Whitewash or razortoothed watchdog attack? It seems yesterday’s report by the Competition Commission into the auditing of our biggest companies fell somewhere between the two. At issue is the fact that KPMG, EY (formerly Ernst & Young), PricewaterhouseCoopers and Deloitte have a 95 per cent stranglehold over auditing the FTSE 350 list of Britain’s biggest companies.
Investors are concerned that this small group of auditors looks far too cosy to hold big business to scrutiny. Some auditors stay with their clients for decades, giving rise to the perception that they are too close to the management teams of the businesses they are supposed to be holding to account. Perhaps, say critics, this was not entirely unrelated to auditors’ repeated failures to spot the financial scandals of the banking crisis. Meanwhile, smaller players in the accounting world complain that they find it almost impossible to win auditing mandates among bigger firms.
The Competition Commission, which has been examining the issue since October 2011, was urged to deal with the situation by forcing companies to rotate their auditors every decade or so. But, in its provisional decision published yesterday, it has, in the words of one commentator, “bottled it” on that score.
Laura Carstensen, who chaired the inquiry, said such a move would actually weaken competition as you would end up with three bidders pitching for the contracts instead of four. What’s more, the incumbent may be doing a decent, honest job and genuinely be the best firm to do it.
Rather, she and her team decided, companies should be forced to put the audit work out to tender at least every five years and give all firms a chance to pitch. That, she says, would at least give new firms a chance of elbowing their way into a big company. It would also encourage big companies to review their auditors’ work.
“More frequent tendering will ensure that companies make regular and well-informed assessments of whether their incumbent auditor is competitive and will open up more opportunities for other firms to compete,” Ms Carstensen said.
Daniel Summerfield at the Universities Superannuation Scheme, one of the biggest pension funds in the UK, said there was “much to be welcomed” in her recommendations. Another large fund manager described them as “surprisingly good, actually, tougher than we had expected”. But both still thought there needed to be a rule forcing auditors out if they stay in place for too long.
Dr Summerfield said: “An upper tenure limit of 15 years for audit firms should be introduced to fully address our concerns around auditor independence and auditor quality.”
EY sounded delighted that compulsory rotation had been “laid to rest”. But it’s only a reprieve: a higher court, the European Commission, is also deliberating over the issue, and word is that it will demand compulsory rotation every 14 years.
One fund manager said: “The Competition Commission probably didn’t want to do anything that gets overturned later on. They’d look pretty stupid if they recommend one thing, only to be overruled a few months later by Brussels.”
Even without mandatory rotation, big companies are still not happy. They complain about the cost and added red tape of five-yearly tenders. Barclays reckons the process will take two years each time and 200 staff. The commission counters that it will probably cost UK plc only £30m a year.
But what of the smaller audit firms’ views? James Roberts, senior audit partner at mid-tier BDO, said: “The frequency in itself will make people think whether there is actually someone different that they can buy out there. It’s inevitable that more liquidity in the market will mean more change of auditors, and more work for us.”
Others were more cynical. Jonathan Russell, partner at ReesRussell, said even in countries with compulsory rotation, few firms outside the big four seem to get a look-in because of the cost of putting together a tender.
And there is the rub. No matter what the Competition Commission had recommended, if it is too expensive for smaller firms even to make a pitch, the big four will always control the market. Furthermore, with our largest companies being increasingly global, it seems hard to criticise them for hiring the most international accountants to do their audits.
Surely the more important issue is establishing whether the auditors, whichever firm they work for, are doing a proper job hunting down the next financial disaster that’s waiting to happen.
Q&A: WHAT IT ALL MEANS FOR THE CITY
What is a company audit and why is it so important?
Auditors are the eyes and ears for outsiders on a company’s financial health. External accountants pore over the books of a company every year to ensure internal staff have been accounting fairly and accurately. They are the clearest external way of spotting wrongoing.
So why was the Competition Commission called in?
In the old days, there were seven big accountancy firms for big companies to use on their audit work. But takeovers have seen just four emerge. They have become so dominant that smaller firms find it impossible to get a look-in when it comes to bidding for business.
How does this affect those of us who are not accountants?
Auditors stay with their clients in some cases for decades. Critics say this could lead to less rigorous questioning of the way the business is being run. That arguably makes it more likely something will go wrong at a company where your pension is invested.
What did the watchdog recommend should be done?
The main point is that big companies must put their audit account out to tender at least every five years. Audits should be scrutinised by the Financial Reporting Council every five years too. And banks are banned from insisting on a big four auditor before lending to a company.
How were the recommendations received?
Broadly, big accountants and companies disliked the idea of five-year tenders. Investors were disappointed that the idea of mandatory switching of auditors every decade was dropped. The FRC fretted about its extra workload and tougher approach. Mid-sized accountants were happy.
Will the plans make a big difference to the corporate world?
They will shake up boardroom complacency about auditors. But the biggest shift awaits as Brussels is soon to force companies who have used the same auditors for 14 years to change them. Expect the lobbying effort against reform to continue.
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