This article was first published in the October UK edition of Accounting and Business magazine.
The proliferation of regulators since the days of the Enron collapse, and acceleration after the financial crash, was seen as a way to bring greater certainty to what had become an unstable business world. But now that we have had a period of time to observe how they all work, doubts are beginning to emerge. The assumption is that they must all be working for the public good. And that is right. But the outcomes don’t always turn that noble assumption into a reality.
The difficulty regulators have is that individually they exist for a specific purpose. And generally they pursue those tasks diligently. The problems arise when one regulator’s objective becomes another’s disaster. This is the root of the difficulties the Competition Commission’s investigation into the market for audit services has created.
There have been several efforts over the last decade either to break up the perceived monopoly of the Big Four accounting firms or to nurture new competitors. But they have tended to founder.
Management specialists argue that in a truly global market having four competitors tends now to be the norm. The sheer size, scale and resources required quite naturally limit the number of entrants.
But this doesn’t deter a regulator whose objective is based on theories rather than practicalities. The Competition Commission investigation and its preliminary findings is a good example. For it the idea of insisting that companies should have to put their audit out to tender every five years seems sensible. To regulators whose responsibility is to promote and maintain audit quality the idea is mad.
And the recently published responses the Commission received to its preliminary findings bear this out. The Financial Reporting Council, whose objective is, among others, promoting high standards in accounting and auditing, and which had previously produced a guideline that all FTSE 350 audits should be put out to tender every 10 years, was far from happy. It said that the Commission’s decision to stick to a five-year re-tendering timetable would ‘not achieve the Commission’s objective and/or is not proportionate having regard to the cost and risk involved’.
The recently created Prudential Regulation Authority was even more scathing. In its response it makes clear that: ‘We could not support proposed remedies that put that audit quality at risk, regardless of the benefits they might bring more generally to the competitiveness of the statutory audit services market.’ And it makes it clear that the five-year tendering requirement should be dropped. ‘If audit quality is not to be put at risk,’ it says, ‘the period needs to be several years longer and perhaps as long as the 10 years that is the newly established current best practice in the UK’.
It underlines its opinion that the Commission’s view is wrong by pointing out that ‘with a mandatory tender process every five years, a new auditor would complete only three statutory audits before the tendering process would start again and, in any case, for two of those audits the new auditor will have been getting up to speed’.
The PRA also reckons the process isn’t going to do much for competition in the audit services market. ‘We question,’ it says, ‘whether holding a tendering process when the auditor has delivered only one up-to-speed audit will achieve the improvements in competition envisaged.’
And the practical points were echoed by many of the responses from within business. Mark Seligman, the chair of the audit committee at energy company BG Group, provided feedback from his experience of having been through the audit re-tendering process recently. Again the idea of doing this every five years struck him as less than sensible. ‘I am certain this period is too short,’ he says. ‘It took nearly two years from my initial wish to re-tender to the change of auditors, including 11 months from when the process actually started until the change was made. Since then, a further four months on, and I would say the bedding-in process is still not complete. The idea that we would be obliged to start rethinking the whole process in approximately three years’ time is too short, too disruptive and too burdensome.’
The 100 Group, representing the bulk of senior FDs, also raised practical points: ‘There is a misconception that for a modern large-scale business it is possible for an auditor to reach optimal effectiveness immediately upon appointment.’ It also pointed out the fundamental business realities that could turn into unintended consequences for the Commission: ‘From a cost point of view, auditors address this by increasing staffing and review processes in the short term. The cost of this tends to be spread over the life of the audit. Accordingly, the commercial risk posed by a mandatory re-tender would be factored into the cost and borne by shareholders.’
Even the lawyers are baffled. GC100, the general counsel and company secretary body, says that: ‘We still do not understand how tendering the audit every 10 years necessarily increases the likelihood of more mid-tier firms being appointed auditors to FTSE 350 companies. Increased barriers to entry from higher costs of entering into a market tend to restrict new entrants to a market, so reducing the likelihood of the mid-tier firms being able to compete.’
In the end it is the fundamental disconnect between the objectives of different regulators operating in similar fields and the resulting overlap which makes all this such nonsense. The pursuit of dogged theory by some and the effort to strengthen practical issues by others doesn’t provide effective solutions. And it is the practical stuff which tends to be left stranded. As one respondent to the Commission’s preliminary findings rather wistfully put it: ‘I wonder how many Commission members have actually sat in an audit committee meeting?’
Robert Bruce is an accountancy commentator and journalist