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Audit market facing referral

THE AUDIT market has been provisionally referred to the Competition Commission, after the House of Lords Economic Affairs Committee recommended a six-week consultation by the Office of Fair Trading (OFT). Stakeholders are agog to see whether it will go all the way to the commission, but most believe referral is likely and the six-week consultation is just a procedural nicety.

If competition authorities get involved, an array of remedies is open to transform the audit market. These are harsher than anything the OFT could enforce, potentially even forcing a break-up of the Big Four. However, with European Commissioner Michel Barnier poised to report on audit competition in November, experts have asked whether UK authorities will go out on a limb, or wait for the big boys’ lead.

The Big Four have been muted ahead of the OFT decision, only stressing the importance of audit quality and allowing market forces to run their natural course.

Richard Sexton, PwC’s head of reputation and policy, says the market is “fiercely competitive” with “sophisticated buyers who thoroughly test the audit service… on an annual basis”. KPMG insists effective competition already exists, while only Ernst &Young has elaborated on possible measures to “increase choice”, proposing the removal of Big Four-only banking covenants and a stronger role for audit committees in auditor appointments.

Institutes have also been cautious about the decision, saying market interventions must be subject to “rigorous impact assessment” while others remain sceptical about intervention by the authorities. Their concerns echo those raised by the OFT when it recently asked whether the global reach of the Big Four would nullify any measures imposed by the UK-bound Competition Commission. However, such worries appear to have been resolved.

Inevitable change

Smaller firms have enthusiastically embraced the announcement, with heel-nippers Grant Thornton and BDO particularly fervent. Grant Thornton audit partner Steve Maslin claims that the referral will remove the “arbitrary cut-off point” that reinforces the Big Four and refocus the market on quality of audit. Both firms have pressed for momentum to be maintained, and RSM Tenon chief executive Andy Raynor enthuses: “Change seems to be inevitable”.

Perhaps the most interesting response has come from investor consultancy PIRC. It has accused firms of “regulatory capture”, leading to defensive standards that reduce auditor liability and are intentionally complex so they “enhance time spent [on audit] and fees of listed company clients”.

Number of arrangements by value bandsIt says mergers are more focused on increasing global reach than proper audit delivery. “This referral must be the beginning of a reform of the industry, its standards in practice and the standards it follows,” it concludes.

Stakeholders have until 9 September to provide the OFT with a written response to the consultation, and a final decision on referral is due before the end of the year.

Most experts think a Competition Commission referral is inevitable. The body has greater powers than the OFT, but will not necessarily go so far as to force break-up or divestment of assets. The commission will be looking for evidence of collective dominance, but Angus Johnson, lecturer in competition law at Oxford University, says that this can be tough to prove: “Without contact evidence, it’s difficult to show enough connectivity between the firms, and you can’t accuse them of collusion.”

But there will be a few easy wins for the commission. Restrictive covenants, whereby banks make Big Four audits a condition of credit agreements, are sure to go. The firms have acknowledged their existence and are now lining up to denounce them.

The commission could also push for audit committee education. This should not be too onerous for the industry, as the last few years have seen an upswing in the number of audits put out to tender, thanks to rising focus on audit independence.

Beyond this, the issues get thornier and stakeholders are sure to put up a fight. One potential remedy could be mandatory tendering, described by one expert as an “ideal compromise”. Proponents say it would give mid-tier firms “the chance to be heard” without forcing companies into frequent auditor changes that could have a hugely disruptive impact.

This option would probably be popular with clients, and certainly preferable for the Big Four, but many mid-tier voices argue mandatory rotation is the only way to break open the audit market.

Two years and a lot of money will be spent on the inquiry, and Barnier and the European Commission will give their opinion in November. It is possible that UK competition authorities will be influenced by the EC report, encompassing as it does a wider region and with the might of the European Parliament behind it.

Once we hear what Barnier has to say, it will be possible to make a more educated guess about the outcome of the UK inquiry. But one thing is certain: the audit industry is in for some changes. ?

 

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