CMA Recommends Audit Reform

The CMA Recommends Audit Reform

Last year, the Competition and Markets Authority (CMA) conducted a detailed study of the UK audit market. The study focused on three main issues:

  • The difficulty of choosing and switching between the Big 4 firms- KPMG, E&Y, Deloitte, and PwC.
  • The Big 4 being “too big to fail” and threatening long term competition between themselves and smaller audit companies in the UK.
  • The incentives between audited companies, audit firms, and investors.

In their final report, the CMA recommend ‘a package of remedies to reform the market’. These are the changes required to improve both the issues raised by the initial reports, and the international audit industry as a whole.

Recommendation 1- Audit Committee scrutiny

 This suggestion aims to increase accountability and draw focus to the quality of audit.

The CMA believe that the Government should legislate the following standard requirements for regulators:

  • To uphold minimum standards of the appointment and oversight of auditors.
  • To monitor compliance with these standards. They should also place observers on Audit Committees if required.
  • If these standards are not met, regulators should take action against the offending Audit Committees. This could include the issuance of public reprimands and the notification of committee shareholders.

Recommendation 2- Mandatory joint audit

This suggestion looks ahead to the possible demise of the Big 4. We need to take action now in order to improve the resilience of the audit sector. In turn, the recommendation aims to enable growth for firms outside of the Big 4.

The CMA actively encourage the Secretary of State to legislate the following:

  • Regulators should establish a set criterion with which to determine whether a company is required to have a joint audit.
  • Those that are required to, must appoint at least one auditor from outside of the Big 4 firms.
  • Integration to joint audit should be gradual. It should not be mandatory to change until a company’s next tender arises.
  • Work between each of the joint auditors should be equal and rewarded with fair fees.
  • Existing UK audit liability should not change.

Recommendation 3- An operational split between the practices of the Big 4

Here, the CMA suggests that the Big 4 separate their audit and non-audit practices. This will improve the quality of audits and would eventually be mandatory for all firms of a similar size.

The CMA suggests that the operational split follows these guidelines:

  • The audit practice and the non-audit practice should not share profits, and both should have separate financial statements recording profit and loss.
  • Transfer pricing should be transparent and checked by the regulator.
  • The audit practice should provide other audit-related services such as regulatory reporting.
  • The audit practice with have a separate CEO and board who should be responsible for career progression decisions. This board should annually hold a general meeting and create a report.

Recommendation 4- A progress review after 5 years

If we implement these changes, it is imperative to set a time frame in which to review their success. Regulators will therefore carry out assessments after five years.

The CMA has provided the following criteria against which regulators should assess:

  • The benefits of moving to the independent appointment of auditors.
  • The effectiveness of the operational split, and whether this should advance to a structural split.
  • The progress of the long-term joint audit operation, and any changes that need to be made to the plan in response to un-forecasted market developments.

Alongside those above, there are many other changes that the CMA feels require further investigation. These include remuneration and claw-back, firm ownership rules, regulations around technology licensing, improving shareholder communication, and streamlining notice and rotation periods.

Summary

The CMA encourages the UK Government to take action “at the earliest opportunity”.

Each year that passes without any action taken runs the risk of major audit failures.

The UK cannot continue to rely on the Big 4 to audit the nation’s biggest companies. We need to share responsibility if we are to protect the future of one of the most important industries, not just in the UK, but worldwide.

“Our recommendations, along with improvements to regulation and clarifying the purpose and scope of audits, will ensure the UK strengthens its position,” states CMA’s Chief Executive, Andrea Coscelli.

Whilst it is clear that the UK Government cannot make industry changes internationally, there is no reason why we cannot pave the way for others to follow.

You can view the full report here.

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