Key Points
- The dominance of the ‘big four’ accountancy firms is under threat on two fronts, with reviews of the market being undertaken by both the Competition Commission and European Commission.
- The key questions are: when will any reforms be likely to come into effect and do they make sense?
Upheaval in the accounting profession seems likely following the Office of Fair Trading’s referral of the statutory audit market to the Competition Commission for investigation. The investigation, which will focus in particular on the dominance of the ‘big four’ accountancy firms, PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young, followed hot on the heels of the leaking of the European Commission’s draft audit reform paper. The European Commission paper proposes, among other things, to prevent auditors from performing other types of non-audit work, such as consultancy, for their audit clients.
There is a query as to the sense in conducting parallel reviews of essentially the same market. However, the OFT’s view is that the referral to the Competition Commission is worthwhile, notwithstanding the leaking of the draft European Commission paper, on the grounds that the “nature, content and timing” of the European Commission proposals were up in the air. As well as somewhat different priorities, the Competition Commission’s investigation will relate only to the UK market, whereas the remit of the European Commission review is EU-wide and its proposals will, if enacted, have EU-wide effect.
Timetable
The Competition Commission has a maximum of two years from the date of the OFT referral to undertake its analysis and, if appropriate, to decide what actions to take. Given the number of stakeholders and the vested interests of the ‘big four’ firms, which are likely to lobby strongly, as well as other contributors to the debate, such as the various professional bodies and the Financial Reporting Council, it seems unlikely that the Competition Commission will be able reach an early determination.
The timing of the coming into effect of the EU level reforms is even less certain, given the potential fluidity of the EU legislative process and the possibility of setbacks. It is not inconceivable that it will take three to five years before the proposed EU reforms (once they have taken shape) are in force in all members states.
Scope
The task of the European Commission and, to a lesser extent, the Competition Commission is made more difficult by the perception that only truly global firms are capable of performing work for multinationals, since the advice required by these companies often requires the advisor to have an integrated base in several countries.
Whilst it may be unfair to describe auditing as a loss leader, the big four firms have in many cases treated their auditing practices as a feeder for more lucrative non-audit services. Audit work can help the firm showcase trophy clients, but is not the key profit driver. The indirect effect of this model is that smaller firms find it more difficult to compete for audit work, since the big four pricing model creates a significant barrier to entry for audit-led firms. It is not however the only barrier, as the smaller firms would need to make a substantial investment in an international network to create the global presence that multinational clients have become accustomed to.
Reform
One of the key suggestions made in the European Commission paper is that an accountancy firm which undertakes audit work should not also be able to undertake non-audit work for the same client. This would remove the relationship advantage a firm undertaking audit work for a client currently has when it comes to competing for non-audit work. Such a restriction is not without its downsides. One obvious issue is the disincentive for accountancy firms to take on audit work, as doing so would prevent the firm from carrying out lucrative non-audit work for the same client. Similarly, a firm which takes on audit work for a client, reduces the pool of accountants who are able to provide non-audit advice, which may have the effect of reducing rather than increasing choice. In the case of multinationals, this may mean, in the short term at least, a choice between three rather than four firms competing for non-audit work.
An alternative could be for the EU to force the big four to ring-fence or divest themselves of their audit functions. There are a number of options as to how this might be implemented, but the purpose would be to ensure the non-audit side of practises are viable in their own right, raising prices to a level sufficient to encourage new entrants. A full legal separation of a firm’s audit function would be more drastic, but could achieve the same effect with fewer risks of leakage or conflict between the audit and non-audit sides of the business.
The prospects for drastic change in the large company audit sector have never been higher, but it remains to be seen how adept the big four will be in maintaining their market-leading position in the face of concentrated government attention.
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