Newsflash – CMA recommendations on the UK audit market

The Competition and Markets Authority (CMA) has published its final report on its statutory audit services market study.

The report details four recommendations: audit committee scrutiny, mandatory joint audit, an operational split, and a five-year review of progress by the regulator.

The CMA’s recommendations have been made to Government to be taken forward through legislation, rather than the CMA putting in place its own order. This is partly to enable the Government to assess how other reforms proposed under, for example, the Kingman Review into the regulator the Financial Reporting Council, and the Brydon Review into the quality and effectiveness of audit, would work together with the CMA’s remedies.

Stephen Griggs, UK Managing Partner for audit at Deloitte, commenting on the proposals said:
“We have been consistent in our support for audit reform and agree with the CMA’s objectives to increase choice and competition in the market. However, we are concerned that some of their headline recommendations don’t meet the objectives on increased choice and competition and that our warnings on unintended consequences, and those of many others, such as lower audit quality, damage to UK competitiveness, and weaker resilience of the sector, have been ignored.”

Recommendation 1: Audit committee scrutiny

The goal of greater scrutiny by the new regulator would be to increase accountability and increase the focus on audit quality. The recommendation includes:

• Giving the regulator powers and a requirement to mandate minimum standards for the appointment and oversight of auditors. 
• Giving the regulator powers and a requirement to monitor compliance with those standards, including the ability to require reporting or to place an observer on a Committee.
• Remedial action by the regulator where necessary, such as issuing public reprimands or direct statements to shareholders.

The CMA notes that this would be complemented by implementing recommendations from the BEIS Select Committee on transparency of fees and a requirement for the auditor to present at the AGM.
 

Recommendation 2: Mandatory joint audit

The goal of this remedy is to address choice and resilience problems. The recommendation includes:

• Legislation to give the regulator flexible powers to implement a joint audit regime and adapt it over time. The CMA believes key elements of this remedy would be:
  • Mandatory joint audit, including at least one non-Big Four firm, for most FTSE 350 companies (with certain exemptions for very simple entities or the largest and most complex entities, as well as those that choose a non-Big Four auditor).
  • Gradual introduction enabling adaptation over time, with companies making the transition no later than when their next tender arises.
  • Each firm receiving work that is substantial and relatively equal, representing at least 30% of the audit fee.
  • No changes to the existing liability framework.
• The regulator should have the power to appoint peer reviewers for companies that are not included in the joint audit remedy (which should not be one of the Big Four, unless reviewing an auditor that is outside the Big Four).
• The regulator should monitor the health of the Big Four audit firms, in the event of a risk of failure of one of the firms, using additional powers or taking executive control to limit the movement of clients to the other Big Three.

The CMA notes that joint audit will need to be implemented carefully to take into account challenger firms’ ability to grow and should be monitored and refined as appropriate by the regulator.
 

Recommendation 3: Operational split

The goal of this remedy is to strengthen the focus of auditors on delivering good audits, to remove the distraction of non-audit work, and to give audit practices incentives to bid competitively for more audits. The recommendation includes:

• Legislation to give the regulator powers to design the specific details of the operational split and to refine it over time. The CMA believes key elements of this remedy would be:
  • No profit sharing between the audit and non-audit practices, with audit partner remuneration linked to the audit practice only.
  • Separate financial statements.
  • Transparent transfer pricing, checked by the regulator, particularly for the use of non-audit specialists on audits.
  • The audit practice to include audit-related services and regulatory reporting requirements.
  • A separate CEO and board for the audit practice, with a majority of independent non-executive directors answerable to investors in audited companies and to the regulator. This board should be responsible for remuneration, career progression and quality standards and should conduct an AGM and produce an annual report.

The CMA notes that whilst an international structural split cannot be undertaken by the UK Government alone, the regulator and / or the government should initiate that debate at an international level. 
 

Recommendation 4: Review of progress

The CMA recommends that the regulator should review the effectiveness of the remedies, initially after a five year implementation period.

Read the CMA’s final report.

Read the CMA’s press release.