EACH time a corporate supertanker slams into an iceberg, we hear the same questions.
Why did nobody try to force it to change course? Why haven’t lessons been learned from previous disasters?
Who was sitting in the corporate equivalent of the crow’s nest and why haven’t they been held to account? In the aftermath of the financial crash of 2008, there was much finger-wagging and promises of “never again”.
Then along came Carillion. The collapsed construction and outsourcing giant left behind a colossal debt pile and pension deficit and hundreds of millions of pounds in unfinished public contracts. The alarm bells had been ringing in the months leading up to Carillion’s implosion. The Federation of Small Businesses, for example, had bravely challenged Carillion, six months before it collapsed, because it found evidence the firm was paying suppliers in 126 days, which was hardly a sign of a firm in rude health.
Policymakers have cast a critical eye over the quality of auditing in the aftermath of Carillion’s demise. The entire profession could be about to witness revolutionary changes.
The Business, Energy and Industrial Strategy Committee is calling on the Competition and Markets Authority (CMA) to aim for the full structural break-up of the ‘Big Four’ firms into audit and non-audit businesses.
The committee’s report endorses the CMA’s proposed operational split between audit and non-audit but believes further action is needed to restore faith in the sector.
The MPs believe that the structural break-up would prove more effective in tackling conflicts of interest.
The report also highlights the lack of competition in the audit market and its impact on market resilience. In 2016-17, EY, PwC, KPMG and Deloitte - known as the “Big Four” - accounted for 97 per cent of FTSE 350 audits and 99 per cent of FTSE 100 audits. The report recommends a segmented market cap and the use of joint audits, on a pilot basis, for the most complex audits to help the challenger firms secure more work.
The report also recommends increasing the frequency of audit rotations to seven-year non-renewable terms and a cooling off period of three years, in which non-audit services cannot be offered to a former audit client.
Rachel Reeves MP, the chairman of the Business, Energy and Industrial Strategy Committee, was scathing in her assessment of the current auditing landscape.
She said: “The ‘Big Four’s’ dominance has fostered a precarious market which shuts out challengers and delivers audits which investors and the public cannot rely on.
“For the big firms, audits seem too often to be the route to milking the cash-cow of consultancy business.
“The client relationship, and the conflicts of interest which abound, undermine the professional scepticism needed to deliver reliable, high-quality audits.”
There have been dissenting voices, notably from ICSA, the Governance Institute, which believes the independent appointment of auditors would usurp shareholders’ right to appoint their own advisers. The ICSA also believes that concerns about the concentration of the audit market have become conflated with the key issue of audit quality.
The CMA should back every element of the MPs’ report. Regulators and policymakers cannot scratch their heads and wait for the next corporate giant to come tumbling down. The demise of any large firm causes misery for shareholders, employees and suppliers, who are innocent victims of a flawed corporate culture.
We need auditors who give their clients the grilling of their lives. There are many fine audit professionals who act with courage and integrity. But it would be the height of folly to claim that the current system is working.
These reforms could save the UK economy from disaster by improving competition and reducing conflicts of interest. The public will finally believe that the auditors’ numbers really do add up.