The influential House of Lords’ Economic Affairs Committee was taking evidence yesterday from Jonathan Faull, director general of Internal Market and Services at the European Commission about the regulation of the audit market.
Lord Lawson argued that the Commission should have tightened the law relating to the relationship between banking regulators and bank auditors to ensure that they both share their concerns about banks.
He accused the Commission of being ‘half-hearted’.
"I am alarmed that you say you just leave it to the regulators and auditors’ discretion about what they disclose. Surely you should have learnt from the experience of the UK that if you leave it to discretion, it doesn’t work?"
He added that he was concerned that the Commission’s proposals were more likely to be watered down than strengthened as they went through the process of scrutiny in the European Parliament and the Council of Ministers, adding, "If you start the ball rolling with weak proposals, then they will only get weaker."
Last March the Economic Affairs Committee issued a hard-hitting report which looked at audit market concentration and the role of auditors.
Key recommendations included: a detailed investigation of the large firm audit market by the Office of Fair Trading; prudence to be reasserted as the guiding principle of audit; and the new framework of banking supervision to provide for bank audit to contribute more to the transparency and stability of the financial system, in particular through two-way dialogue between auditors and supervisors about the financial health of banks.
As a result, the Competition Commission is now investigating the market.
The Lords also expressed concern about what would happen if one of the Big Four disappeared, leaving just three, and whether or not the Commission’s proposals would lead to improved choice in the audit market.
Lord Smith of Clifton pointed out that there was evidence that the mid-tier firms were ‘not anxious’ to get into the FTSE 100 audit market but would be more interested in getting more business from companies in the FTSE 250. ‘In other words, the chances of better competition are somewhat limited’.
Faull made it clear that, in drafting the proposals, the Commission was keen to ensure that greater competition in the large audit market. He pointed to ‘incentives’ such as mandatory rotation of audit firms, mandatory tendering and the banning of Big Four-only contractual clauses which were designed to persuade the mid tier firms to step up to the challenge of taking on a large listed company audit.
Faull said, "We hope that when the legislation is enacted, the market will be better and firms’ ability to enter the market at the upper end will improve.
"We think there is a link between the structure of the market and the confidence in high quality audit that the market should be providing. Market structure is a means to an end and the end we want is the restoration of trust in audit. There have been too many celebrity failures. One of the reasons for our having concerns about the audits that were carried out was simply a structural one. There are too few suppliers and so the links between auditors and auditee are breeding familiarity."
He added that the proposals are now ‘experiencing lively debate’ between officials and Council of Ministers’ working groups.
"There is still some way to go and the Commission doesn’t claim to have found definitive answers but we believe that we have identified the problems and struck the right balance in answering them."