EC looks to break the audit 'oligopoly'

The European Commission has just announced a series of wide-reaching measures that are set to shake-up the audit market in Ireland. Unsurprisingly, it is being met with some resistance

IT’S A CLOSE relationship – some would say “cosy” – that for most companies, typically stretches back many years. The Kerry Group for example, has been audited by Deloitte for more than 20 years, while AIB depended on PwC or its earlier incarnation, Coopers Lybrand, for decades until KPMG replaced it following the Rusnak affair in 2002.

Now however, a series of wide-reaching measures from the European Commission is set to shake-up the audit market in Ireland, challenging the dominance of the Big 4 and forcing companies to switch auditor on a regular basis. Unsurprisingly, it is being met with some resistance.

The Commission’s desire to reform the audit market stems from a number of high- profile audit failures both at home and abroad, as well as the “oligopoly” operated by the Big 4 which, it says, is reducing choice for companies. So it is looking to deal with these issues by imposing mandatory rotation of auditors on companies every six years, or nine years if two auditors are used. The proposals will apply to publically listed companies, as well as companies that are in the public interest.

According to the Commission, such an approach will “will increase transparency and openness in the award of audit mandates”, while it will also “give mid-tier firms more opportunities to bid for audit mandates at the top end of the market”.

The proposals are currently being debated in the European Parliament (EP) and by the Council of Ministers (Council), with a view to adopting legislation in 2013. But will these proposals, which are deemed to be “quite far-reaching and radical” by Aidan Lambe, director of technical policy with the Chartered Accountants Ireland (CAI) actually come to fruition?

“No doubt there will be change, but quite what that will be remains to be seen,” says Lambe. Indeed, the issue of mandatory rotation, which could see Big 4 firms lose lucrative audit contracts after just six years, is dividing opinion. This is borne out by a consultation of the CAI with its members, which indicated that larger audit firms did not support it, while mid-tier firms are supportive of switching auditors.

On the opposing bench are those who argue that switching auditors could lead to a decline in standards.

“There is a lot of concern that some of the Commission’s proposals, such as mandatory rotation, wouldn’t improve audit quality and could actually damage audit quality,” says Kevin Egan, head of the audit practice at PwC, adding that this could be particularly true of larger, more complex public companies.

“There is a concern that mandatory rotation in that environment risks disregarding years of accumulated knowledge about those entities,” he argues, suggesting that current measures aimed at dealing with “familiarity risk”, such as rotating senior members of audit teams – but keeping the business within the practice – are adequate.

The Commission however, finds this approach “insufficient”. It argues that the main focus still remains client retention and it would be unlikely that a new partner would criticise the work of the previous audit partner.

Joe Carr, managing partner of Mazars, a mid-tier firm, is in favour of the proposals, but argues that they don’t go far enough.

“The market is not wide enough and not open enough,” he says, adding, “the reality is that the market is operated in effect with four firms. If anything were to happen those, then they would be ‘too big to fail’ which poses a systemic risk.”

There is no doubting the dominance of the Big 4 when it comes to auditing larger companies. Amongst EU member states for example, their market share exceeds 85 per cent, while in the UK, the top four accountancy firms audit 99 per cent of FTSE 100 companies. But that raises the question: if larger companies so obviously favour the Big 4, will they still not favour them even if mandatory rotation is introduced?

For Carr, its “familarity” that keeps listed companies with the Big 4.

“My sense is that the market needs some sort of legislation to nudge companies. On its own it will stay the way it is,” he says, adding that it would have been preferable if the Commission went ahead with proposals to introduce a joint audit.

A joint audit would see two firms appointed to an audit of a larger firm, and, drawing on the example of France where it is standard, Carr says it would reduce the dominance of Big 4.

Egan suggests differently however.

“We wouldn’t see any obvious benefits to joint audits. There is a risk that you’d end up imposing more costs on business with no apparent benefit,” he says.

In any case, intense lobbying from UK representatives succeeded in getting this dropped. Lobbyists there are now calling for mandatory tendering as an alternative to rotation, whereby companies must invite at least one non-Big 4 firm to tender. For Carr however, this would just mean that the audit would “rotate around the Big 4”.

The Commission seems unlikely to row back on mandatory rotation however, as it says this is the sine qua non of its reforms. Without it, it says that the other measures would not “be sufficient to reinforce independence and professional scepticism”.

And while professional services firms may be on the fence, the companies that use their services are also undecided. A recent Grant Thornton survey, for example, showed that more than half of businesses surveyed across the EU support mandatory rotation, in order to address the risks of “over-familiarity”.

When it comes to the larger firms, however, there is a clear opposition. In the UK, the influential Hundred Group of Finance Directors has come out against the proposals, arguing that it would increase the cost of audit and risks reducing audit quality.

European political think tank Centrum für Europäische Politik (CEP) agrees. It recently found that a prohibition of consultancy services infringes “the right to entrepreneurial freedom” and argued that the rotation rules are “unnecessary”, as the danger of a conflict of interests can be also tackled by enhanced supervision.

The Commission also wants to restrict auditing firms from providing non-audit services to the companies that come under the remit of the new proposals.

In general, auditing firms accept that auditors’ independence and objectivity be preserved, but there is again a difference of opinion on this proposal, with mid-tier firms in favour, and larger firms opposed.

“The EU’s proposal for a complete ban on non-audit services and a restriction on audit related services is too prescriptive a requirement. Very often, the audit firm will be the most efficient provider of appropriate non-audit services because of knowledge of the entity’s business gained through the audit process or if the need for such services is urgent,” says Egan.

But whether the proposals as suggested by the Commission come to fruition or not, there is a sense that change is in the air.

“In practice we have not succeeded in winning a listed company, but I think something has changed. We are now being asked by the larger companies to tender for the first time. It’s a sign that companies understand that biggest doesnt necessarily mean best. There’s an openness to have a look which wasn’t there before,” says Carr.

THE EUROPEAN COMISSION PROPOSALS: WHAT’S IN AND WHAT’S OUT

Whats in:

* Mandatory audit rotation every six years

* Big 4-only contractual clauses abolished

* Prohibition of providing other services to audit clients

* Separation of audit activities into pure audit firms

* National audit supervisory authorities to be strengthened

* European passport for the audit profession

Whats out:

* Mandatory joint audits