CMA launches immediate review of audit sector
By Anne Adrain, Head of Sustainability and Assurance
12 October 2018
The Competition and Markets Authority (CMA) has launched a detailed study of the UK audit sector to examine concerns that it is not working well for the economy or investors.
The scope of the market study will be the supply of statutory audit services in the UK to large companies, both listed and private, and public interest entities (PIEs). It is unclear at this moment whether the reference to the term ‘large’ is in line with the definition of a large company in the Companies Act 2006.
As part of its review, the CMA will investigate whether the sector is competitive and resilient enough to maintain high-quality standards. They plan to issue their provisional findings before Christmas.
The move by the CMA comes amid growing concerns and criticism of auditors following recent corporate collapses, and poor results from the Financial Reporting Council (FRC) audit quality reviews.
The CMA identified five themes from the concerns that it has heard from stakeholders so far as well as the Competition Commission’s report in 2013 and its initial view of how the market functions. It aims to focus on three of these:
- Market choice - Changes put in place by the Competition Commission appear to have increased competition between the big four firms - Deloitte, KPMG, E&Y and PwC – but the largest UK companies still almost exclusively use one of them when selecting an auditor.
- Resilience - The market study will examine what the role of the big four firms means for the resilience of the audit market with the risk being that each of the big four auditors is “too big to fail”, potentially threatening long-term competition.
- Incentives - Companies, rather than their investors, select their auditor. The CMA’s work will examine whether that this results in a lack of incentive to produce challenging performance reviews.
In addition to the above, the CMA also identified two other themes, namely: the scope and purpose of the audit; and regulation of audit in the UK. However, it does not intend to focus on these because the former is furthest from its focus and expertise in the operation of markets, and the latter is to be addressed by the ongoing review of the FRC led by Sir John Kingman.
If the CMA finds evidence that the market is not working well after examining these areas, it will scrutinise all proposals for tackling them. It has, on a preliminary basis, identified three groups of measures which it believes are likely to hold the most promise in addressing the issues it has identified. These groups of measures could seek to:
- increase competition between the Big Four, for instance, by creating audit-only firms or placing greater restrictions on the other services that they can provide;
- increase competition from non-Big Four audit firms, for instance, through a market share cap and/or joint/shared audits; and/or
- address the incentives arising in audits, for instance, by moving responsibility for appointing auditors away from audited companies, in certain circumstances, to an independent body
Whilst the CMA acknowledges that one potential solution to increase choice and resilience would be to forcibly break-up the Big 4 firms, it acknowledges that the design and implementation of this measure would pose significant and potentially insurmountable challenges.
The CMA has written to the government about its market study and the possible need for legislation to implement its findings and those of the independent review of the Financial Reporting Council led by Sir John Kingman.