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The Competition Commission and statutory audit – a lot of sense and sensibility – part 1

Guy Strafford
Nov 1, 2013 4:31:00 AM

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The verdict is in, judgement is pronounced.

The Competition Commission (CC) has delivered its final ruling on the market for statutory audit services in the UK, amending its remedies from the provisional ruling announced a couple of months back (here are our comments from July) and the reaction from the industry is generally positive.

Here, Proxima's Richard James and Guy Strafford take a look at the seven remedies the CC has proposed, and the resultant implications for finance / procurement teams and audit committees within FTSE350 companies.

  1. “FTSE 350 companies must put their statutory audit engagement out to tender not less frequently than every ten years” but if you don’t do it within five years, you have to state in your Annual Report when you plan to issue the tender.

    This is a sensible response to the deluge of feedback received from all corners other than a few accounting firms outside of the Big 4 who had most to gain from the original pronouncement of mandatory tenders every five years. It’s aligned with the FRC’s current “comply or explain” timing and sits comfortably with the industry view that it takes a couple of years for a new auditor to bed in and really deliver value, while still ensuring a competitive process is undertaken on a reasonably regular basis.

    But what does this mean for the market? Will it actually help to break the Big 4’s dominance of the FTSE350? Was that ever a sensible objective?

    Well, at first glance it means there will clearly be more activity in the market. On average that’s between 35 and 70 tenders a year (there have been more than 700 companies in the FTSE350 over the last 10 years), compared to just 24 in the last 12 months and far, far fewer in previous years. Presumably in the next few years there will be an even bigger flurry of activity as companies with decades of stasis are forced by the ruling or shareholder pressure to move quickly.

    On the face of it, this will be a boost to competition and a driver for innovative and creative approaches to the audit. Our experience from running several tenders with our clients is that a well-run tender leads to a variety of different approaches being put forward, a drive towards efficiency and a strong commitment to quality. In most instances, audit costs have reduced, sometimes very significantly, but this tends to be driven by innovative audit approaches rather than haggling over rate cards.

    However, the increase in activity may have the perverse effect of driving up audit costs for some companies. Accounting firms will have to build up their bid response teams and will need to find ways to recoup these business development / retention costs. We also anticipate some firms may decline to bid or put in half-hearted responses if a client is seen as less attractive or if the firm risks losing more lucrative advisory work.

    As a consequence, outside of “prestige” clients, buyers may still need to work hard to create a genuinely competitive marketplace, especially in certain sectors where advisory fees for those Big 4 firms who are not the incumbent auditor are much more important than the potential audit fee they would gain.

    On a positive note, the firms outside of the Big 4 are building their credibility and client base so those companies not over-burdened by complex financial or organisational structures, especially where their global footprint is more limited, would do well to include one or more non-Big 4 bidders on their tender list. As a result, we’d predict some shift over the next 10 years in the supplier landscape.

  2. The Audit Quality Review (AQR) team should report on the Big 4 firms’ capability annually and should review every FTSE350 engagement on average every five years and at least every seven years.

    This is a very sensible “beefing up” of the FRC’s role, ensuring that there is an independent approach to “audit the auditors” and ensure the industry’s quality standards are maintained and improved.

These first two points highlight that the Competition Commission’s ruling should encourage greater visibility amongst existing service providers and create more competition in an oligopolistic market – which can only benefit buyers of Audit services. However, the pressure is now on smaller Audit service providers to rise to the challenge and ensure they can compete with the Big 4, which means significant beefing up of capabilities to meet the demands of complex business environments.

In the second post in this two part mini-series, we will discuss the remaining five remedies and their implications. In the meantime, we welcome your thoughts and comments around this topic – please add them below.

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