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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Ken Clarke: Theresa May has “no idea” what to do about Brexit

According to the former Chancellor, “nobody in the government has the first idea of what they’re going to do next”.

Has Ken Clarke lost the greatest political battle of his career? He doesn’t think so. With his shoes off, he pads around his Westminster office in a striped shirt, bottle-green cords and spotty socks. Parliament’s most persistent Europhile seems relaxed. He laughs at the pervasive phrase that has issued from Downing Street since Theresa May became Prime Minister: “Brexit means Brexit.”

“A very simple phrase, but it didn’t mean anything,” he says. His blue eyes, still boyish at 76, twinkle. “It’s a brilliant reply! I thought it was rather witty. It took a day or two before people realised it didn’t actually answer the question.”

A former chancellor of the Exchequer, Clarke has served in three Conservative cabinets. His support for the European Union is well known. He has represented the seat of Rushcliffe in Nottinghamshire for 46 years, and his commitment to the European project has never wavered over the decades. It has survived every Tory civil war and even his three failed attempts to be elected Tory leader, standing on a pro-Europe platform, in 1997, 2001 and 2005.

“My political career looks as though it will coincide with Britain’s membership of the EU,” Clarke says, lowering himself into an armchair that overlooks the Thames. There are model cars perched along the windowsill – a hint of his love of motor racing.

Clarke won’t be based here, in this poky rooftop room in Portcullis House, Westminster, much longer. He has decided to step down at the next election, when he will be nearly 80. “I began by campaigning [in the 1960s] in support of Harold Macmillan’s application to enter [the EU], and I shall retire at the next election, when Britain will be on the point of leaving,” he says grimly.

Clarke supports Theresa May, having worked with her in cabinet for four years. But his allegiance was somewhat undermined when he was recorded describing her as a “bloody difficult woman” during this year’s leadership contest. He is openly critical of her regime, dismissing it as a “government with no policies”.

For a senior politician with a big reputation, Clarke is light-hearted in person – his face is usually scrunched up in merriment beneath his floppy hair. A number of times during our discussion, he says that he is trying to avoid getting “into trouble”. A painting of a stern Churchill and multiple illustrations of Gladstone look down at him from his walls as he proceeds to do just that.

“Nobody in the government has the first idea of what they’re going to do next on the Brexit front,” he says. He has a warning for his former cabinet colleagues: “Serious uncertainty in your trading and political relationships with the rest of the world is dangerous if you allow it to persist.”

Clarke has seen some of the Tories’ bitterest feuds of the past at first hand, and he is concerned about party unity again. “Whatever is negotiated will be denounced by the ultra-Eurosceptics as a betrayal,” he says. “Theresa May has had the misfortune of taking over at the most impossible time. She faces an appalling problem of trying to get these ‘Three Brexiteers’ [Boris Johnson, David Davis and Liam Fox] to agree with each other, and putting together a coherent policy which a united cabinet can present to a waiting Parliament and public. Because nobody has the foggiest notion of what they want us to do.”

Clarke reserves his fiercest anger for these high-profile Brexiteers, lamenting: “People like Johnson and [Michael] Gove gave respectability to [Nigel] Farage’s arguments that immigration was somehow a great peril caused by the EU.”

During the referendum campaign, Clarke made headlines by describing Boris Johnson as “a nicer version of Donald Trump”, but today he seems more concerned about David Cameron. He has harsh words for his friend the former prime minister, calling the pledge to hold the referendum “a catastrophic decision”. “He will go down in history as the man who made the mistake of taking us out of the European Union, by mistake,” he says.

Clarke left the government in Cameron’s 2014 cabinet reshuffle – which came to be known as a “purge” of liberal Conservatives – and swapped his role as a minister without portfolio for life on the back benches. From there, he says, he will vote against the result of the referendum, which he dismisses as a “bizarre protest vote”.

“The idea that I’m suddenly going to change my lifelong opinions about the national interest and regard myself as instructed to vote in parliament on the basis of an opinion poll is laughable,” he growls. “My constituents voted Remain. I trust nobody will seriously suggest that I should vote in favour of leaving the European Union. I think it’s going to do serious damage.”

But No 10 has hinted that MPs won’t be given a say. “I do think parliament sooner or later is going to have to debate this,” Clarke insists. “In the normal way, holding the government to account for any policy the government produces . . . The idea that parliament’s going to have no say in this, and it’s all to be left to ministers, I would regard as appalling.”

Clarke has been characterised as a Tory “wet” since his days as one of the more liberal members of Margaret Thatcher’s government. It is thought that the former prime minister had a soft spot for his robust manner but viewed his left-wing leanings and pro-European passion with suspicion. He is one of parliament’s most enduring One-Nation Conservatives. Yet, with the Brexit vote, it feels as though his centrist strand of Tory politics is disappearing.

“I don’t think that’s extinct,” Clarke says. “The Conservative Party is certainly not doomed to go to the right.”

He does, however, see the rise of populism in the West as a warning. “I don’t want us to go lurching to the right,” he says. “There is a tendency for traditional parties to polarise, and for the right-wing one to go ever more to the right, and the left-wing one to go ever more to the left . . . It would be a catastrophe if that were to happen.”

Clarke’s dream of keeping the UK in Europe may be over, but he won’t be quiet while he feels that his party’s future is under threat. “Don’t get me into too much trouble,” he pleads, widening his eyes in a show of innocence, as he returns to his desk to finish his work. 

Anoosh Chakelian is deputy web editor at the New Statesman.

This article first appeared in the 29 September 2016 issue of the New Statesman, May’s new Tories