward these changes through legislation, alongside Sir John Kingman’s recommendations on regulation and the results from Sir Donald Brydon’s review on the quality and effectiveness of audit," Mr Coscelli concluded.