17 October 2013
The Competition Commission (CC) has published changes that will open up the UK audit market to enhance competition and ensure that audits better serve the needs of shareholders.
The CC’s final report summary on the supply of statutory audit services to large companies in the UK finds that competition is restricted in the audit market due to factors that inhibit companies from switching auditors and by the incentives given to auditors to focus on satisfying management rather than shareholder needs.
A package of remedies in response to these findings has been set out, which includes measures to improve the bargaining power of companies and encourage rivalry between audit firms; measures to enhance the influence of the Audit Committee; and measures to promote audit quality and shareholder engagement in the audit process.
Main measures the CC has proposed includes the requirement that FTSE 350 companies put their statutory audit engagement out to tender at least every ten years. Differing from guidance introduced by the Financial Reporting Council (FRC) in 2012 that encouraged companies to go to tender on a ‘comply or explain’ basis, no company will be able to delay beyond ten years.
According to the CC, many companies would benefit from going out to tender more frequently at every five years. If companies choose not to go out to tender this frequently, the Audit Committee will be required to report in which financial year it plans to put the audit engagement out to tender and why this is in the best interests of shareholders.
A prohibition of ‘Big-4-only’ clauses in loan agreements has also been added to the package of measures.
The CC is recommending the FRC’s Audit Quality Review (AQR) team to review every audit engagement in the FTSE 350 on average every five years, adding that the Audit Committee should report to shareholders on the findings of any AQR report concluded on the company’s audit engagement during the reporting period.
In addition, the regulator has stated that there must be a shareholders’ vote at the AGM on whether Audit Committee Reports in company annual reports are satisfactory.
Further measures to strengthen the accountability of the external auditor to the Audit Committee and reduce the influence of management includes a stipulation that only the Audit Committee is permitted to negotiate audit fees and influence the scope of audit work, initiate tender processes, make recommendations for appointment of auditors and authorize the external audit firm to carry out non-audit services.
Responses to the CC’s summary have been positive – calling it a ‘sensible outcome’, Pricewaterhouse Coopers (PwC) head of assurance James Chalmers said, ‘these measures will enhance competition, transparency and quality’, with Deloitte’s managing partner David Barnes adding that it will ‘enhance investor dialogue and strengthen the role of the audit committee’.
PwC’s Chalmers added that ‘the Competition Commission's decision to mandate tendering every 10 years recognises strong concerns from investors, the Financial Reporting Council, companies and the market that a five year interval would have created a disproportionate burden to business, and risked undermining the intensity of competition and audit quality’.
This has been echoed by KPMG’s EMA head of audit Tony Cates, saying ‘we believe that a 10 year tender process strikes a better balance between, on the one hand, allowing an auditor to get under the skin of complex, global businesses and provide real insight and management challenge while, on the other hand, ensuring an effective and rigorous tender process to choose the best auditor.’
However Cates added that while ‘we continue to believe that the ‘comply or explain’ principle is an appropriate basis for UK corporate governance in that it provides discretion to audit committees, overall the final Competition Commission’s remedies complement the recent FRC changes which have resulted in stronger audit committee engagement, increased audit tendering, and more detailed audit committee and auditor reporting.’