The Financial Reporting Council – regulator of accounting and auditing standards and practices in the United Kingdom – on September 28 slipped this subtle sentence into section C.3.7 of its Governance Code:
“FTSE 350 companies should put the external audit contract out to tender at least every ten years.”
Called “limited changes” by the FRC, this stealth provision has been little remarked at home and virtually ignored in the United States. But the impact and effects – once the dust settles – will be profound, if difficult to predict.
Consider first the global market for audit services. The largest 100 and second 250 British companies span the globe in their size and reach – from the agency giant WPP to BP in the energy sector to consumer leaders Diageo, SABMiller and Unilever to global bankers HSBC and Lloyds – with dominant business operations, dual stock listings and deep capital market participation across the world’s developed economies.
Audits of their financial statements are, with a handful of exceptions, the exclusive province of the Big 4 firms – 99 of the largest 100 and 234 of the next 250, when last surveyed (here and here). For reasons of cost and efficiency in any process of re-tender, the CFO’s and audit committees of those companies will invariably seek either the retention of the incumbent auditor, or the ability to transfer to another single provider. So choices made in London will be reflected in the structure of the audit market across the globe.
But, given the spotty and unequal world-wide distribution of audit competence and technical expertise, it is predictable that any auditor shifts resulting from the FRC’s dictate will, if anything, further tighten concentration at the top of the market.
Will any real changes actually emerge? The debate on mandatory rotation has been conducted in a vacuum of either evidence or intelligence on these two fundamental questions:
1. Why is there a total absence of facts even suggesting a causal connection between audit quality and the length of auditor tenure?
2. And, are choices for auditor replacement truly constrained by either disabling scope-of-practice conflicts or the firms’ unwillingness to surrender the value of such other services as tax, banking and consulting?
Two competing assessments are offered. One would be reluctance to tender – with the audit firms unwilling to invest the considerable time and expense to build sufficient size, expertise and geographic presence to pursue the uncertain process, especially when obliged to forego the certain revenue streams now generated by their non-audit work for these global giants.
In that case, the non-incumbents will take a pass; the result of re-tendering will only be the rationalized re-engagement of incumbents – a public relations exercise in “comply or explain” that may buy a decade or two of rhetorical peace but little else.
A second scenario rests on the hypothesis that large global companies now concentrate their non-audit services mainly in a single alternate Big Four provider. That firm might be a rotation candidate, assuming a “shadow cabinet” of existing skills enabling it to switch over to the audit with minimal disruption – and likely resumption of the non-audit status quo ante when it yields back the audit brief a decade hence.
A skeptic would be entitled to question whether professional skills are so fungible and transferable, much less available; or that the large firms’ current client relationships organize into such neat duopolies; or that, indeed, such a “pass-the-parcel” exercise is quite what the proponents of mandated rotation have in mind.
It is sure that London is already a-flutter. Fund manager Schroders has announced a re-tender after forty years of audits by PwC, for one example – despite no indication of either dissatisfaction or impaired quality.
About the only certainty is that the UK initiative will finesse both the already speed-bumped path to rotation urged by EU markets commissioner Michel Barnier and, in the US, PCAOB chairman Jim Doty’s extended series of hearings -- the latest, set for Houston on October 18th which shows Doty’s willingness to pursue out-of-town try-outs in the futile search for an adult witness with a fact-based case in his favor.
Put another way, the FRC has now kicked down the road of mandatory rotation a can that bears the label, “Made in the UK -- for world-wide consumption.”
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