Edward Haigh 11 Sep 2018 12:23pm

Mind the gap: audit clients and regulators on a different page

There is a loud and growing debate brewing about the audit, particularly in the UK where it has been fuelled by collapses of prominent companies, including Carillion and BHS

Caption: A contrast between regulator and client satisfaction is evident

But while regulators work to foster greater competition and drive up audit quality – with press reports of a possible Competition and Markets Authority review in the UK – audit clients seem generally happy with what they are receiving.

This contrast between regulator and client satisfaction was quite evident in our research for the Source Audit Market 2018 report, released yesterday. Covering eight major markets, including the UK and the US, we surveyed 160 finance professionals and conducted a series of interviews with audit partners, finance directors and non-executive directors. So what are clients saying?

Clients’ view

Overall 8 out of 10 clients are happy with levels of choice in the market, although this is lower in the UK (where nearly a third would welcome more choice). Clients say that audit quality is rising, driven by the need for the Big Four to compete harder amongst themselves, which is leading to greater innovation and use of new technologies.

Companies are relatively comfortable with audit firms doing non-audit work, subject to appropriate governance controls – 60% believe that auditors should be able to carry out some non-audit work while only around 10% believe there should be a blanket ban.

Meanwhile, in some countries, including the US, France and Germany, nearly two-thirds of companies have been with their auditor for 20 years or more, further indicating client satisfaction. Contrast this with the regulatory trends:

Regulators’ view

More and more regulators have been introducing mandatory audit firm rotation (MAFR) in a bid to increase competition and choice – even as the Big Four continue to dominate, with a 94% market share. In the UK, the Financial Reporting Council has expressed strong concerns about audit quality, and it and other regulators have floated the idea of breaking up audit firms, separating audit arms from tax and advisory practices so as to eliminate the possibility of conflicts of interest arising between audit and non-audit work.

So, what are we to make of this disconnect? In some respects, it is quite expected – regulators of a service and the users of that service do not fully share the same set of priorities, and they serve different groups. Indeed, the fact that most clients are ‘happy’ may hold little assurance for regulators: they want to see audit fulfilling a role of robust and sometimes uncomfortable challenge.

But what this gap does suggest is that radical reform of the audit market will be very difficult to achieve. Granted, companies will ultimately have to comply with whatever rules are imposed. But if most companies do not believe there are pressing problems that need addressing, it will be harder to achieve the momentum needed for significant overhaul.

To date, corporate Britain has embraced the new audit rotation expectation, with innumerable audits changing hands – but only from one Big Four firm to another. Asking them to move their audit to a non-Big Four firm (because of market share caps on the Big Four or other systemic change) is a different proposition. For listed FTSE businesses in particular, having the stamp of a Big Four firm on their financial statements and the credibility that brings is a large part of what they’re paying for.

Furthermore, even if clients were enthusiastic about such proposals, there remains the significant barrier raised by audit’s international dimension: in a global economy, regulatory changes to the audit market could unravel if they are not consistent across the world. But what prospect is there of major markets changing their regulations in unison? We would answer nearly none.

Still, our research identifies another major market trend that could ultimately see regulators getting the competition and quality improvements they want: the introduction of new technologies in the audit, such as robotics and machine learning.

Game-changing audit applications are coming, and it is not beyond the bounds of possibility that we could see the tech giants developing them as a means of breaking into the audit market at some level.

If tech players were offering services of the right quality, companies would have more incentive to look beyond the Big Four for at least some of their audit requirements. It could help to close the gap.

Edward Haigh is a director at Source Global Research, a research and strategy firm for the global management consulting industry.