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17 Jun 2016 11:26am

Super Friday: the dawning of a new era for auditors

UK audit firms will never again be able to emulate PwC’s 120-year relationship with Barclays Bank or KPMG’s 80 years looking after Associated British Foods

From today, the new audit regime for auditors in the European Union comes into operation, introducing mandatory audit tendering, rotation of auditors and a ban on most non-audit services (NAS) for audit clients.

Under the new rules, companies will have to tender their audit at least once every 10 years and rotate their auditor at least every 20 years to ensure that their dealings with their auditors are seen to be independent .

Audit firms also face a 70% cap on the level of fees they can earn from their public interest entity (PIE) clients, and restrictions on what services  they can and cannot offer those clients – the blacklist includes, for example, providing certain tax advice and compliance services, and designing and implementing internal controls.

BDO believes that the new reforms have the potential to open up a £10bn market for advisers, particularly for accountancy firms that rank in size immediately below the Big Four.

It has analysed 895 of the approximately 2,500 PIEs registered in the UK and predicts that £10bn worth of audit and non-audit services could change hands in the next 10 years, thanks to the EU legislation.

Regulators and standard-setters will be assessing the impact of these innovations in the future

Henry Irving, Head of ICAEW's Audit and Assurance Faculty

According to BDO senior audit partner James Roberts, breaking into the larger listed audit market will take non-Big Four firms a long time – “a five to 10-year game” – since the “big ticket audits” will be well defended by current auditors.

Indeed, experience to date shows that auditor rotation in anticipation of the ARD’s implementation has resulted in a game of musical chairs among the Big Four. But it is the Big Four’s potential conflicts of interest arising from the NAS market where the Group A firms see opportunities coming their way.

Genuine opportunities to win larger company audits are likely to come to fruition in the second round of rotation, he believes.

Nevertheless, as BDO tax partner Jo Gilbey points out, there are plenty of opportunities presented by the new regime, particularly in the non-audit services market.

She expects the very largest listed companies to make a very rigid demarcation between audit and non-audit services which would benefit the non-Big Four firms. “Because we are already giving advice to 35% to 40% of the FTSE 350, we think that the demarcation is going to help us grow our business.

“It’s exciting times,” she adds. “We are looking forward to all the increased opportunities and we are pretty confident we will be there.”

Roberts says that in the run-up to implementation, once it was clear how the new regime would shape up, there was a huge increase in the number of companies contacting the firm.

Inevitably, some of it was “ticking the governance box” to ensure that there was at least one non-Big Four firm involved in audit tenders. “That’s fine but the problem for us is that we need to be careful to engage only in activity where we think we are doing anything other than making up the numbers. So we have said no to tender opportunities where, for example, we don’t have the right resources available or we have no relationship with the company and can’t detect any enthusiasm from them.”

They both identified a developing trend for companies to ask the firm to go through what is effectively a full procurement process so that when they need to commission non-audit services, the firm is on the list of “approved suppliers”.

Introduction of the new audit regime will inevitably involve a steep learning curve not just for audit firms but also for audit committees. As well as the legislative changes contained in the Statutory Auditors and Third Country Auditors Regulations 2016, which was approved by parliament earlier this week, today the Financial Reporting Council (FRC) is publishing revised ethical and auditing standards that run to more than 1,000 pages.

PwC’s head of regulatory affairs Gilly Lord says she doesn’t expect too many surprises – firms have known the approximate content through the consultation process. Nonetheless, “there’s going to be a lot of weekend reading”.

“There’s lots and lots to think about and not just for auditors. I was talking to a group of audit committee chairs the other week about a change that a lot of people may have missed in the detail. There is some new guidance for audit committees on how they need to approve non-audit services.

It is likely that with the new EU audit regulations we will see the development of yet more specialised advisory firms, which would be a good thing

Tim Wach, managing director of Taxand

“In the past some audit committees have done that by saying that anything that falls into a particular category of NAS will be deemed permanently pre-approved so the firm doesn’t have to come and seek any specific commissions.

“In the new guidance, you can still take that category approval approach but only – and this is entirely new – for things that are trivial which nobody knows quite what it means but it sounds like a very low threshold.”

The difficulty is, she adds, that changes like this one are “half a line on page seven hundred and thirty six or whatever” and audit committees have not yet had the time to go through the rules in enough detail.

Tim Wach, managing director of Taxand says the audit regulation changes mark a "watershed moment not just for the audit industry, but for the advisory market worldwide, and one which we hope will result in increased quality of advice for clients across global markets".
 
“Restricting the offer of multiple services to companies is fundamental to the provision of independent advice, so as to avoid conflicts of interest and to focus advisers in concentrating solely on meeting clients’ specific needs in a specific discipline, be that audit, tax, M&A or any other practice.
 
“Of course, this is not a new issue and is one with which regulators as well as external advisors and their clients have been wrestling since at least the days of the Enron bankruptcy and Sarbanes-Oxley proposals of over a decade ago. It is likely that with the new EU audit regulations we will see the development of yet more specialised advisory firms, which would be a good thing.”

Audit committees will also face complications in deciding which firms to use for NAS and for the audit, Lord suggests. “Any audit committee looking forward to perhaps the next year or the year after and planning to change their auditor – and of course there are lots of people in that situation because we are now in this era of mandatory rotation – will have work out the implications for the others suppliers of professional services it has in mind.

“So let’s say your auditor is currently PwC and you happen to use EY to give you loads of help on tax, well if you want EY to be one of the people bidding for your audit then the consequence of that is if they win, you couldn’t use them for all of that tax advice.

“So you end up with this complicated pattern of moving parts – well if I change my auditor will I also have to change my tax adviser, or my internal audit provider and so on? You can no longer deal with these appointments in isolation.”

The FRC meanwhile is adopting a “collaborative approach” and says that it will be working with the firms and audit committees to ensure that the new regime is implemented as smoothly and quickly as possible.

Launching the new auditing and ethical standards, FRC chief executive Stephen Haddrill said that they would provide auditors with a comprehensive basis to comply with their updated obligations. “The changes to the ethical standard set out the principles that underpin high quality, independent audit and, particularly for the audits of PIEs, strengthen auditor independence by prohibiting or restricting a range of engagements that could result in a conflict of interest.

“Reflecting the FRC’s commitment to proportionate regulation, the revised standards contain some flexibility to allow an auditor to provide some additional assistance to smaller and medium-sized entities.”

The regulator has also issued updates to the UK Corporate Governance Code and Guidance on Audit Committees to reflect changes arising from the legislation on audit committees and auditor appointments.

Head of ICAEW's Audit and Assurance Faculty Henry Irving said that anticipation of the audit reforms had already wrought major changes to the way that the profession worked. He pointed to the longer and better information in the audit reports of the largest companies, increased competition through tendering and changing auditors, and a reducing trend in non-audit services supplied by the auditor which enhanced independence.

"Innovation has been stimulated with more diverse and interesting approaches to auditor reporting, and new approaches being developed such as data analytics and in audit staffing by the larger networks," he added.

"Regulators and standard-setters will be assessing the impact of these innovations in the future. Reform will also affect smaller businesses and practices and ICAEW Audit and Assurance faculty will be promoting effective implementation through its events, publications and international resources over the coming months."

Julia Irvine

 

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