Competition Commission proposals ─ broadly positive but concerns remain

01 Sep 2013

The debate over changes to the provision of statutory audit services to large companies remains at a critical stage, with the UK’s Competition Commission (CC) releasing its provisional decision on remedies to promote a more competitive audit market.

In a statement on 22 July, Laura Carstensen, chair of the Audit Market Investigation Group said that although “tender processes are thorough, fair and transparent . . . we need to see more of them”. She said the measures would “ensure that shareholders are better served by a more competitive market for statutory audit which is more responsive to their requirements…a more dynamic, contestable market will reduce the dangers that come with overfamiliarity and long, unchallenged tenures”.

Main measures

The main measures proposed by the CC are:

  • FTSE 350 companies should put their statutory audit engagement out to tender at least every five years. Companies may defer this obligation by up to two years in certain circumstances
  • The FRC should review every audit engagement in the FTSE 350 every five years, with the findings reported to shareholders
  • So-called ‘big-4 loan clauses’ should be prohibited
  • There should be a shareholder advisory vote on whether AC reports in annual reports contain sufficient information
  • Further measure are included to strengthen the accountability of the external auditor to the AC
  • The FRC should be given a secondary objective to have due regard to competition

“Much of the proposed package does effectively address competition, choice, quality and transparency,” said Gilly Lord, UK regulatory leader at PwC, “and the Commission decided against its most controversial proposal – mandatory firm rotation. But there remain elements of the suggested solutions that are a cause of considerable concern to auditors and the wider business community.”

Concerns remain

In a detailed letter to the commission, James Chalmers, PwC UK Assurance leader, outlined the firm’s strong opposition to the first proposed remedy, and suggested some improvements. Instead of the CC’s mooted requirement that firms tender the audit every five years, the letter proposes that companies tender at least every 10 years with a possible two-year deferral; and that the audit committee explain to shareholders one year in advance of the audit partner rotation (up to five years) whether or not a tender will be held and why. Mr. Chalmers argues that this would empower shareholders, via their advisory vote, to confirm the audit committee recommendation or to register dissatisfaction.

Mr. Chalmers also explained that the Financial Reporting Council’s mandated 10-year tender period – which enjoys broad-based support – isn’t yet a year old, and has so far proved effective in increasing the number of tenders among FTSE 350 companies. The letter described how under the proposed further reduction, companies would be reluctant to switch auditor after having spent significant time and resources getting their new auditor up to speed. A five-year period, it says, would devalue the tender process, adversely affecting the number or quality of bids and raising the risk that many tenders will simply become a costly compliance exercise.

The Commission has grossly underestimated the costs of five-yearly tendering.

Indeed, the cost of implementing the proposed remedies is a primary concern. PwC calculated that the CC’s estimated (based on historic data from 2005) costs of five-year tendering would be in the region of £10m with an upper limit of £30m, grossly underestimates the true costs in a changed audit landscape. The firm is concerned that the calculations rested in part on the notion that audit partners could allocate tenders to their ‘quiet periods’ – a strange assumption, given that companies have a range of year ends. The true cost, PwC estimates, is in the region of £52m – or 5% of annual total audit fees.

Mr. Chalmers said that the additional costs “should not be imposed on the market in the absence of compelling evidence that such frequent tenders are necessary”. He added that a move to five-yearly tendering would fail to achieve any further benefits beyond the FRC’s current regime and risks “damaging the effectiveness of tenders at substantial additional cost”.

There is also concern in the auditor community at the apparent lack of significant support from any quarter for the CC’s proposal to reduce the tender term, and also at their refusal to publish a detailed breakdown or complete summary of the results of the investor questionnaire, making it difficult to assess whether the proposed remedies were representative of the responses received.

The Competition Commission expects to publish its final report by the statutory deadline of 20 October 2013. The comment period for the Summary of provisional decision on remedies is now closed.