The Big Four accounting firms may have to split their operations into separate U.K. business units as part of a sweeping overhaul of the industry proposed by regulators that stopped short of the measures sought by some critics.
The Competition and Markets Authority said audit work should be split from the much larger consulting business at an operational level, but held off on recommending a full structural breakup or a cap on auditor’s market share. A further report said the U.K. needed a tough new watchdog to prevent the failings of the past.
The reports "represent a meaningful effort to address long-standing weaknesses in the audit market by addressing insidious conflicts of interest," said Natasha Landell-Mills, head of corporate governance at asset manager Sarasin & Partners. "There is now an urgent need to make clear what exactly the audit is for."
Stung by a string of scandals at prominent British firms including Carillion Plc, the government demanded regulators set out reforms to roll back the dominance of the largest accounting firms. The industry has had a turbulent year, with record fines and reprimands in the U.K.
“These intractable problems may take some years to sort out," CMA Chairman Andrew Tyrie said in a statement. "If it turns out that the proposals are not far-reaching enough, the CMA will persist until the problems are addressed."
Separately the U.K. government said it agreed with a new report that the country’s heavily criticized Financial Reporting Council should be abolished and replaced with a new accounting regulator. The new watchdog, the Audit, Reporting and Governance Authority, would have powers to investigate companies, their accounts and governance.
The FRC was accused of being to be too close to the firms it oversaw, especially Deloitte, KPMG, EY and PricewaterhouseCoopers. "I have sympathy with the view that the FRC has tended overall to take too consensual an approach to its work," said John Kingman, who led a review of the regulator.
KPMG said the reports contained “constructive suggestions,” while David Sproul, chief executive of Deloitte’s U.K. business, acknowledged that many had lost faith in auditors.
"It’s clear that trust and confidence in the role of the profession is not where it should be and we are supportive of change that enhances audit quality," he said.
PwC and EY also issued statements pledging support for measures that boost public trust in the audit sector.
The operational split envisaged by the CMA would allow for separate profit pools within the firms -- ensuring that auditors are only paid for the audit work they do. Under the current structures, profits are drawn from the entire firm.
The Big Four avoided a full breakup of accounting and consulting into separate companies, as the CMA said such proposals would be "protracted and complex" because of the reach of the firms’ large international networks. The regulator said “drastic but harder-to-implement remedies” would need to be revisited.
Industry groups largely praised both reports.
“The CMA has recognized the benefits of an integrated audit model and is right to ignore misplaced calls for a break-up of the major firms,” said Matthew Fell, chief U.K. policy director for the Confederation of British Industry. “At the heart of this reset must be a focus on tackling the expectation gap that is undermining trust in corporate reporting.”
To encourage more competition, the CMA said it currently preferred to have the largest companies require joint reviews -- with two audit firms signing off on the accounts -- rather than a market share cap on the auditors.
It’s not the first time that antitrust regulators have looked at the market power of big audit firms. Just four years ago, authorities ruled that U.K. corporations must re-tender audits every 10 years. The EU has also threatened to split off auditors’ consulting arms in recent years, before adopting watered-down proposals.
The CMA said it would accept comments on the proposals until Jan. 21.
Under Kingman’s proposals, likely to be adopted by the government, accountants would move away from self-regulation. So much so, that the new watchdog should be empowered to look for "warning signs" at U.K. companies, he said.
"This is and should think of itself as a regulator," said Kingman, who is chairman of Legal & General Group Plc, the U.K.’s largest manager of pension assets. The FRC was "a hangover from a different world that needs to be fixed."
