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http://www.minterellison.com/articles/uk-audit-sector-review-cma-review-frc-program-of-reviews

More reviews of the UK audit sector?

15.10.2018

CMA to review the UK audit sector; FRC to proceed with planned program of reviews

The UK Competition and Markets Authority (CMA) has announced it will conduct a review of the UK audit sector and deliver its findings by Christmas in the wake of recent scandals and declining trust. Separately, the FRC (which is the subject of an independent review) has also announced a program of reviews of the sector including consideration of banning audit firms from undertaking audit work.


Key takeouts


The FRC under review: An independent 'root and branch' review (Kingman review) of the FRC is currently being undertaken and is due to be completed by the end of 2018.

The UK audit sector is under review by both the FRC and the CMA: The CMA review is being launched following the release of the Work and Pensions and BEIS Committee report into the collapse of Carillion plc which recommended (among other things) that KPMG, EY, PwC and Deloitte should be referred to the Competition Authority for possible break up. The CMA is due to deliver its findings by the end of 2018. The FRC is also conducting a series of planned reviews of the audit sector, including consideration of whether the audit firms should be banned from undertaking consulting work.

Restoring trust in the sector and the quality of audit has been identified as a key priority by industry, by the FRC and by the CMA. The CMA has indicated that legislative reform may be required to implement both the findings of its own review, and the findings of the Kingman review.


The UK Competition and Markets Authority (CMA) has announced the launch of a detailed market study into the audit sector to examine 'concerns that it is not working well for the economy or investors'. The review is being undertaken, the CMA writes, 'amid growing concerns about statutory audits, in particular following the collapse of construction firm Carillion and the criticism of those charged with reviewing the organisation’s books, as well as recent poor results from reviews of audit quality'. As part of its review, the CMA will investigate whether the sector is competitive and resilient enough to maintain high quality standards.

The announcement followed a separate announcement by the Financial Reporting Council (FRC) of completion of its 'state of the nation' review of audit in the UK, and a series of planned further reviews/actions into various issues in the sector.

A brief overview of the CMA review, and separately the FRC's planned reviews/actions is below.

Focus of the CMA Review

The review will examine three main areas.

  1. 'Choice and switching': Is there a real choice available? The CMA writes that changes put in place by the Competition Commission appear to have strengthened competition between the big four firms — Deloitte, KPMG, E&Y and PwC — but that despite this, the largest UK companies 'still turn almost exclusively to one of them when selecting an auditor to review their books'.
  2. Does the perception that the big 4 are 'too big to fail' and their market dominance threaten long-term competition? The CMA will examine what the role of the big four firms means for 'resilience — the risk being that each of the big four auditors is 'too big to fail', potentially threatening long-term competition'.
  3. Is there a lack of incentive to produce challenging audits? As companies, not their investors, pick their auditor, there are 'concerns' the CMA writes that there is a lack of incentive for auditors to product challenging audits.

[Note: The CMA review is being undertaken following the delivery of a report by the Work and Pensions and BEIS Committees into the collapse of Carillion plc. Among other things the report recommended that KPMG, EY, PwC and Deloitte should be referred to the Competition Authority for possible break up. See: Governance News ]

Possible regulatory response to implement recommendations?

The CMA writes that if the review finds that the market is not working well, it 'will scrutinise all proposals’ including the possible need for legislation to implement the its findings and those of the independent review of the FRC being led by Sir John Kingman.

[Note: On 17 April, the UK government announced the launch of an independent 'root and branch' review of the FRC to be led by Sir John Kingman (Kingman Review). The purpose of the review according to the government's statement is to 'make the FRC the best in class for corporate governance and transparency, while helping it fulfil its role of safeguarding the UK’s leading business environment'. See: Governance News 20/04/2018]

Commenting on the need for the review

CMA Chairman Andrew Tyrie said 'If the many critics of the audit process are right, it is not just the companies which buy audits that lose out; it is the millions of people dependent on savings, pension funds and other investments in those companies whose audits may be defective. Sir John Kingman’s independent review of the regulator is a big step in the right direction. And the CMA will now examine the market carefully to establish what contribution more effective competition could make to improving audit quality.'

Timeline

The CMA intends to consult on provisional views by the end of 2018 and to 'complete its work as soon as possible thereafter'. The CMA states that as part of this process it will take into account the views of a range of stakeholders including the Financial Reporting Council (FRC) as the sector regulator.

