Barnier leak may hang the Big Four out to dry

Philip Salter
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RECENTLY a leaked document from the European Commission’s (EC) Michel Barnier made front pages, including that of City A.M.. The details of what could come to be concrete proposals threaten the Big Four accountancy firms – PwC, KPMG, Deloitte and Ernst & Young. The stakes are high: one of London’s, and the UK’s, most successful industries is under attack.

The most radical proposal in Barnier’s leak is the suggestion of audit-only firms. This would prohibit the Big Four from offering both audit and professional services. James Chalmers, who is the UK head of assurance at PwC, describes it as “an extraordinary intervention”, which “could severely disrupt services available to companies.” He adds: “There are many situations where the knowledge and insight we gain through our role as auditor make us best-placed to assist organisations with a range of issues and challenges impacting their businesses.” Chalmers also says: “We also use the skills and capabilities from people right across the firm to ensure that we are able to deliver the highest quality audits. These include tax, actuarial and technology skills.”

Oliver Tant, head of audit at KPMG, describes the proposals as “clearly pretty radical,” saying the idea of audit-only firms is “ill-conceived.” Tant likes the idea, touted in the leak, of attempting to create EU-wide market standards, but he is very concerned that audit-only rules would diminish the quality of the service.

Chief executive of the Institute of Chartered Accountants in England and Wales (ICAEW) Michael Izza points out that accountancy is the “biggest single recruiter of graduates.” He posits that audit-only firms wouldn’t be such an attractive destination. Similarly, Chalmers says “accountancy firms in the UK attract highly-talented people because of the variation of work they offer and the ability to move easily around different parts of the firm and expand their knowledge-base.” He says that because “we live in a global workplace with a highly mobile workforce, if these proposals are carried through, people may simply choose to work elsewhere in the world.”

One of the proposals from the leaked document is to force joint audits, in which an audit is undertaken by two or more auditors to produce a single audit report. Unsurprisingly, the Big Four are not keen on the idea. A spokesman at Deloitte responded: “We do not support certain matters that have been discussed such as joint audits.” Equally unsurprisingly, a few auditors that would pick up business are in favour. However, even companies that could potentially gain from forcing businesses to take on two audits were largely against the plan. PwC notes: “Based on an analysis of responses to this consultation, over two thirds of respondents were opposed to joint audits.”

Joint audits are already mandatory in France. Contrary to its aims, the Big Four still dominate – joint auditing has failed to break their dominance. Meanwhile French banks don’t look to have benefited greatly from the practice. Firms outside the big four aren’t employed by businesses because they aren’t considered – rightly or wrongly – to be up to the task. Also, the smaller auditing firms aren’t ready to step up to the plate by merging to compete.

Another requirement in Barnier’s leak is for mandatory rotation of accountancy firms. The idea is for a fresh pair of eyes to take a look at the accounts. The managing director of specialist recruiters Marks Sattin points out that in 2003 the US General Accounting Office looked at this issue in its Required Study on the Potential Effects of Mandatory Audit Firm Rotation. This report found that “nearly all of the Fortune 1,000 public companies believed the costs of mandatory audit firm rotation would exceed the benefits,” and that “80 per cent of the Fortune 1,000 public companies and largest 90 accountancy firms operating in the US said they believed changing audit firms increased the risk of an audit failure.” Also, the financial costs and loss of knowledge of rotation are a high price to pay.

The failure of the bureaucratic mind is its inability to understand the benefits of failure and the danger of moral hazard. Auditors should thrive and perish by their reputations and the 2007/8 financial crisis has certainly thrown up many challenges. These tests can only be met from those within the industry itself – whether from within or outside the Big Four – not by the regulators. Although still in its early stages, if this leaked document manifests itself into policy, it could turn out to be a dangerous bargaining chip in the UK’s almost inevitable renegotiations with its European partners, as they move towards closer fiscal integration to try to smother their sovereign debt and banking crises.