ICAEW submission to BEIS initial consultation on the CMAs Market Study of the statutory audit market
The Competition and Markets Authority (CMA) launched a formal Market Study into the statutory audit sector in October 2018. The purpose of the Study was to look at choice and competition, resilience of the sector, and incentives for producing robust audits. The CMA published their final recommendations in April 2019, and the Department for Business, Energy and Industrial Strategy (BEIS) launched an initial consultation on the proposals in July 2019.
The audit sector plays a key role in creating and sustaining domestic and international investor confidence in the UK business sector and wider economy. Any possible measures to increase competition and choice in the market for large corporate and PIE audits must be seen in the context of the need for the UK to be perceived positively as a global trading partner, and as a place where the business and investment environment is both attractive and well-regulated.
Most importantly, ICAEW believes that the paramount issue is audit quality and ensuring that it continues to improve and continues to meet the existing and evolving expectations of audit customers and other stakeholders. While important, the actual number of competitors operating at any time is not necessarily directly connected to audit quality. It would not be a positive outcome if regulatory or legal interventions brought more firms into the market for large corporate and PIE audits, but seriously jeopardised quality and increased costs.
ICAEW believes that a consensus now exists across the audit sector that increased choice in the statutory audit market is both necessary and desirable. The measure of this should be the extent to which challenger firms are successful in winning, conducting and retaining audit work in the FTSE 350. This will require a basket of measures which address three interconnected aspects of the current situation: changing how the Big Four firms operate, reducing the obstacles which currently deter their potential challengers from entering that market and, finally, supporting audit customers to exercise their extended freedom of choice.
Joint and Shared Audits
Given the current stark difference in capacity and scale between the Big Four firms and even the largest of their potential challengers, increased competition and choice will not be achieved if the latter are expected to compete for unitary audits on a like-for-like basis – unless there is a radical re-ordering of the sector through an intervention such as a segmented market share cap.
ICAEW therefore sees the benefit of proposals which aim to bring about a partnering approach, mandating or facilitating for each large corporate audit a level of formal collaboration between one of the Big Four firms and a firm from the next tier or elsewhere. In this context, we believe that joint or shared audits would certainly help challenger firms acquire relevant experience, specifically in the eyes of potential audit customers in the FTSE 350.
With sufficient time, effort and goodwill, either could be made to work, although both face significant practical obstacles. ICAEW does not dispute that these obstacles can be overcome, but we would be concerned that, within the overall reform package which must integrate the outcomes of the work of Kingman, Brydon and the CMA, implementing joint audit could consume disproportionate time and resources. Similar considerations would apply to shared audit, but, arguably, to a lesser extent.
ICAEW believes that the use of peer review, as proposed by the CMA, raises some very significant practical issues, such as around the required level of experience required by the peer reviewer, independence restrictions and depth of the peer review itself. We can see a potentially valuable role for an independent review panel, probably appointed by the regulator, although this will do more to improve audit quality than address issues of market resilience.
Regulatory Oversight of Audit Committees
While ICAEW is broadly supportive of the CMA’s proposal to increase regulatory oversight of audit committees, we caution that this would be a complicated and sensitive undertaking. We agree it may have some place in situations where there are specific concerns about the competitiveness of an audit tender, or quality of audit work. We question, however, whether a regime of detailed and regular reporting by all audit committees to the regulator would be a proportionate remedy.
We remain sceptical that increased regulatory oversight of audit committees will have a major impact on market resilience but see it as part of a wider drive to improve accountability and visibility to investors and other stakeholders. Nevertheless, given the likely investment of time and resources it will require, set against the potential benefit, we believe that implementation of this power should not be in the top tier of priorities, although provision for it should certainly be included in any new primary legislation.
As was also stated in ICAEW’s submission to the consultation on the recommendations of the Kingman Review, the importance of not over-burdening ARGA cannot, in our view, be overstated. ARGA should concentrate from the start on improving audit quality, governance and reporting, leaving some complex technical matters emerging from both from the Kingman Review and the CMA Market Study, which are important but less urgent, to be worked through in due course.
While welcoming the CMA’s conclusion not to seek the break-up of the Big Four firms, ICAEW has concerns about the recommendation that these firms put in place a strategic and operational split between their audit and non-audit services. We believe that although it would be difficult to justify not extending this principle to challenger firms outside the Big Four, doing so is likely to handicap significantly their ability to compete in the market for FTSE 350 audits.
Alongside that, ICAEW recommends that time should be allowed for the effect of changes already made voluntarily by the Big Four firms to be assessed, and consideration given to whether any necessary further effect could be achieved by strengthening the application of existing safeguards. We believe that much greater focus should be given to strengthening and sustaining this positive culture in firms, which will help ensure the confidence of capital market participants in contexts beyond their use of audited financial statements.
While ICAEW believes strongly that the momentum of reform must be maintained, we recommend that sufficient time is allowed for further consultation, debate and development given the radical and untried nature of some of the proposals set out by the CMA and their potential consequences.
The application of the Better Regulation principles is also incredibly important. Alongside the outcomes of the Kingman and the Brydon Reviews, the overall cost of the audit reform programme to business is likely to be very significant, so it is essential that the expected benefits that justify this are carefully identified through a rigorous impact assessment. Although they would be difficult and time-consuming to arrange, ICAEW also believes that it would be prudent to conduct pilots or trials of both joint and shared audits (and possibly other proposed measures) before proceeding to full implementation, and that the interventions which finally emerge from the Market Study process should be periodically reviewed (probably by ARGA) to assess whether the desired effect has been achieved, and whether their continued operation is necessary and beneficial.
These proposals need to be future-proofed, particularly in light of the Brydon Review. In ICAEW’s response to the Call for Views by the Brydon Review (ICAEW Representation 64/19), we recommended consideration of a ‘new three pillar model of User-Driven Assurance, one directed by the needs of the primary user – the shareholders. This would comprise a range of assurance outputs, demanded and delivered as and when appropriate, and could involve multiple providers’. We stated that such an approach ‘could be an effective way of meeting the needs of all users –and finally and fully closing the expectation gap’. However, we also consider that such an approach could play an important role in increasing competition and choice in the audit market, as it would encourage the development of ‘niche providers with particular assurance specialisms’. ICAEW is ready to work with the Brydon Review to develop further the concept of User-Driven Assurance.
ICAEW believes that a significant national economic opportunity will emerge from the current fundamental challenges facing audit in the UK, and the systemic reform which must follow. While the work of the CMA on longer-term market resilience in the UK might be less applicable elsewhere, the outcomes of the Kingman Review of regulation and the Brydon Review of the quality and effectiveness of audit may well combine to produce a programme which becomes an international exemplar and allows Britain to show global leadership in developing solutions to issues affecting many other major jurisdictions.
Particularly in the context of the exit of the UK from the EU, it is important that the UK maintains a fair, open, welcoming economy for inward investment: robust audit and corporate reporting are a key part of this, but it must not be at disproportionate cost. We should be careful to ensure that the package of measures supports and strengthens the audit sector in the UK and does not impede its international competitiveness as a key export.