The UK Competition Commission (CC) has decided against mandatory rotation of audit firms and further restrictions on audit firms providing non-audit services, but has suggested that FTSE350 companies should put their audit out to tender every five years.
The CC said in its provisional remedies decision announcment that companies may defer the five year retendering obligation by up to two years in "exceptional circumstances".
"There will be a transitional period of five years before the measure comes into full effect," said the CC.
The UK Financial Reporting Council (FRC) has only recently introduced mandatory retendering every 10 years.
CC audit market investigation group chairman Laura Carstensen said: "More frequent tendering will ensure that companies make regular and well informed assessments of whether their incumbent auditor is competitive and will open up more opportunities for other firms to compete. A more dynamic, contestable market will reduce the dangers that come with over familiarity and long, unchallenged tenures".
"Whilst there are costs involved in going out to tender, we think that they are outweighed by the benefits of a more competitive market in which shareholders can have increased trust," Carstensen said.
She also said that a "comprehensive set of measures will ensure that shareholders are better served by a more competitive market for statutory audit which is more responsive to their requirements".
Other remedies suggested by the CC are:
- The FRC's Audit Quality Review (AQR) team should review every audit engagement in the FTSE 350 on average every five years. The audit committee should report to shareholders on the findings of any AQR report concluded on the company's audit engagement during the reporting period;
- A prohibition of 'Big-Four-only' clauses in loan documentation;
- A shareholders' vote on whether audit committee reports in company annual reports contain sufficient information;
- Measures to strengthen the accountability of the external auditor to the Audit Committee and reduce the influence of management, including a stipulation that only the Audit Committee is permitted to negotiate and agree audit fees and the scope of audit work, initiate tender processes, make recommendations for appointment of auditors and authorize the external audit firm to carry out non-audit services and,
- The FRC should amend its articles of association to include a secondary objective to have due regard to competition.
Commenting on the role of the audit committee Carstensen said they have, "a vital role in ensuring that the external audit is effective".
"We found that finance directors often have considerable influence over the audit relationship in practice despite the formal authority of audit committees. We are therefore proposing measures that increase the influence and responsibilities of the audit committee."
In its provisional remedies and conclusions document issued in February the CC considered remedies such as mandatory audit firm rotation, extending reporting requirements and further restrictions to auditors providing non-audit services. Carstensen said the CC "gave careful consideration" to those measures, "but we think that the measures that we have provisionally chosen will be the most effective and proportionate way to address the problems we have found".
"We do not see a competition problem with audit firms retaining business if they do a good job -- but they will have to demonstrate this on a regular basis," she said.
"The CC is aware that its proposed package of remedies may be affected by measures currently being discussed by the EU. However, there are as yet no definitive EU proposals, and we have therefore proceeded on the basis of the evidence produced by our inquiry."
Stakeholders are able to provide comments on the provisional remedies until 13 August and the final report is expected in October.
Industry response
Commenting on the CC's announcement PwC UK head of assurance James Chalmers said: "We have long argued against mandatory rotation because of its adverse effects on competition. After careful and detailed consideration of the evidence and listening to the concerns of the market, the CC has arrived at the same conclusion."
"The proposed halving of the retendering period from the Financial Reporting Council's recently introduced 10 year regime to five years is a significant change which will have a major impact on UK companies. It will be critical to get the transition right in order to manage the cost for businesses and potential market disruption," he added.
Similarly EY UK's assurance managing partner Hywel Ball said: "...we struggle to see why there is a necessity to extend the provisions already made by the FRC in the Corporate Governance Code for mandatory tendering every 10 years, to every five. We've yet to see any compelling evidence from the CC to support this change. It is not in the public interest and will likely only serve to increase the financial burden on companies at a time of ongoing economic uncertainty".
Ball also expressed concern over FRC's audit reporting powers by saying: "Whilst a matter for the FRC, we are uncertain about the feasibility of creating high level public reporting on individual listed company audits. Very considerable technical and resource implications arise. There is also no body of experience anywhere else in the world on which to draw".
Ball welcomed the decision to remove mandatory rotation, limiting further the provision of non-audit services, and joint audits from the remedies list.
High cost of 5 year retendering
KPMG UK chairman Simon Collins said the CC's decision mandating companies to tender their audits every five years, "not only undermines the fundamental 'comply or explain' principle of UK corporate governance, but also gives rise to a substantial incremental cost - far higher than the estimated £30m - and could have a highly disruptive effect on business".
The firms UK head of audit Tony Cates added that as large, global companies put their audits out to tender it creates a substantial burden and the process can take up to two years of preparation. "Five year audit tendering will feel relentless to many companies, audit committees and investors who may only see audit quality damaged rather than improved, with the possible end result that the process of tendering becoming an empty box-ticking exercise, rather than a more meaningful, engaged exercise on a ten year basis."
Deloitte UK managing partner and head of public policy David Barnes said that five year retendering "is unlikely to advance audit quality or increase market competition, nor will it lead to benefits for shareholders or companies".
Institute of Chartered Accountants in England and Wales (ICAEW) chief executive Michael Izza said it is an open question whether tendering on a five year basis will achieve the desired increase in competition.
"There needs to be a balance between the costs and resources required from both businesses and firms when tendering and the desired outcomes," he said.
"It is therefore disappointing that the CC has decided on more frequent tendering than that now required on a comply or explain basis by the FRC, which has not had a chance to embed yet."
Mid-tier view
BDO UK senior partner James Roberts said that the rejection of mandatory firm rotation, "will cause some surprise, but it's our belief that the frequency of mandatory retendering which the CC proposes is such that rotation would be a superfluous remedy".
"The strengthening of accountability between auditors, audit committees and shareholders is also welcome. However, we're unlikely to see genuine liquidity in the market if the same small number of firms are invited to tender. There are more than four companies that deliver quality, large-scale audits. We intend to actively pursue opportunities that mandatory retendering opens up," Robert said.
"The CC has until September to finalise its report and we hope that the proposed remedies are not diluted further between now and then," he added.
Mazars partner David Herbinet said "this is a classic case of the half full glass" as the firm supports the remedies put forward by the CC, however " further action is needed to create a level playing field for new entrants into the FTSE 350 market and comparable markets across the EU".
"As is widely recognised, we must guard against the risk of one of the Big Four leaving the market unexpectedly. We cannot have firms that are 'too big to fail'. Moreover, it's new players who drive innovation in markets, not the old ones who have held cosy positions for decades."
"Leading institutional shareholders who proposed a limit on non-audit services and mandatory firm rotation will be disappointed that their views have not been reflected in the latest proposals. It is important that their voice be heard on auditing and other governance matters," he added.
Grant Thornton UK chief executive Scott Barnes said the CC provisional remedies have the "potential to introduce positive change in the market".
"The CC has concluded that a combination of UK shareholder pressure for change and frequent tendering has made mandatory firm rotation redundant. However, regulatory change will only go so far and these proposals rely heavily on changes to buying habits."
"These proposals represent another opportunity to build on our strategy of developing deeper relationships with FTSE boards across selected sectors," he said.