Julia Irvine 12 Jul 2018 02:48pm

Breaking up is hard to do, say auditors

Work and Pensions Committee chair Frank Field has criticised the Big Four for failing to entertain his suggestion that they need to be broken up to encourage greater competition in the audit market

In a scathing attack to coincide with publication of the responses to the Carillion report from those individuals, representative bodies and government departments mentioned in it, he says, “Once again, the fingers are out pointing everywhere but here.

“The Big Four admit there is a problem but insist their break up is no part of the solution. How the CMA [Competition and Markets Authority] deals with the lack of audit competition will be the sign of whether the new chairman is able to break this existing culture and impose a new one which makes clear that his organisation is about delivering for individuals, and not for cosy oligopolies.

“Business as usual brought us Carillion,” he continued. “It is bad for the good business that is the lifeblood of our economy, for workers, and for pensioners. We’ve learned the lessons. Get on with it.”

In the Carillion report, the two select committees – the Work and Pensions Committee and the Business, Energy and Industrial Strategy (BEIS) Committee – propose that the statutory audit market should be referred to the CMA and that the CMA’s investigation should consider “both breaking up the Big Four in to more audit firms, and detaching audit arms from those providing other professional services”.

It also calls for an “ambitious and wide-ranging set of reforms that reset our systems of corporate accountability in the long-term public interest”.

However, the Big Four all make it clear that, while they recognise that it would be better to have a greater choice of auditors in the PIE market, breaking them up into smaller units is not the answer.

As Margaret Cole, PwC’s general counsel, points out in her letter to the committee chairs, “The committee’s recommendation to break up the large firms would not solve the problems of audit effectiveness or the ‘expectation gap’.

“A break-up could also harm audit quality when it is imperative that any solution has this as a priority. The delivery of high quality audit requires audit teams who are able to access a broad base of specialist knowledge (within the UK and internationally). This would be difficult to maintain in a firm which focused only on audit services.”

Deloitte’s chairman Nick Owen suggests breaking up the firms would also make the UK less attractive as a capital market.

“Larger more diverse firms are more financially independent and are therefore far better positioned to objectively and robustly challenge the largest companies that they audit and to make the significant investments required in systems and technology…,” he says.

“…Firms with a multidisciplinary model – providing wider services beyond audit – have the best mechanisms to challenge large companies, attract specialist talent and develop the skills, expertise and global consistency needed for good quality audits.”

Like the other Big Four, EY chairman Steve Varley says that the firm has invested “significantly” in enhancing audit quality, “including investment in digital audit, blockchain, robotics, artificial intelligence and other cutting-edge technologies that further extend our ability to provide high quality work in a dynamic and changing world.

“Our multidisciplinary model and related investments provide the structure, breadth and depth of technical skills, and industry expertise necessary to deliver high-quality audits, particularly to large, complex, international businesses,” he added.

KPMG, whose role as Carillion’s auditor is being investigated by the Financial Reporting Council, is therefore unable to comment directly on the content of the report. However, as chairman and senior partner Bill Michael makes clear, the firm “respectfully” disagrees with the report’s description of its audit work as “complacent”. This, he says, does not reflect the hard work and commitment of the Carillion audit team.

“We understand why the circumstances of Carillion’s failure have led to public questioning of KPMG’s role, and fully accept that the auditor’s work should be subject to appropriate scrutiny. However, as we have said, while a company might fail following issuance of an unqualified audit opinion, this does not automatically mean the auditor did a bad job.”

Michael gives his backing to a wider debate on the role of the audit and the expectation gap. But he doesn’t agree that changing the audit market structure us the key to driving up quality. “We all need to be confident that changes are made only where this will improve – or certainly not be to the detriment of – audit quality.”

ICAEW has also given its backing to moves that will widen competition in the audit market. In its response, chief executive Michael Izza reiterates the point that high quality audit is not the preserve of the Big Four but the right circumstances need to be created to attract other “challenger” firms back into the market.

But he also thinks that breaking up the Big Four is not the answer. “It could be an issue if audit-only practices did not retain access to the global networks and capabilities which the current multidisciplinary firms enjoy,” he warned. “Although not impossible to address, it would require international coordination and could increase costs for clients.”

Choice, he added, needed “to progress in lockstep” with quality. “As much as the dominance of the Big Four, smaller audit firms have also cited the cost of regulation the long time frame for reviewing audits and unlimited liability as some of the reasons they are reluctant to enter the market.”

Along with the Big Four and the rest of the Group A firms, ICAEW is supporting the Audit Quality Forum’s move to set up a group to consider the future of audit. Rachel Reeves, chair of the BEIS Committee, has more faith in the CMA, however.

“Even the Big Four have started to recognise that business cannot go on as normal, with investors losing faith in the accounts, a woeful lack of meaningful competition, and consulting and auditing relationships that are far too comfortable for the public or investors to expect any real challenge,” she said.

“The CMA needs to closely examine the audit market and as a committee we will be keen to see what remedies are proposed to fix the broken audit market.”

The newly-appointed chair of the CMA, Andrew Tyrie, was not in a position to comment as his response was sent to the committee before he joined the authority. However, he reassured both Reeves and Field that he would bear in mind their advice “not least about brooms”.

This was a reference to a joint letter from them in May in which they called on him to “demonstrate what a new broom [he is] at the CMA”, by asking his staff to initiate a review of the audit market and the Big Four as soon as possible.