Singapore will do well to keep close eye on UK audit industry shakeup

BRITAIN'S parliament will launch an inquiry into the nation's scandal-hit auditing industry in the new year - a move that could result in sweeping changes to the way audits are carried out and the firms (namely, the Big Four) that predominantly perform them.

While changes to the auditing industry in the United Kingdom might not have an immediate impact on public accounting firms in Singapore - as these tend to operate as independent entities in their various jurisdictions, albeit as part of a larger network of firms - they are likely to have a knock-on effect here. As the changes in the UK are likely to be extensive, the industry and corporate arena here ought to take heed.

Britain's parliamentary inquiry comes after a series of high-profile corporate failures there - such as the collapse of construction group Carillion and retailer BHS - revealed serious inadequacies in the auditing process.

The UK launched two separate reviews: the Competition and Markets Authority (CMA) is looking into what can be done to improve the audit sector, while the government is looking at how the sector's regulator, the Financial Reporting Council (FRC), can be strengthened.

Rachel Reeves, chair of the UK parliament's business select committee, was quoted last week as saying that the British parliament will launch an inquiry in January to ensure that these two reviews would not be simply left to gather dust.

"Our committee's inquiry seeks to ensure these reviews are acted upon swiftly and effectively and that they genuinely deliver the improvements to audit quality and corporate governance," Ms Reeves was quoted by Reuters to have said.

"The audit market is broken. The Big Four's overwhelming market domination has failed to deliver audits which are fit for purpose."

Lawmakers are set to hold hearings in January to hear from representatives of the Big Four accounting firms and their detractors, as well as from other parties such as the finance chiefs of big listed companies, the CMA, the FRC, and professional body ICAEW, short for Institute of Chartered Accountants in England and Wales.

What's at stake? The continued existence of the multiple-disciplinary approach taken by the Big Four (they offer a host of non-audit services, such as consultancy services, in addition to audit work), as well as their oligopolistic hold on the auditing market.

KPMG is under scrutiny for its role in Carillion's collapse; the firm earned some £1.5 million (S$2.65 million) annually as the company's auditor, with reportedly millions of pounds more earned from non-audit work. PwC, meanwhile, has been accused of failing to conduct sufficient oversight of BHS's accounts at a time when it was reportedly earning significant sums from non-audit work, and was fined a record £6.5 million over its audit failings.

In the UK, Deloitte, PwC, Ernst & Young and KPMG audit 98 per cent of the largest listed companies. Grant Thornton, the UK's fifth largest accountancy firm, announced this year that it would stop bidding for audit work because it could not compete with the Big Four.

Should the CMA find that there are competition issues, it could force firms to separate their audit offerings from their non-audit ones. Ms Reeves has also urged the CMA to end "the stranglehold" of the Big Four.

In a sign that it expects such sweeping changes to the industry, KPMG's UK chairman Bill Michael this month circulated a briefing note - a copy of which was seen by Sky News - which said the firm would phase out all but essential non-audit services for the 90 FTSE-350 companies that it serves as the auditor. Mr Michael said this would "remove even the perception of a possible conflict".

Some observers have said they hope the rest of the Big Four will follow suit, while others want such a division of services to be mandated by a regulatory body rather than left to the whims of individual firms.

But would separating audit offerings from non-audit ones (or banning auditors from offering non-audit services) cure the perceived shortcomings of the audit industry? And would spreading the Big Four's clientele across a greater range of audit firms or limiting the number of large companies they can audit lead to better audit quality?

Proponents of multi-disciplinary firms argue that such firms offer their clients a better value proposition, thanks to the cost savings and economies of scale they can pass on from having in-house expertise; opponents question if such firms necessarily offer a better audit.

As for breaking the "stranglehold" of the Big Four, observers have pointed out that - in the UK, at least - there is competition among firms of varying sizes for audit work; the problem is choice. The big companies tend to want to engage the Big Four because the firms' depth, expertise, scale and geographical reach make them better equipped at handling the complexities of auditing the world's largest corporations.

Some have also suggested that an independent body be set up to select the auditor for companies, as opposed to the current practice of leaving it to the discretion of the company's audit committee. This process may allow auditors to feel more comfortable in challenging companies over their accounts. But would such a move diminish the very competition that the CMA is hoping to cultivate and would it necessarily restore the market's faith in the integrity and value of an audit?

It's probably fair to say that, at this juncture, the only thing that's clear is that these issues require further investigation and deliberation - something the UK has acknowledged with its respective reviews and inquiry.

The rest of the world would do well to pay attention to these proceedings - not just for an indication of how they may be impacted, but also for a better understanding of the audit challenges and failings in their own market and how these can be surmounted.

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