As the consultation on the future of audit closes, Peter Manser, head of audit and assurance at Kreston Reeves LLP, argues that managed shared audit needs careful consideration but could open up much-needed competition among audit firms
The government’s proposals for audit reform are part of their initiative to ‘restore trust in audit and corporate governance’. Audit is one strand, along with corporate reporting and corporate governance including the role of a new audit regulator.
As a mid-tier network, Kreston International supports the bigger picture concept that trust in corporate reporting involves auditing and corporate governance and the work of the regulator over auditors, directors and companies.
High-profile corporate failures inevitably and rightly fuel debate over improving audit quality. Carillion failed in 2018, BHS in 2016. Three significant public consultations have subsequently examined the different issues.
Reform in the corporate world always takes time and inevitably the proposals for audit reform are going to take time to produce change. Some commentators are looking at 10 years plus. That’s a long enough time window for further corporate failures to add to the ongoing debate.
The key issue for audit quality for listed and larger companies is the lack of choice. Increasing competition through wider choice will drive innovation and improve audit quality. Mid-tier firms can add to both quality and choice in the right circumstances. Yet there are significant barriers to entry to listed audit work for the challenger and mid-tier firms. These include the management of liability and risk including reputation, recruiting, and retaining resources, adapting our audit processes, and developing our quality control and management systems.
Managed shared audit
In response to the consultations, the government has proposed managed shared audit which provides opportunities to overcome these barriers. For our member firms, the shared audit could provide a route to gain experience and build a reputation in an area where we are effectively currently excluded.
For firms to engage in shared audits will require boldness and significant investment. The lack of competition for listed company audits has become extreme with the Big Four accountancy firms auditing 100% of the FTSE 100 and 97% of the FTSE 350. Such market concentration raises questions over the resilience of the audit profession for listed and other large entities.
Failure or even the perceived risk of failure of one of the Big Four would result in severe disruption and of course yet further market concentration.
There is a significant difference between the Big Four firms, challenger firms, and mid-tier firms in terms of resource and expertise. Increasing the number of viable competitors for the more complex audit assignments is a sizeable project but a vital one. The conclusion of public consultation is that more audit firms enabled to compete for listed and large company audits will improve both resilience and quality of audit for these entities.
The main barriers to entry are usually seen as capacity, capability, and reputation. Would changing the rules currently precluding majority control by external investors help (as has recently been suggested by the former head of the Financial Conduct Authority (FCA))?
Building capacity, capability, and reputation will require investment, but this is only one factor. Lack of investment due to the constraints on ownership of audit firms has not been identified as a significant factor during the current public consultations. After all, the current ownership rules spawned the Big Four.
Access to further investment will be necessary to challenge the Big Four, but to build the infrastructure is a long-term project that will necessitate careful planning and oversight. Changing investment rules for audit firms will require detailed consideration of the independence issue that will arise, and the impact on audit quality.
Mid-tier firms will also need to thoroughly consider the cost of the compliance regime for auditors of listed and large entities.
At least one of our member firms has made representations that the role of the regulator needs to be proportionate, one of enabling competition through education.
A further barrier to competition is the current liability regime. For many of our member firms, this would preclude involvement in joint audit (as opposed to managed shared audit), which was previously mooted by the Competition and Markets Authority (CMA).
There appears to have been little sympathy for firms’ liability during the consultations process. This is a significant reason why joint audits will not help increase competition and choice.
Managed shared audits overseen by a supportive regulator could create the right environment for firms to commit to the required investment in people and resources. The objective needs to be to enable firms to accumulate the relevant experience to add competition.
As a network, we are excited by the potential opportunities of managed shared audit, as the effects ripple through our profession. Yes, this will be a phased approach to building capacity, capability, and reputation outside the Big Four.
In the long term, the shared audit will improve auditor choice and audit quality. It would be good to see shared audit beyond the FTSE 350 explored as a means of developing mid-tier firms. This would encourage firms to make the required investment in people, resources, quality control, and management systems in a way that would be commercially viable.
Audit is one strand in restoring trust in the corporate world and the signs are there that with care and investment, the changes can be made. It remains to be seen how far the proposed changes to corporate governance and reporting will go towards to restoring trust.