FRC responds to the Competition Commission proposals

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12 Aug, 2013

The Financial Reporting Council (FRC) has published its response to the Competition Commission’s (CC’s) ‘Summary of Provisional Decision on Remedies’ for the statutory Audit Market. The FRC supports the removal of original proposals for mandatory auditor rotation but has expressed concerns over proposals for 5 yearly audit tendering and those in relation to the role of the Audit Quality Review (AQR) Team.

The proposals are intended to address what the Competition Commission sees as lack of competition within the provision of statutory audit services in the UK and ensure that competition is directed towards satisfying the demands of shareholders.  The proposals are also intended to increase the influence of audit committees, something that the FRC has re-emphasised in publishing their guidelines for an efficient audit tender process

While the FRC “supports the objectives that the Competition Commission is seeking to achieve through the remedies it has proposed”, they have raised a number of concerns (link to FRC website) around the proposal for FTSE 350 companies to put their statutory audit engagements out to tender at least every five years highlighting that the tendering could become a “sham process” as it is not taken seriously by companies or by firms. 

The FRC note that there are a number of benefits to regular audit tendering, highlighting that, among other things, it will “guard against complacency on the part of the auditor”, “stimulate innovation and spread best practice” and will provide “audit firms which are seeking to expand the opportunity to win new work”.  The FRC also recognise that there are risks and costs associated with regular audit tenders such as time and resources spent on the tender and the inability to fully understand the business and risk of the company to be audited if tenders are too frequent. 

The FRC do not see that the benefits of retendering every five years will outweigh the costs and highlight that, for “non-Big Four firms” the 5 yearly proposals may actually impede their ability to enter the market for FTSE 350 audits due to the costs involved.  The proposals also remove comply or explain which is central to the UK Corporate Governance Code

Instead, the FRC favours a ten year retender period in line with their recent revisions to the UK Corporate Governance Code.  They would like the Competition Commission to give the ten year period “time to demonstrate its effectiveness”. 

They comment:

We are concerned that if the retendering period is reduced from ten years, a firm will not be confident of recovering the costs of tendering, introducing innovations and securing any necessary skills.  It may therefore be less willing to innovate or, if it has invested, seek a close relationship with the company to increase the chance of reappointment but, in the process, jeopardise its independence.

Concerns were also expressed over the proposals in relation to the role of the AQR team.  The Competition Commission proposed that

The Audit Quality Review team (AQR) should review every audit engagement in the FTSE 350 on average every five years; and

Those firms that audit ten or more public interest entities should be inspected and reported upon by the AQR on an annual basis

The FRC “supports the Competition Commission’s objective of enhancing the effectiveness of audit committee oversight of audits by increasing the availability of information on audit quality at the main firms auditing public interest entities”.  However they are concerned that the level of review proposed will require an increased budget for the investigations and also could “undermine” their risk-based approach to the selection of audits for inspection.  The Competition Commission would like the AQR list to be limited to the six largest firms - and not the nine that the proposed remedy would catch.  The FRC points out that “thematic reviews” could be carried out for the smallest firms which focus on particular aspects of the audit process rather than carrying out an annual AQR.

A number of other comments are made by the FRC on areas of the Competition Commission proposals. 

On the proposals to strengthen the accountability of the external audit the FRC are broadly supportive but are of the view that there areas of the proposal that “would undermine the independence of the auditor”. 

In response to the proposal for the FRC to “amend its articles of association to include a secondary objective to have due regard to competition”, the FRC highlight that they are not a competition regulator but “will continue to have regard for competition issues”

Aside from expressing concerns over a number of the proposals, the FRC does support the removal of mandatory auditor rotation, compulsory joint audit and a role for the FRC in the appointment of auditors which were included in original proposals of the Competition Commission.  The European Commission (EC), however, does not support the removal of mandatory auditor rotation insisting that it is "as essential step for ensuring the independence and professional scepticism of auditors". 

The views of the FRC are echoed by the Institute of Chartered Accountants in England and Wales (ICAEW); and other organisations such as the UK Shareholders Association have also criticised the Competition Commission proposals.  In their response to the Competition Commission proposals the ICAEW note that by requiring FTSE 350 companies to retender every five years it is "unlikely to enhance competition and will increase cost".  They also note that linking the audit tender proposal to the FRC's requirement for engagement partners to rotate every five years "ignores the point that those requirements are to achieve a completely different purpose, namely auditor independence".

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