Competition commission has put the cat among the pigeons

Musical chairs for the audit market?

When the relationships between auditors and some listed companies can be measured in decades, with some spanning more than a century, the idea that companies should be forced to retender for audit services as often as every seven years is a bold suggestion indeed.

But this is what the UK’s Competition Commission (CC) has – albeit provisionally and with much further consultation to come before a final statement in the Autumn – suggested this morning, in what the CC’s audit group chair Laura Carstensen admits represents “some quite radical suggestions”.

The issue Carstensen’s group originally set out to address was the perception that extended relationships between businesses and their auditors breed a kind of familiarity that prevents shareholders’ interests from being protected when auditors run the rule over corporate accounts.

It stands to reason, after all, that an auditor with a longstanding rapport with the management of a business might be inclined to audit financial statements in a way more beneficial to the interests of that management team than to its shareholders.

To shake up this supposedly cosy state of affairs, the CC has proposed mandatory retendering and rotation of audit firms. This, in addition to the prohibition of "Big Four only" clauses in loan documentation, which restrict lending to companies audited by PwC, Ernst & Young, KPMG and Deloitte, and measures to increase engagement between auditors and shareholders.

On paper, mandatory rotation certainly looks like it would protect shareholder interests and increase competition, with smaller firms gaining audit market share from the Big Four, which currently take the lion’s share.

In practice, the concept invokes serious practical considerations that many, especially among the Big Four, think could be counterproductive to the quality of audit services.

First and foremost, mandatory rotation has cost implications to both auditors, who spend time and money on pitches to prospective clients, and those being audited. There are also setting-up costs for auditors and companies in new audit engagements.

Audit rotation after short periods also poses a threat to audit quality, particularly as engagements come to an end. Auditor rotation on a seven year basis is arguably ill-suited to large, complicated financial institutions whose inner workings require a long period for audit teams to understand.

In any case, audit firms already rotate engagement partners with clients to ensure independence, so it is not as if the profession has done nothing to address the issue of over-familiarity.  

But then again, this is exactly what consultation periods are for, and the CC itself acknowledges both the range of possible approaches to the rotation and retendering issue, seeking views on rotation periods of seven, ten and 14 years, and the fact that further recommendations would be contingent on responses to the current proposals.

Carstensen, speaking to me for International Accounting Bulletin this morning, said there is “evidence there is a price benefit to tendering, but we have to weigh up the costs and benefits – we want to know how we can find a point of equilibrium where the benefits are captured, but in such a way that it is not unduly costly or burdensome.”

There is plenty of time to find this point of equilibrium. This morning’s release only represents a summary of provisional findings, and the full text won’t be available until next week, with final recommendations to come in August at the earliest.

Nevertheless, they certainly represent a more aggressive stance to shaking up the market than many in the audit market had expected, and are likely to prompt a broader change in attitudes beyond the UK.

For some time the EU has been rumbling through its own debate on audit reform, and after making some fairly conservative recommendations towards the end of last year, has been widely regarded as waiting on what comes out of the CC before making further statements. Certainly, the CC’s suggestions on mandatory rotation are unambiguously more hard line than anything that has come out of Brussels.

Carstensen told me she expected today’s comments and future findings from the commission to have a definite impact on the continuing EU debate. “Brussels has a lot of respect for our process as very rigorous and very evidence based, and I would expect parties there to be very interested in what we conclude, and the basis on which we reach it.”

In this context, one wonders if the decision to start the rotation discussion at a benchmark of five to seven years was a move designed to bring more impassioned debate to a discussion that some perceived as having become quite flat. Whatever the intention, it has certainly had that effect.  

Links:

http://www.internationalaccountingbulletin.com/news/cc-audit-chairman-comments-on-radical-suggestions/

http://www.internationalaccountingbulletin.com/news/cc-provisional-findings-split-the-profession/

Photograph: Getty Images

By day, Fred Crawley is editor of Credit Today and Insolvency Today. By night, he reviews graphic novels for the New Statesman.

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Richmond is a wake-up call for Labour's Brexit strategy

No one made Labour stand in Richmond Park. 

Oh, Labour Party. There was a way through.

No one made you stand in Richmond Park. You could have "struck a blow against the government", you could have shared the Lib Dem success. Instead, you lost both your dignity and your deposit. And to cap it all (Christian Wolmar, take a bow) you self-nominated for a Nobel Prize for Mansplaining.

It’s like the party strategist is locked in the bowels of HQ, endlessly looping in reverse Olivia Newton John’s "Making a Good Thing Better".

And no one can think that today marks the end of the party’s problems on Brexit.

But the thing is: there’s no need to Labour on. You can fix it.

Set the government some tests. Table some amendments: “The government shall negotiate having regard to…”

  • What would be good for our economy (boost investment, trade and jobs).
  • What would enhance fairness (help individuals and communities who have missed out over the last decades).
  • What would deliver sovereignty (magnify our democratic control over our destiny).
  • What would improve finances (what Brexit makes us better off, individually and collectively). 

And say that, if the government does not meet those tests, the Labour party will not support the Article 50 deal. You’ll take some pain today – but no matter, the general election is not for years. And if the tests are well crafted they will be easy to defend.

Then wait for the negotiations to conclude. If in 2019, Boris Johnson returns bearing cake for all, if the tests are achieved, Labour will, and rightly, support the government’s Brexit deal. There will be no second referendum. And MPs in Leave voting constituencies will bear no Brexit penalty at the polls.

But if he returns with thin gruel? If the economy has tanked, if inflation is rising and living standards have slumped, and the deficit has ballooned – what then? The only winners will be door manufacturers. Across the country they will be hard at work replacing those kicked down at constituency offices by voters demanding a fix. Labour will be joined in rejecting the deal from all across the floor: Labour will have shown the way.

Because the party reads the electorate today as wanting Brexit, it concludes it must deliver it. But, even for those who think a politician’s job is to channel the electorate, this thinking discloses an error in logic. The task is not to read the political dynamic of today. It is to position itself for the dynamic when it matters - at the next general election

And by setting some economic tests for a good Brexit, Labour can buy an option on that for free.

An earlier version of this argument appeared on Jolyon Maugham's blog Waiting For Tax.

Jolyon Maugham is a barrister who advised Ed Miliband on tax policy. He blogs at Waiting for Tax, and writes for the NS on tax and legal issues.