The Competition and Markets Authority (CMA) should aim for the “full structural break up” of the Big Four firms into audit and non-audit businesses, say the Business, Energy and Industrial Strategy (BEIS) Committee.
A report by MPs as part of its ‘future of the audit sector’ inquiry endorsed the CMA’s proposed operational split between audit and non-audit but argued that going further with a structural break-up would prove more effective in “tackling conflicts of interest” and “providing the professional scepticism needed to deliver high quality audits”.
The report also tackled the lack of competition in the audit market and its impact on market resilience, with concerns that it could go down to a “Big Three or worse”. In 2016-17, EY, PwC, KPMG and Deloitte accounted for 97% of FTSE 350 audits and 99% of FTSE 100 audits.
To improve resilience and choice, the report recommended a segmented market cap and the use of joint audits, on a pilot basis, for the most complex audits to enable the challenger firms to step up. The report also recommended increasing 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.
In the report, MPs refuted claims made by auditors – particularly the Big Four and Grant Thornton – that the crisis in audit was a “perception problem” arising from an “expectation gap”. The report noted that 27% of audits reviewed for 2017/18 did not meet FRC standards and found there was a “delivery gap” and a “serious failure of audit to deliver on its own current terms”. The report said the detection of material fraud should be a priority and said, in light of the failings at Patisserie Valerie, audits must state how they have investigated potential fraud, including by directors.
The BEIS Committee’s report called for a range of improvements to the audit product, encouraging Sir Donald Brydon, chairman of the London Stock Exchange Group and the Sage Group, to look into how to make audits more “forward-looking”.
The report recommended audits move to include graduated findings, providing more nuanced information to investors and others. In the future, the report suggested that audits could provide a better picture of a company’s overall corporate governance.
Highlighting the collapse of construction firm Carillion, the report called for a “tightening” of the UK dividend regime and welcomed the introduction of new regulator Audit, Reporting and Governance Authority (ARGA) to replace the FRC.
Rachel Reeves MP, chair of the BEIS committee, said: “Change in the audit market is long overdue. The reviews from the CMA and Kingman highlight the failings; now we need action. The Big Four’s dominance has fostered a precarious market which shuts out challengers and delivers audits which investors and the public cannot rely on.
“A segmented market-cap and the piloting of joint audits would help to break the stranglehold of the Big Four and deliver a healthier and more resilient audit market. For the big firms, audits seem too often to be the route to milking the cash-cow of consultancy business. The client relationship, and the conflicts of interest which abound, undermine the professional scepticism needed to deliver reliable, high-quality audits.
She added: “Splitting audit from non-audit business would be a big step to boosting the culture of challenge needed to deliver high-quality audits. Change is needed to deliver for investors, workers and the public.
“The Big Four may not like it, they may seek to undermine the case for reform, but vested interests should not be allowed to get in the way of positive change. We must not wait for the next corporate collapse. Government and regulators need to get on and legislate to deliver these reforms and ensure that audits deliver what businesses, investors, pension-holders and the public expect.”