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October 14, 2007

MPG report offers ‘modest’ solutions to audit choice

By Nicholas Moody

MPG report offers ‘modest’ solutions to audit choice

The UK Financial Reporting Council’s (FRC) Market Participants Group (MPG) report on audit choice is not likely to have far-reaching consequences on the UK auditing market. That is the consensus of industry leaders speaking to TA following the release of the report earlier this month. A mid-tier managing partner fears the UK might have lost the initiative to introduce more choice into its audit market, while another mid-tier firm and a Big Four firm remain unconcerned.

BDO Stoy Hayward’s managing partner, Jeremy Newman, made the comments in response to the recent release of the FRC final report on audit choice from its MPG. The report made 15 recommendations but declared it had found no silver bullets that could rapidly increase choice in the audit market.

Newman is disappointed by the “modest nature” of the proposed changes and is wary of a heavy US-style regulation solution to the audit choice question. “The fear I have is that this is not just a UK problem but a global problem and the US has set up a working party to look into it. And the initiative, which has been in the UK for the past couple of years, is in danger of shifting to the US,” Newman said. “It worries me that a reaction to the competition and choice piece from the [US] will actually impact on us in the UK and we will end up having to take on an American solution that wouldn’t necessarily fit.”

Fellow mid-tier firm Grant Thornton UK takes a longer-term view of the UK audit market and did not expect overnight changes from the MPG report. Steve Maslin, head of external professional affairs, said a meaningful change to the audit market is going to take five to ten years. “I don’t think it’s practicable to bring about a much quicker change, unless you are going to take action such as breaking up one or more of the Big Four, or forcing them to give up some clients to other firms, and neither of those outcomes is good for the audit market and the capital market,” he said.

Maslin pointed out that although change may be a long way off, the FRC’s focus on audit concentration has coincided with a 20 to 25 percent increase in Grant Thornton’s larger corporate audit business. “One of the fastest-growing areas of our business in the last year has been the public interest audit functions and to a degree I think that’s come about because the FRC has raised the issue of concern about too much concentration on the Big Four,” he said.

Gerald Russell, a senior partner at Ernst & Young UK, said the report is balanced but he agrees it is unlikely to dramatically introduce choice in the UK audit market. “There will be an impact over time but it’s not going to be seismic and it is not going to suddenly change the size of the audit market in the FTSE 250 global companies,” he said.

Newman said the fact that something is happening is good, but he rallies against what he perceives as institutional prejudice against non-Big Four firms. He said this is evident in recommendation nine, relating to the disclosure about appointing certain types of auditing firms. “We are concerned that a number of banking agreements included a clause that said you had to pick a Big Four firm as your auditor. Those clauses reinforce a prejudice that the Big Four are ‘better’,” he said.

Russell and Newman both agree they prefer market-led solutions, but Newman wants to see a more concerted effort to shunt the process along. “I think it needs a little shove from a regulator that leaves you with a market solution,” he said.

UK Market Participants Group final report

Key recommendations 1. The FRC should promote wider understanding of the possible effects on audit choice of changes to audit firm ownership rules, subject to there being sufficient safeguards to protect auditor independence and audit quality.

2. Audit firms should disclose the financial results of their work on statutory audits and directly related services on a comparable basis.

5. The FRC should continue its efforts to promote understanding of audit quality, and the firms and the FRC should promote greater transparency of the capabilities of individual firms.

9. When explaining auditor selection decisions, boards should disclose any contractual obligations to appoint certain types of audit firms.

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