Rachel Reeves on fixing “broken” audit market

Summary

The Business, Energy and Industrial Strategy Select Committee is launching an inquiry into audit reforms in response to the Competition and Markets Authority (CMA) and Kingman reviews. The inquiry will explore the need for increased competition, improved audit quality, and reduced conflicts of interest in the sector. The dominance of the Big Four audit firms, which audit 97% of FTSE 350 companies, is a central issue. The inquiry will scrutinize proposed reforms such as splitting audit and non-audit services and enhancing the role of regulators like the FRC to restore public trust and ensure the UK's leadership in corporate governance.

Takeaways

• 😀 The Business, Energy, and Industrial Strategy Select Committee is launching an inquiry into the delivery of a new landscape for audit in the coming year, after the CMA and Kingman reviews are published.
• 😀 Public hearings will be held to explore reactions to these reviews, involving a range of stakeholders such as the Big Four, challenger firms, audit committee chairs, regulators, and experts.
• 😀 The inquiry aims to provide strong parliamentary input before the CMA delivers its final verdict on market competition in the audit sector.
• 😀 The goal of reform is to improve audit quality, increase competition, and reduce conflicts of interest within the industry, benefiting both businesses and the public.
• 😀 The current audit market is dominated by the Big Four accounting firms, auditing 97% of the FTSE 350 businesses, which is considered an unhealthy market due to the lack of competition.
• 😀 The Select Committee will examine various proposed reforms, including market share caps, splitting audits from non-audit services, and breaking up large firms.
• 😀 There is debate over whether splitting audit and non-audit services would reduce conflicts of interest or whether non-audit skills are necessary for comprehensive audits.
• 😀 The Financial Reporting Council (FRC) has been criticized for being too close to the industry it regulates, reducing its ability to independently challenge audit quality.
• 😀 The need for more competition in the audit market is recognized, as audits from the Big Four are not currently of high enough quality to justify the lack of competition.
• 😀 Smaller firms could potentially handle many of the businesses currently audited by the Big Four, as 80% of listed firms are not global multinationals, providing space for challenger firms in the market.
• 😀 The inquiry will look into whether audits should be more forward-looking, rather than just serving as a retrospective exercise, to improve their value and effectiveness.

Q & A

What is the main purpose of the inquiry announced by the Business, Energy, and Industrial Strategies Select Committee?

The main purpose of the inquiry is to explore the delivery of a new landscape for audit in the UK, particularly following the publication of the CMA and Kingman reviews. It will focus on improving competition, quality, and trust in the audit sector.

What role will public hearings play in the Select Committee inquiry?

Public hearings will be used to gather evidence and scrutinize the views of key stakeholders, including the Big Four audit firms, challenger firms, regulators, and experts. These hearings will ensure transparency and allow for public scrutiny of the proposed reforms.

What are some of the potential reforms being considered in the audit market?

Potential reforms include separating audit and non-audit services to reduce conflicts of interest, breaking up the dominance of the Big Four firms, and possibly implementing caps on market share or introducing dual audits.

Why is the Select Committee concerned about the dominance of the Big Four audit firms?

The Big Four audit firms dominate 97% of FTSE 350 businesses, which creates an unhealthy market. The lack of competition is seen as a key issue in the sector, contributing to lower audit quality and reduced trust in the system.

How does the inquiry aim to restore trust in the audit sector?

The inquiry seeks to restore trust by improving the quality of audits, increasing competition among firms, and addressing conflicts of interest. By implementing reforms and holding public hearings, it aims to ensure greater transparency and accountability.

What is the role of the Financial Reporting Council (FRC) in the audit process, and why is it being criticized?

The FRC is responsible for regulating the audit sector, but it has been criticized for being too close to the industry it regulates, leading to a lack of independent challenge. The inquiry calls for stronger oversight to ensure that audits meet high-quality standards.

What is the issue with audit quality in the current system?

Audit quality is seen as inadequate, with several high-profile failures highlighting the need for reform. The Big Four firms, despite their dominance, are not producing audits of sufficiently high quality, leading to calls for more competition and better standards.

Why is increasing competition in the audit market important for improving audit quality?

Increasing competition is believed to lead to higher standards and lower prices. It encourages firms to improve their services, ensuring audits are more thorough and trustworthy, and reducing the concentration of power in the hands of a few dominant firms.

How might separating audit and non-audit services improve the sector?

Separating audit and non-audit services is expected to reduce conflicts of interest, as auditors would no longer be incentivized to provide non-audit services to their clients. This could help improve the independence and objectivity of audits.

What is the significance of the 97% figure regarding the Big Four's market share?

The 97% market share of the Big Four in the FTSE 350 businesses illustrates the overwhelming dominance of these firms in the audit market. This concentration of power is considered detrimental to both competition and audit quality, highlighting the need for reform.