It’s nearly four years since Carillion's collapse in the United Kingdom triggered the latest wave -– “Where were the auditors?” While that question is pursued in the Official Receiver's £ 1 billion lawsuit launched against KPMG on November 19, what passes for broader discussion on the Big Audit model has come down to this:
Proposals for “managed shared audits” -- by which the smaller audit firms would perform a material portion of the audits of the FTSE 350 public companies –- have failed to achieve any traction. Is there an alternative?
Still floated with varying degrees of enthusiasm is the idea of a “market cap” –- enforced reduction of the Big Four’s currently dominant share of the large audits -– cited by, among others, the financial press (here and here), the ICAEW, and the chief executive of the UK’s audit regulator, the Financial Reporting Council.
To be taken seriously?
Nope. A rude reality check would await an FRC ukase to forcibly reduce Big Four market share. However wishful or earnest the attempt, there is no other source.
For the multiple reasons why managed shared audits so lack favor, the same limitations exist no less for the unfortunately-described “challengers” –- BDO, Grant Thornton, Mazars, and the other smaller firms in rapidly-descending size –- and the even greater complexities of their taking on full audit performance and responsibility.
My practice in confronting such a conundrum is to consult my academic colleague, Professor A Fortiori.
He begins with the context: Under the indifference of the Boris Johnson government, and the functional absence of the secretary for business, energy and industrial strategy, Kwasi Kwarteng, the prospects for substantial change of any kind are minimal. Not least, the likelihood of Parliamentary attention, much less actual legislation, necessary to replace the shambolic history of the FRC with the mooted new ARGA, ranks somewhere below the chances that the British will return to Greece the Parthenon marbles looted by Lord Elgin two centuries ago.
Nor is there any real wrangling over changes in the audit model, attention having long dissipated to the post-Carillion trio of official reports and the admirable work of Sir Donald Brydon.[1] Rather than active engagement among the parties, the faint glow of the public discourse has not generated heat enough to brew a tempest in a teapot.
The estimable A Fortiori commends these points:
“Audit quality” being ostensibly the ultimate goal, commentators (as referenced above) point to the spate of recent company failures and regulatory investigations and sanctions against the auditors both small and large, needless to repeat here. With that list, the position of the head of audit at one of the “challengers” -– that “audit firm size isn’t necessarily correlated to quality” –- should bear the qualifier, “one way or the other.”
The same holds for FRC audit inspections -– summarized by the Financial Times to “not help the challengers’ case” –- although caution in extracting conclusions from the numbers is always appropriate, when a compliance-enforcement agency can design and apply its own procedures and then grades the results of its own work.
More importantly, the inhibitions on the “challengers” actually to assume the up-scaled responsibilities of managed shared audits have not been answered. As sketched out here last April 21, those include: the difficulty for a reporting company to identify operations or subsidiaries to be audited within the capabilities of the smaller firm; the burden on a lead auditor of full responsibility for the work of a “challenger,” with the prospect of expensive duplication or re-performance of work; the geographic constraints on the smaller firms of the globalized operations of the large UK-based companies; and the auditors’ cross-border litigation exposure for companies whose securities trade in multiple jurisdictions, notably the lawsuit-friendly United States.
The glancing mention of market share caps has yet to address the yawning resources gaps of the “challengers” -- industry and technical expertise, geographic presence, experienced partners and managers at the line level, investment funding, financial and risk-oriented resources, that such explosive growth would require.
Further, those invoking the possibility of steps to cap the market share of the Big Four have yet to grasp the enormity of the numbers -– not to say, the practical impossibility of the task.
As outlined here on August 23, audit clients of the “challengers” presently comprise a mere 1.6% of the FTSE 350's total market capitalization of £ 2.219 trillion –- a figure undisturbed by the rapid rise of Grant Thornton client Darktrace from its April IPO through its prompt entry to the FTSE 250 and further October index bump-up. The available numbers indicate that the capacity building obligation of the smaller firms to take on a mooted 20% of FTSE 350 audit work, over ten years, would require them to add clients with capitalization of £ 41 billion, each year if evenly spread, or if done gradually, at an unrealistic annual growth rate of some 29%.
With all that, a Big Four market share reduction is even less practical or achievable than managed shared audits –- so says the wry A Fortiori.
Although he also notes that continued inattention to the compelling facts on the market structure of Big Audit is likely, as the observably dreary environment in the UK makes it predictable that the entire topic will continue to be kicked even further into the tall grass.
Where it will lie, ignored and unattended, until the inevitable “next time.”
[1] Sir John Kingman’s Independent Review of the Financial Reporting Council (December 18, 2018).
The BEIS select committee report, ”The Future of Audit” (April 2, 2019).
The Final Report of the Competition & Markets Authority on its Statutory Audit Market Study (April 18, 2019).
Sir Donald Brydon’s Independent Review into the Quality and Effectiveness of Audit (December 2019).
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