Tuesday 18 December 2018 12:01 am

Audit sector faces huge shake-up as new reports make radical recommendations

The stage has been set for a radical shake-up of the UK’s audit sector, following the release of two highly-anticipated reports.

Britain’s audit watchdog, the Financial Reporting Council (FRC), should be scrapped and replaced with a new statutory body, Sir John Kingman’s review of the Financial Reporting Council (FRC) has said.

Meanwhile, the Competition and Markets Authority (CMA) revealed interim proposals from its probe into the audit market, including pulling apart the audit and advisory sections of professional services firms, which could trigger a major reconfiguration of the industry.

The reports released today come at a crucial time for the sector, which has been the subject of a series of controversies.

In his hotly-anticipated government-backed review, Kingman found the the beleaguered FRC, branded “toothless and useless” by MPs earlier this year, needed to be brought up-to-date to become “feared by those it regulates”.

Legal & General chairman Kingman said the regulator needed “new leadership, new mission, new powers and new funding”, calling for the creation of a new body, which he dubbed the Audit, Reporting and Governance Authority (Arga).

Read more: Here are five key findings from Kingman’s report

He also called for greater audit transparency, an end to sector self-regulation, and for a “fundamental overhaul” of quality assurance tests for local authority audits.

FRC chairman Sir Win Bischoff welcomed the recommendations, saying they could bring about “significant improvements to the work we do” and should be implemented “speedily”.

Competition probe makes findings

Kingman’s review today arrived as the CMA reported on the initial findings from its probe of the audit sector.

The Competition and Markets Authority (CMA) has identified “serious competition concerns” in audit, endorsing a series of proposed reforms.

These included splitting the audit and advisory sections of major audit firms – a suggestion that is likely to face strong resistance from the sector’s Big Four firms – closer scrutiny of audit appointments, and the introduction of joint audit system similar to the regime in France. The CMA also said imposing a market share cap on top audit contracts was a possible remedy.

It will now undertake a further consultation, before issuing a full report next year.

CMA chairman Andrew Tyrie said while most people would never read an auditor’s opinion on a company’s accounts, “tens of millions of people depend on robust and high-quality audits. If a company’s books aren’t properly examined, people’s jobs, pensions or savings can be at risk.”

Reacting to the reports, PwC UK chairman and senior partner Kevin Ellis said: “This is a comprehensive package of proposed interventions from the Competition and Markets Authority. We recognise it is time for change and a watershed moment for the audit sector. Audit quality must be front and centre of any reform. We support measures which strengthen audit quality, boost public confidence and encourage more choice in the market.

“The proposals will require careful and wide consultation in order to deliver practical remedies which serve the best interests of shareholders, companies and society at large. We look forward to seeing the CMA’s report to better understand its findings and recommendations.

“The UK has a world leading professional services sector and it is important that the CMA, Kingman and other reviews lead to changes which further strengthen confidence and trust in the UK as a place to do business.”

David Sproul, senior partner and chief executive of Deloitte, said: “It’s clear that trust and confidence in the role of the profession is not where it should be and we are supportive of change that enhances audit quality and maintains the competitive position of the UK as we prepare to leave the EU.

“This is a critical moment for the profession in the UK and internationally,” he added. “We will carefully analyse the detail within the CMA proposals and look forward to working with the CMA in conjunction with the findings of the other reviews to develop a world-leading profession in the UK.”

Atul Shah, a visiting professor at City University, called the CMA’s findings a “bold and welcome report with constructive policies for improving audit quality and independence.”

Fresh review

The government has also today announced a separate review – led by Donald Brydon, the outgoing chair of the London Stock Exchange – examining the scope of audit more widely.

Brydon’s review will run alongside a probe launched by the Business, Energy and Industrial Strategy (BEIS) Select Committee, which will aim to ensure the findings of Kingman and the CMA are “not left to gather dust,” according to BEIS chair Rachel Reeves.

Business secretary Greg Clark said: “I’m delighted that Donald Brydon will be leading this review, following the important work of Sir John Kingman and the CMA, and his work should help us improve and restore confidence in the quality and rigour of audit companies.

“Audit companies need to learn the recent lessons from high profile audit failures and reform to regain public confidence, or they will be forced to do it,” he added.

Reeves said the CMA’s proposals “get to the heart of concerns about market dominance and the conflicts of interest which jeopardise audit quality”.

She added the FRC had been “too timid and too reluctant” to use its powers to tackle audit failure.

Any future regulator should be able to step in before audit failure happens, “rather than picking up the pieces in the aftermath”, she said.

A sector under fire

The audit sector has been battered by a series of scandals in recent years, most notably surrounding the high-profile failures of department store BHS and outsourcing giant Carillion, both of which are the subject of going regulatory investigations. Outside of the Big Four, fifth-biggest audit firm Grant Thornton has also been criticised for its work for cafe chain Patisserie Valerie.

Calls for a review of the sector reached a fever pitch following the collapse of Carillion, which prompted a damning joint report by the Work and Pensions and Business, Energy and Industrial Strategy Select Committees. The government appointed Kingman to review the FRC over the summer, and the CMA launched its probe in in October.

Particular attention has fallen on the Big Four – Deloitte, EY, KPMG and PwC – who carry out 97 per cent of FTSE 350 companies – responsible for signing off the accounts of most of the UK’s largest companies.

A shake-up of the sector’s top end could create opportunity for mid-sized audit firms, often ruled out in favour of the Big Four, to grab a share of the most lucrative contracts.

Last week, the Labour Party released its own report into the audit sector, commissioned by shadow chancellor John McDonnell and carried out by Professor Prem Sikka, professor of accountancy at Sheffield University.

The report called for a breakup of the Big Four. recommending the audit sections of professional services firms be split off from their other divisions, as well as backing market caps, joint audits and the creation of a state-backed body to carry out audits of public interest entities such as banks, building societies, credit unions and major investment firms. It said: “the auditing industry is in disarray, dysfunctional and stumbles from one crisis to another”.