Private equity and its impact on audit quality

With the growth of private equity (PE) investment in accountancy, the Institute of Chartered Accountants of Scotland (ICAS) has called for a multi-stakeholder review of the framework governing who can own audit firms. The Accountant hears from James Barbour, director of policy leadership at ICAS, to find out more

ICAS’s call for a multi-stakeholder review follows the publication of a paper by the ICAS Private Equity working group, which examines the impact rules governing audit firm ownership.

ICAS CEO Bruce Cartwright said: “The audit profession is evolving at an unprecedented rate, driven by developments in AI, increasing focus on sustainability and global economic uncertainty. In fact, we expect more change in the next five years than we’ve seen in the past 50.

“As the landscape shifts, it’s crucial that government, regulators and professional bodies keep the public interest at the heart of any decisions. Audit plays a vital role in how capital is allocated in our economy, and that responsibility must guide any changes to the current framework. 

“Our top priority is maintaining strong audit quality and auditor independence, regardless of where investment in audit firms comes from. That’s essential to ensure continued trust in financial reporting.”

ICAS has called for urgent action in these areas:

• Further review and study of the impact of private equity investment and other external capital providers in audit and other professional service firms, in the UK and abroad. A key focus of this would be recognising the risk that financial considerations can unduly influence behaviours;
• An open and balanced debate of the ownership requirements amongst key stakeholders, considering not only the role of private equity, but other models and approaches, including the scope for a more principles-based approach. The restrictions contained in the extant model are there to mitigate the threat that providers of capital will unduly look to influence behaviour. Therefore, any changes that are proposed will need to be assessed to ensure that they contain appropriate safeguards to mitigate this threat;
• Closer collaboration between auditor licensing bodies to make sure that the ownership requirements are being applied consistently, identifying and understanding the scope for audit firm structures that are compliant in form but not substance.

TA: How much PE investment is currently being made into audit firms?

JB: A recent report published by Accountancy Europe (Private Equity Investments in Accountancy Firms) indicates that while PE investment in accountancy has surged overall, audit-specific firms still receive a smaller share due to regulatory constraints.

The report suggests that around 40% of all PE transactions in European accountancy firms since 2015 involve firms that include audit and assurance services.

TA: How do you anticipate this to grow in the future?

JB: PE investment growth will depend on a range of factors, including economic conditions, perceived success of those already in this space, alternative opportunities for PE capital, technological and regulatory developments, and other sources of capital for firms.

TA: Change in regulation can often be slow in the accountancy sphere. Do you believe regulation can keep up with the current rate of PE investment in the audit profession?

JB: Change in regulation can be slow generally, partly because there is a need to ensure proper due process is followed. As we state in our paper, there would appear to be merit in revisiting the audit firm ownership rules to assess whether they remain fit for purpose but not just with a focus on private equity investment. We would also caution against a rush to change long-standing provisions without appropriate due process. Getting it right is more important than making any such change quickly, for example.

TA: How does PE investment in UK audit firms compare to PE investment in other countries?

JB: It depends on the country. Accountancy Europe’s report suggests that the UK is among the top three regions – along with the US and Nordics/Benelux – in terms of PE platform investment in accountancy firms.

TA: How will PE investment disrupt the current partner model?

JB: Only time will tell. The impact in those firms where investment has already taken place will depend on the terms and conditions of the deal.

TA: The report suggests that PE Investment may be contributing to the decline in licensed firms. What impact will this have on competition within the market in the long-term if this trend continues or increases?

JB: At present this is unlikely to have any real impact on the FTSE 350 audit market. In the area of the audit market in which investment is taking place, there has been some reduction in the number of audit firms active in this space. The longer-term impact remains to be seen and will depend on various factors.