There is only weak competition in this sector as all UK based international companies need to be audited by international firms, of which there are only four: Deloittes, EY, KPMG and PWC. Their collective share of FTSE 350 auditing had reached 98% by 2018.
The remaining 2% was presumably represented by UK-based Grant Thornton who found that they were winning so few audits that it wasn't worth spending lots of time and money on the bids. So they stopped bidding for audit contracts from the UK's largest listed companies in 2018.
(Grant Thornton's charismatic chief executive, Sacha Romanovitch, was sacked by her fellow partners later that year. Ms Rabinovitch believed in 'profits with a purpose' where the purpose was to work with clients who behaved responsibly; to share profits with all staff, not just partners; and to promote changes which would make company audits fit for purpose. But some of her colleagues accused her of having "a socialist agenda" and pursuing a "higher social purpose" rather than profitability. External commentators were not impressed. Matthew Vincent commented that "the overgrown schoolboys who bullied her out of the firm ... have removed a much needed advocate of audit reform.")
(There was an interesting development in late 2018 when two even smaller firms - BDO and Moore Stephens - announced that they intended to merge. The combined entity would then be larger than Grant Thornton.)
This market concentration might not be too bad on its own, but all the firms also sold very lucrative consultancy advice to their audit clients, and it looked very much as though they then gave over-favourable audit opinions so as to avoid upsetting those lucrative clients. Whether or not this was really happening, their were some serious scandals - mentioned below. So KPMG announced in November 2018 that it would no longer offer consultancy to audit clients.
The firms' partners do pretty well as a result of this market structure. Deloitte's 700 partners were paid an average of £830,000 in 2017.
A Weak Regulator?
There were also persistent complaints that the Financial Reporting Council (FRC) did not have the power, or is anyway very reluctant, to take effective enforcement action against misbehaving larger firms.
In the case of HBOS, for instance:
The FRC had to be forced by the Treasury Select Committee of the House of Commons to mount an inquiry into auditor KPMG's role in the 2008 collapse of HBOS which had failed only eight months after being given a clean bill of health by KPMG.
Paul George, an FRC executive director and former KPMG partner, was said to have driven through a rule change which added the word 'significantly' to the rule that requires firms to 'fall significantly short of standards' before being censured, fined or banned. The rule change allowed the FRC to announce in September 2017 that KPMG had escaped censure despite the fact that KPMG had given HBOS a clean bill of health is large part because a number of stock market
analystspundits had 'buy' ratings on the bank, oblivious of the fact that the pundits believed the numbers that the auditors were signing off.
The FRC's November 2017 report is here.
KPMG then noted that the inquiry had "highlighted a gap between what society expects of an audit and what an audit has been designed to do".
(This is a fair point. Audits are basically designed to assure shareholders that a company is financially sound. Auditors do not accept any responsibility or accountability to customers, suppliers or wider society.)
Despite claiming that its powers were insufficient, the FRC announced, in November 2017, that it intended that 'seriously poor' audit work by the Big Four accountancy firms would in future result in much larger fines - maybe over £10m.
There were subsequent strong complaints that auditors had failed to identify problems in advance of the collapse of Carillion and BHS. The FRC censured KPMG (Carillion's auditors) for 'unacceptable deterioration'' in its audit work. And it fined PWC £6.5 million and banned one of its partners from the profession for 15 years for atrocious work carried out on BHS before its sale by Sir Philip Green.
And then ...
There were then three almost simultaneous developments around September 2018:
- The government asked Andrew Tyrie, head of the Competition and Markets Authority to swiftly examine competition in the audit industry. The CMA decided to mount a Market Study which might in due course trigger a Market Investigation, thus in turn releasing the CMA's pretty enormous powers. Click here to read the CMA's letter announcing the Market Study and detailing the questions that it would ask.
- Separately, HMG asked John Kingman, a former Treasury official and chairman of Legal & General, to consider ways to remove conflicts of interest, including whether the auditors of large listed companies should be appointed by a public body. Business Secretary Greg Clark said he wanted to consider the conclusion of both inquiries in tandem and has indicated he would act on the recommendations and was ready to legislate if required. The FT noted that taking the choice of auditors out of companies’ hands would be a radical step, but it would theoretically address two significant concerns about the audit market. First, auditors are arguably too beholden to company managers because they want to hold on to their fees at all costs. Second, company boards seem biased towards selecting the Big Four firms, helping to entrench their already dominant position in the market.
- And the FRC said it would assess whether new action was needed to prevent the independence of auditors being compromised, including whether all consulting work for bodies they audit should be banned. This would go further than existing EU rules which restrict consulting fees to 70% of audit fees. (As noted above, KPMG two months later unilaterally announced that it would no longer undertake consultancy work for its audit clients.)