Response to the CMA's announcement

  • The FRC said: 'We have expressed concern about concentration at the top of the audit market so we welcome this announcement. We will work closely with the Competition and Markets Authority as they carry out this study. It is essential that there is widespread confidence in the quality of company audit in the United Kingdom'.
  • CEO of the Institute of Chartered Accountants in England and Wales (ICAEW) Michael Izza said that the announcement of the review is a 'very positive development' and the 'accountancy profession as a whole will welcome it'. He added that the ICAEW will 'need to coordinate closely with other processes already under way, such as the review of the operation of the FRC by Sir John Kingman' as well as with FRC initiatives and that 'it is vital that we rebuild public trust in audit – the success of UK business depends on it.'
  • Mazars UK senior partner Phil Verity welcomed the announcement and the 'tight timescales' to which CMA is working. He added that there is 'a widely accepted need for reform of the listed market and we support changes which help to create a genuinely competitive market which addresses stakeholders’ needs'. He went on to say that 'Previous attempts at reform have not brought about the necessary change. We now look forward to discussing with the CMA solutions that can be successfully implemented and are guaranteed to make a real difference.'

[Sources: CMA media release 09/10/2018; FRC media release 09/10/2018; AccountancyAge 09/10/2018; [registration required] The FT 11/10/2018]

FRC 'state of the nation audit review' and series of planned actions announced

Prior to, and separately from, the CMA review The Financial Reporting Council (FRC) released its own a 'state of the nation' audit review covering audit quality, confidence in the sector and the future of audit. Based on the issues identified, the FRC also announced a further program of planned reviews, intended to address falling trust levels in the UK audit sector. The planned review actions include, among other things, consideration of whether auditors should be banned from consulting work.

Report findings

Among other things, the FRC found that trust in the quality of audit is falling and that the 'Big Four' (PwC, KPMG, Deloitte and EY) still dominate both audit and non-audit consultancy work for listed companies which raises questions over conflicts of interest and independence.

Further planned reviews/actions in response

  1. Banning consulting work? The FRC writes that as part of a comprehensive review of the 2016 auditing and ethical standards, it will 'test the effectiveness of the rules on [auditor] independence'. More particularly, the FRC writes that that the review will include determining whether 'further actions are needed to prevent auditor independence being compromised, including whether all consulting work for bodies they audit should be banned'. The FRC states that it will work closely with the Competition and Markets Authority (CMA) in this area.
  2. Tighten auditor requirements for assessing whether an organisation is a 'going concern': ‘Taking lessons from recent company failures’ the FRC states that it will develop proposals to strengthen requirements on auditors when considering whether an organisation is a going concern. This includes whether the responsibilities of auditors in assessing companies’ statements on their longer-term viability should be enhanced and whether auditors should report publicly on 'their views of the realism of assessments made by companies'.
  3. Consider whether auditors are undertaking enough work to determine whether information is misstated in annual reports: The FRC states that it is undertaking a review of the work auditors do ‘on the front half of the annual report’ to assess whether auditors are undertaking enough work to conclude it is not materially misstated. The FRC adds that it will shortly launch a major review of stakeholders’ needs for information in corporate reports and will consider to what extent such information needs to be assured.
  4. Additional monitoring: The FRC states that it has adopted an enhanced program of audit firm monitoring and has strengthened its enforcement capacity to enable it to conclude cases more quickly. In addition the FRC notes that its revised sanctions framework includes penalties that ‘reflect the gravity’ of the conduct.

 Actions are intended to address the trust gap:

Commenting on the release of the report, and the FRC’s planned reviews/actions, FRC CEO Stephen Haddrill said the planned 'comprehensive reform programme addresses fundamental issues underlying falling trust in business and the effectiveness of audit, whilst also looking to ensure that the requirements on what companies say about themselves are fit for the future needs of stakeholders. If stakeholders are to have confidence in audit, they also need to have confidence in audit rules and regulation. The FRC has reviewed how we can improve audit quality and our supervision of audit firms. In addition to the programme set out today we look forward to proposals from Sir John Kingman and the CMA.'

Who will be reformed first?

In an opinion piece, the FT suggested the FRC's release of the report, and suggested further actions, is as an indication that it is 'seemingly oblivious' to recent events and the criticisms that have been levelled against it and against the audit sector. The article adds that 'The watchdog [The FRC] has serially been criticised for its poor performance, its muddled structure and for being in thrall to the firms it oversees. The race is on to see which will be reformed first — the bean counters or their watchdog'.

[Sources: FRC media release 08/10/2018; Developments in Audit 08/10/2018; Reuters 08/10/2018; The Guardian 08/10/2018; [registration required] The FT 09/10/2018; CityAM 08/10/2018]

 

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http://www.minterellison.com/articles/uk-audit-sector-review-cma-review-frc-program-of-reviews

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