A spineless and captured watchdog has fallen short, writes Atul Shah
We have known since the 2008 financial crash that there are serious problems with British accounting and auditing. The recent failures of Carillion, BHS and Patisserie Valerie have only added fuel to the fire. We face a serious breakdown in the architecture of financial regulation, where proper accountability plays a central role in corporate governance.
The heart of the problem rests with the Big Four accounting firms — KPMG, Deloitte, EY and PwC — and their near total dominance of the auditing of FTSE 350 companies. In my view, research by Prem Sikka, professor of accounting at Sheffield university, and others shows that they are neither professional nor independent and, instead of policing corporate conduct, they have been doing exactly the opposite and have made it easier for multinational corporations to rip off governments, taxpayers, the environment and society.
I had high hopes for the Competition and Markets Authority review of the sector, which announced its conclusions this week. The technical nature of accounting and auditing has made it hard for ordinary people to question the expert language and calculations — and smart suits, talented graduates and exclusive offices — of the Big Four.
But the recommendations have shown the CMA is spineless and captured. The watchdog recommends requiring large companies to hire two auditors, including one firm that is not in the Big Four; seeks to strengthen the role of audit committees; and sets up greater oversight of the audit process. It also recommends that firms be split operationally between audit and consulting to reduce conflicts of interest.
But it avoids tackling directly the monopoly power of the Big Four and the urgent need to break them up to preserve competition and independence.
I am sceptical as to how joint audits will improve audit quality, given the fundamental failure of the profession to reform the way audits are conducted. Today’s accounting standards and policies have been significantly influenced by the Big Four firms, so audits are based on weak, compromised and inconsistent rules that make failure “normal”. If we are not careful, joint audits can lead to a division of blame and responsibility, making it harder to hold firms accountable in the case of audit failure.
As for the operational split that the CMA recommends, we have already lived through the costly experience of the failure of such “Chinese walls” in banking. Why should we still believe they can and will work here?
The heart of the audit problem is that the Big Four have highly commercial cultures, which will not be transformed if they continue to operate as one firm. As an example, if audit partners continue to profit from their consultancy arms, can their judgment and reporting be truly independent and robust when both sides are selling services to the same large companies? Furthermore, how can society rely on their timely and trenchant challenge of excessive risk-taking by those corporations?
The other major contributor to audit failure is the UK’s system of corporate governance. My research into the 2008 collapse of HBOS, the largest corporate failure in British history, shows that the bank’s board and audit committee failed to adequately question the business strategy and risk-taking or to police the quality and conduct of audits.
Most non-executive directors rarely challenge the executives they ostensibly oversee. Instead, they have become habituated to rely on auditors to provide them comfort, and the auditors have in turn relied on management.
Everyone has been far too comfortable for far too long, and this CMA review does not change that in the slightest. Since the financial crisis, the UK has quite rightly revamped its system of regulating banking, but powerful corporate interests continue to capture the regulation and governance of accounting.
Sadly, once again, society has been utterly failed.
The writer, a professor at City University, is author of ‘The Politics of Financial Risk, Audit and Regulation: A Case Study of HBOS’.
The CMA’s plans could weaken audit and do severe damage to UK companies, writes Gerry Grimstone
When companies consider whether to invest in Britain, they value our expertise, and the highly developed ecosystem of legal, regulatory and audit services that makes the UK the obvious global choice for transactions.
Since the Brexit vote, that case has weakened, with looming questions over trading relationships and regulation that had been taken as read. So it comes as a surprise that a regulator would cause major disruption to one of those world-leading sectors, which could further diminish the country.
Moves to separate audit from non-audit business within firms will hamper their ability to carry out highly complex and specialised services: the very reason that they are world-renowned for their skill and expertise.
Quite simply, joint audits and the potential for further separation of audit practices risk increasing the cost and complexity of doing business in Britain and are out of sync with other major economies, particularly the US, which is our major competitor as a financial centre.
In the wake of corporate failures such as Carillion and BHS, it is right to ask questions of audit along with a whole range of other business management issues, but the wrong solution will make things worse not better.
Trust in the role of the audit profession has been damaged and change is required. So the encouragement of choice, quality and a robust audit market should be the absolute priority of all of us. But that’s precisely where the CMA’s proposals fall short. They would reduce, not increase, choice and the quality of audit because they would be carried out by fewer, less expert practitioners. It is hard to see how that would increase quality.
Auditing highly complex companies is an incredibly sophisticated task. Their multi-faceted needs require expertise across a range of disciplines and investment in those skills. The Big Four firms, including Deloitte, where I am a non-executive director, are able to build up that capacity in part through their substantial consulting work.
The move to force joint audits is intended to bring new entrants into the market and to allow smaller players to carry out more work. The intention is good, but is hard to see how doubling auditor involvement does not lead to a vast increase in bureaucracy, cost and time. This will not be welcomed by any business.
The proposals would also force smaller firms to share the joint liability, something that seems an unfair burden and risk. The CMA itself acknowledges enforced joint audit would not be appropriate for the “largest and most complex” businesses given the relative lack of expertise and experience.
Introducing these measures in the UK would put us out of step with other markets and make us a less favourable environment. Providing more onerous and potentially less effective audit services in the UK will reduce our pulling power for businesses and companies that would once have plumped for Britain.
There are better ways to increase quality and choice. We should draw on lessons that have been learned in other places.
Capping market share would limit any one firm’s ability to dominate, and it is a good idea to ban firms from providing non-audit services to the FTSE 350 and large public interest entities they audit.
We also need a stronger, fully accountable governance structure for audit practices, and many firms have taken steps on this front to ensure a robust approach.
Finally, the UK should consider introducing a corporate accountability regime like the one set up by the Sarbanes-Oxley Act in the US and apply it to the largest listed UK companies. This would make it easier to hold management responsible in the wake of corporate failure.
This more measured and thoughtful approach is much better than what the CMA is proposing. With it we would stand the best chance of remaining a global business success story. Large multinationals are not sentimental. Britain must remain the obvious choice for professional services that provide certainty, skill and efficiency, or prepare for a bleak future.
The writer is a former chairman of Standard Life Aberdeen and Barclays bank and serves as a non-executive director at Deloitte