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Multinationals expect UK proposals to reform Big 4 to fail

The UK’s plan to break up the Big 4 accounting firms to separate the audit and tax functions will fail because of the scale of work large taxpayers require, say TP directors.

An independent investigation commissioned by the UK opposition Labour Party, led by Prem Sikka, professor of accounting and finance at Sheffield University, has found that the auditing industry is exposed to conflicts of interest and a lack of competition that has reduced audit quality. The report recommends breaking up the Big 4 firms and separating the audit function from all other areas of business.

However, the Competition and Markets Authority (CMA) is already investigating the UK accounting industry and its regulatory standards. Although it is yet to conclude its examination, it has already hinted that it will not support the break-up of the Big 4.

Nevertheless, one head of TP at a FTSE 100 company in the UK suggested the market needs greater diversity and competition to flourish.

“The lack of competition holds back innovation,” they told TP Week. “When there are so few top firms, the incentives to properly challenge and think differently aren't there.”

They added that the monopoly of firms means “high fees, even extortionate fees and, in some cases, the hourly rate of senior staff is higher than the GDP per capita in some small countries”.

The head of TP was keen to stress, however, that the quality of the work is very high among the Big 4. “I wouldn’t say there’s over-engineering going on,” they said. “The work is usually of a high standard, it’s thorough and it reflects past experience. However given the increase in audits that have failed to spot fundamental flaws in businesses this illustrates that there needs to be more diversity to have a healthy industry.”

The advocates of audit reform claim the break-up of the biggest accounting firms would ‘free up’ the market and make it more competitive. They argue that this, combined with an overhaul of the corporate governance and regulatory framework, would help prevent new scandals.

But tax directors speaking to TP Week believe the break-up of the Big 4 might only serve to increase competition in the short-term and any regulatory changes may favour the biggest firms just like the existing rules.

This is what happened in France, where the 2003 Financial Security Law (LSF) tore apart the tax service and audit divisions of firms like Deloitte. It did create a bit more diversity and a few boutique firms picked up contracts, but it did not make much of a lasting difference. These firms eventually merged with bigger entities.

Scale and complexity

What the CMA may recommend following its investigation is greater audit rotation or even a market share cap. Yet taxpayers have expressed doubts over either approach. The size and scale of Deloitte, EY, PwC and KPMG and their expertise makes them the most attractive service providers for the world’s biggest companies.

“The scale and complexity of our audit would make it extremely challenging for any audit firm that is not part of one of the large global audit networks to acquire sufficient expertise and reputation to be appointed as sole auditor,” David Bucknall, group controller at BP, told the CMA.

“The Big 4 will survive, no matter what changes,” according to Matthew Dwyer, partner at Cain Dwyer, who has been recruiting tax specialists for almost a decade.

Post Enron, Arthur Andersen was broken up and umpteen service lines have been created since then and the pie is getting bigger and bigger, particularly for Deloitte and PwC,” Dwyer told TP Week.

Although the head of TP believes contract rotation will improve things, he said that tax matters are likely to “end up being handled by the same type of people, doing things in the same type of way with a different logo”, adding that it is likely that the CMA’s recommendations and those being suggested by the Labour party will not be “enough to properly challenge the monopoly of the biggest firms”.

Shell is also among the companies that believes the CMA’s possible recommendation of a share cap will fail to provide a competitive audit market because most large multinationals have an internal policy on external auditors.

“Many companies, Shell included, apply a policy where the external audit firm is prohibited from providing any services that are not related to the audit,” Anne Riley, group antitrust counsel at Royal Dutch Shell, told the CMA. “This is an important policy that is intended to ensure that appropriate auditor independence will be maintained.”

Nevertheless, one board member at an accounting firm told TP Week that competition is still intense. There are even signs mid-tier firms are breaking through, for example, Goldman Sachs is reportedly considering going to BDO or Mazars for audits.

“I don’t think there’s enough choice, but there is really cut-throat competition in the audit market,” the board member said. “The firms are competing hard against one another, not just for the FTSE 50 clients or even the top 100, but for the FTSE 350 contracts as well.”

“The competition in the UK is not being driven by price differences,” the board member said. “Unlike in the rest of Europe, we compete on quality not by price.”

Not a normal market

Competition is not the only concern driving calls to reform the audit market though.

Prem Sikka, who chaired the independent investigation into the audit market, wants to see wholesale reform of the entire industry. This is a step beyond measures like auditor rotation and restrictions on tendering.

“The real problem is that the audit market is not a normal market,” Sikka said. “The state guarantees the market, and the accounting firms often help design the very standards they are being held to.”

“Auditors should be focused on auditing alone,” added Sikka. “There should be a consultancy role or tax advisory role. The auditing service should be completely ring-fenced from everything else. I’d like to see separate legal structures.”

The CMA’s investigation and wider debate on accounting reform is still open. In the meantime, firms will have to prepare for all possible outcomes while regulators decide the future of the industry and businesses deal with the fallout.

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