Competition and Markets Authority launches market study in the audit sector
The Competition and Markets Authority (“CMA”) announced on 9 October 2018 that it is carrying out a market study in the audit sector to see if it is working for investors and the wider economy. It will be looking into whether the audit sector is competitive and if it is resilient enough to maintain high quality standards.
The Competition Commission (“CC”), the CMA’s predecessor, last looked into statutory audit services in 2013 and implemented a package of remedies following its detailed market investigation. Despite these measures, and subsequent legislative changes at European level, concerns remain as to the effective operation of the audit market.
Following the collapse of companies such as Carillion plc and BHS, there are widespread and growing concerns about the quality of audits. The CMA notes the wider importance of trustworthy financial information in providing the confidence necessary for the proper functioning of the market economy.
The CMA will be building on the work already carried out by the CC and so is aiming to move swiftly in progressing this market study. It has now issued its Invitation to Comment (“ITC”), responses to which are requested by 30 October 2018. The CMA will then publish its provisional views by the end of 2018.
The market study will closely examine three main areas of concern:
- Resilience: in particular, the role the Big Four firms (Deloitte, KPMG, E&Y and PwC) play in terms of market resilience. The CMA will explore the notion these firms are “too big to fail”.
- Choice and switching: despite evidence competition has been strengthened between the Big Four, the largest UK companies almost exclusively instruct these firms as auditors.
- Incentives: companies pick their own auditors. The CMA will examine if this results in a lack of incentive to produce performance reviews which challenge the organisation.
The CMA’s ITC identifies potential measures to address the issues of concern
These measures seek to:
- Increase competition between the Big Four. For instance, possible restrictions on audit firms providing non-audit services.
- Increase competition from non-Big Four firms. The CMA is considering measures to reduce barriers for non-Big Four firms to build capacity. The CMA also refers to public calls for the break-up of the Big Four into smaller firms.
- Improve incentives. This includes potential measures to break the link between company management and auditors in order to improve auditor independence – for example, making the auditors accountable to a body other than the company.
There clearly remains an issue in the sector regarding which auditor firms are being instructed by the UK’s largest companies. According to Financial Reporting Council (“FRC”) figures cited by the CMA, in the UK 97% of audits of FTSE 350 firms are undertaken by the Big Four. In its market investigation, the CC had found that mid-tier firms lacked experience of auditing sufficiently large and complex businesses and thus did not have sufficient reputation to convince a FTSE 350 business to award an audit contract. Issues regarding conflicts of interest (perceived or actual) are also highlighted by the CMA in relation to auditor choice. In its study, the CMA will be looking more closely at any barriers to entry in the sector in order to consider how best to increase competition from non-Big Four firms.
While its market study will not focus on detailed remedies relating to regulation, the CMA notes the importance of the interplay between competition and regulation. The CMA’s work is running in parallel with the separate independent review of the FRC, headed by Sir John Kingman, due to conclude by the end of 2018. The CMA’s intention to feed into the FRC review is likely to be a significant factor behind the CMA’s decision to issue its provisional findings quickly and by Christmas.
It is also relevant that the CMA is not starting from scratch with this market study and will be drawing on the extensive work already carried out in this sector by the CC in 2013. A number of the measures outlined in the CMA’s ITC are more stringent than the CC’s measures. The CMA recognises some of its proposals are a significant departure from the status quo, for example shifting responsibility for the management of audits away from companies and to independent institutions. This would be a major change from the current way audit committees appoint and manage auditors. We await with interest the CMA’s provisional findings and the outcome of the FRC review, both due to be published later this year.
More information can be found on the CMA’s audit market study page here.
The CMA is inviting general comments on the market study as well as specific responses to the questions in section 6 of the ITC available here. Responses can be submitted to the CMA via email or post. The deadline is 30 October 2018.
If you would like further information about the CMA’s market study, or would like specific advice regarding a response to the CMA’s ITC, please contact Freeths’ Head of Competition, Andrew Maxwell.
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