The Competition Commission and statutory audit – a lot of sense and sensibility – part 2
Nov 1, 2013 9:43:00 AM
Our previous post discussed three of the seven remedies that the competition commission proposed as part of their ruling around statutory audit rotation. In this post, part two of this mini-series, Proxima's Richard James and Guy Strafford will look at the remaining four remedies and some key questions finance / procurement teams and audit committees should be asking when tendering this high profile service.
- Restrictive “Big 4 only” auditor clauses in loan agreements are to be prohibited.
This was expected and trumpeted in the provisional findings. There doesn’t seem to have been a lot of evidence that this was occurring overtly but it would be clearly inappropriate in the new environment.
- Shareholder engagement is to be enhanced with greater obligations on companies to engage directly with shareholders, particularly institutional shareholders, to address any audit issues
While this remedy is not very specific, again it seems a sensible path to follow and increases the transparency of the audit engagement process.
- Only the Audit Committee (AC) will be permitted to “negotiate and agree audit fees and influence the scope of audit work.”
From a Procurement perspective it will be interesting to see how these obligations are interpreted. At first glance, this seems to give the AC more wide-ranging and indeed operational duties and obligations than at present, implying that they are more directly involved in the detailed scope of the audit and direct negotiation of fees and that non-executive directors are effectively being given a licence to commit funds on behalf of the company.
In practice, we suspect that this might give rise to more direct oversight of the management team’s activities but that it will be practical to ensure some formal delegation of duties to Finance teams who will have more direct access to the relevant information and will be closer to the facts that will drive the award process. There is also the potential for more direct involvement of Procurement, or external advisors, in this area as they may be seen as more independent than the Finance management team.
This remedy also makes explicit the role of the AC in managing Non-Audit Services provided by the auditors. Interestingly, the CC has not sought to further restrict the non-audit activities of auditors and this process may even make it easier for auditors to carry out non-audit work. This might, therefore, for some companies address the concerns that firms might lose out on more lucrative advisory work if they took on the audit. This could be a very clever move from the CC.
- A new obligation for companies to report on the AQR’s report on the company’s audit.
This is a natural requirement from Remedy 2 and should not be a great burden on companies.
- The FRC’s articles of association will be changed so that “it will have due regard to the need for competition in the statutory audit market for FTSE 350 companies.”
Again, it’s not clear what the full implications of this Remedy will be, or how the FRC will put it into practice. However, it clearly leaves the door open for further investigations of the market over the coming years if we don’t see a marked improvement in the competitiveness of the market; for example, if companies are tendering but consistently remaining with their incumbent or if opportunities for non-Big 4 firms continue to be highly restricted.
One remedy that was not pursued by the CC was the issue of joint, shared or consortia audits. Non-Big 4 firms are clearly advocates of such an approach: it gives them a route to market with clients where they would not have the credibility or maybe capability to deliver or a “testing ground” where they can deal with less strategic subsidiaries.
The CC rejected a remedy in this area due to perceptions that such audits may reduce quality and increase costs. Nevertheless, this model is used more widely in continental Europe and there have been examples in the UK market. Given that we believe that some companies may find a lack of competition within the Big 4, this could be a consideration for them to generate competitive pressure and alternatives.
There are therefore some key messages and questions for companies to consider when tendering:
- How will you make sure that the providers offer you their “A Team”, drive innovation, maintain or improve the quality of the audit and give you a market-leading deal?
- Can you be confident that providers will truly compete against one another?
- Are there ways in which you can promote yourselves or adapt your approach to aid the competitive environment?
- How will you conduct a fair and open tender process? After all, this isn’t a normal procurement tender process of choosing the cheapest of three bids!
- How will you assess and quantify the benefits of bidders?
- When should you go to market to get the best from it?
Overall, our view is that these recommendations are sensible, proportional and generally good for the market. The ball is now in the court of the companies, and indeed of procurement practitioners, to really use these developments to create a vibrant and competitive market that delivers value for shareholders and companies alike.
As usual, we welcome your thoughts and comments on this topic – please add them below.
Part 1 of this series can be viewed here