From or not from concentrate? Potential changes to the U.K. audit market could have significant global implications

The U.K. Competition Commission (CC) is now seeking views on a list of possible remedies to address what the CC considers to be adverse effects on competition.

Following a comprehensive sixteen month study of the supply of statutory audit services to large companies, the U.K. Competition Commission (CC) is now seeking views on a list of possible remedies to address what the CC considers to be adverse effects on competition. But will they have unintended consequences for global audit quality?

The CC study arose out of concerns that the audit market in the U.K. is highly concentrated (the four largest firms – PwC, KPMG, Deloitte and Ernst & Young – earned 99 per cent of audit fees paid by FTSE 100 companies in 2010), with low levels of switching and substantial barriers to entry. The study resulted in provisional views and findings that:

  • there are barriers to switching auditors, for example because companies and firms invest in a relationship of mutual trust and confidence from which neither will lightly walk away
  • management faces significant opportunity costs in the selection and education of a new auditor
  • mid-tier firms face experience and reputational barriers to expansion and selection in the FTSE 350 audit market
  • auditors have misaligned incentives and so compete to satisfy management rather than shareholder demand
  • auditors face barriers to the provision of information that shareholders demand, from reluctance of management to permit further disclosure
Many will debate these and other CC views. Nevertheless, they are the drivers of seven possible remedies on which the CC seeks input, the two key ones being mandatory tendering and mandatory audit firm rotation.

The CICA (now Chartered Professional Accountants of Canada) and the Canadian Public Accountability Board (CPAB) Enhancing Audit Quality initiative (EAQ), focused on three interrelated key areas in enhancing audit quality – the independence of external auditors, the role of audit committees, and auditor reporting. Its objective was to provide a Canadian perspective on international initiatives. The EAQ submitted a response to the CC in which it brought attention to the EAQ’s work and the conclusions reached on several of the remedies on which input is being sought by the CC.

Emphasizing that the EAQ evaluated different proposals in the context of their potential effect on audit quality, David Brown, chair of the EAQ steering group, noted that there is a perception that audit firms could develop an overly close relationship with clients over time. This may create a threat to independence that impedes the ability of the firm and, more specifically, members of the engagement team, from exercising an appropriate level of professional skepticism. In evaluating these threats, the EAQ considered each of mandatory tendering, mandatory audit firm rotation and mandatory comprehensive audit firm review (MCAR) in the context of several factors: their effectiveness as a safeguard against the threats as well as their potential impact on transparency, audit quality, governance and the work effort/cost to implement. The EAQ strongly recommended that the CC consider MCAR as an alternative to mandatory audit firm rotation or mandatory tendering.

David Brown also advised the CC that competition remedies need to be considered in relation to the global context as U.K.-centric solutions could have unintended consequences. In particular, there are various other global bodies (such as the European Commission) that are in the process of considering many of the same potential remedies. If different bodies were to arrive at different conclusions as to such remedies the EAQ believes that this may cause significant friction in the functioning of audits globally. Brown encouraged efforts to reach consistent solutions on a global basis.

The CC’s comment deadline was March 18. It hopes to publish a final report in the fall.

Keep the conversation going… what are your views on the CC's remedies or the EAQ's response?

Post a comment below; or email me directly.

Eric

Conversations about Audit Quality
is designed to create an exchange of ideas on global audit quality developments and issues and their impact in Canada.

About the Author

Eric Turner, CPA, CA

Director, Auditing and Assurance Standards, CPA Canada

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