5 Competition in the audit market
Domination by the few
58. The number of firms successfully competing in
the public sector audit markets is small. The Audit Commission
has 70% of the local government market with only five other firms
involved in the remaining 30%. Foundation Trusts use only a small
number of audit firms: the Audit Commission Chairman told us that,
effectively, this is now down to three including the Audit Commission.[92]
The NAO uses private audit firms for less than 20% of central
government work.
59. The issue of market competition and choice in
the public sector cannot be addressed in isolation from the private
sector audit market, which is dominated by a small number of large
accountancy firms. The House of Lords Economic Affairs Committee
recently reported that the dominance of the "Big Four"
has limited competition and choice and that attempts to introduce
greater competition had failed.[93]
It recommended that the Government should work to encourage the
development of a competitor.[94]
The Financial Reporting Council is keen to see the Audit Commission
audit practice emerge as a fifth large practice, competing in
both the public and private sectors.
60. The Government says it wants to see a competitive
market develop for local government audit providing choice and
lower audit fees. Some of our witnesses were concerned that a
similar model of the dominance by a few large audit firms would
emerge in the public audit sector, with limited choice and competition.
The experience of the Foundation Trusts is not encouraging: only
six companies provide audit services, all of which did so through
the Audit Commission prior to 2004.[95]
Witnesses also questioned how the market would be managed to encourage
new entrants in the absence of a central procurement body. During
the lifetime of the Audit Commission, the number of private firms
undertaking local public audit has fallen from 13 in 1983 to five
today.[96]
61. Unless the Government can crack the problem
of the very limited competition in the audit market in the UK,
it will be open to the accusation that the abolition of the Audit
Commission is not a measure to save public money but merely a
mechanism to transfer public money into private hands. For local
auditor appointment to work, the local government audit market
must be opened up to wider competition that provides local authorities
with a genuine choice of audit firms. This will require active
management and learning from developments in the private sector,
such as the outcome of the OFT's current review. DCLG should work
with other appropriate bodies, including DBIS, Competition Commission,
FRC, the LGA and professional accountancy bodies to deliver a
more open and competitive local government audit market.
Audit Commission audit practice
62. The Audit Commission audit practice is the fifth
largest audit practice in UK. It is a respected, professional
body, as acknowledged by DCLG and others, which has helped to
raise standards in local government public audit.[97]
63. The DCLG is now developing plans to establish
the Audit Commission audit practice as a separate entity from
Audit Commission, possibly as a mutual, that will compete for
local government audit work in future. The proposals are not part
of the DCLG consultation. Financial consultants FTI were appointed
on 18 April 2011 at a fee of £100,000 "to provide advice
on the most cost-effective options for disbanding the Audit Commission"
and transferring its in-house audit practice into the private
sector.[98] It was unhelpful
that the Minister did not inform the Committee during oral evidence
of the imminent appointment of advisers.[99]
At that stage the appointment process was well advanced, having
started in February.[100]
64. The Audit Commission audit practice has proved
its ability to compete against private audit firms and now audits
52 foundation trusts, comprising 38% of the FT audit market. Gareth
Davies, Managing Director of the Audit Commission audit practice,
was keen to emphasise to us the positive approach that the practice
is taking towards securing a successful future as an all-employee-owned
(mutual) business.[101]
In contrast, Prospect was pessimistic[102]
about the capacity of a reformed and floated-off audit practice
to survive in a competitive environment:
The idea of pulling an organisation like the
Audit Commission into that competitive world within the lifetime
of this Parliament, let alone in the next 12 to 18 months, is
fanciful. I do not believe it has the skills, nor could it attract
them.[103]
The Government made three appointments to the Board
of the Audit Commission in November 2010 which it said would "bring
significant private sector expertise that will be crucial in steering
the organisation as it addresses new challenges".[104]
65. We do, however, note Prospect's concern that
staff may be lost to the profession entirely[105]
if arrangements are not handled properly and speedily, although
they told us that the level of staff turnover had not changed
significantly.[106]
The practice may find conditions tougher in future without its
core workload of guaranteed local government audit work. It is
almost inevitable—and desirable, in terms of promoting choice
and competition—that its market share will reduce from 70%
of the local government audit market.
66. It is vital that the Audit Commission audit
practice's skills and expertise are not lost and that it remain
a significant player in local government audit market, in order
to provide fee competition and choice. Our favoured outcome is
the establishment of a stand-alone company, preferably a mutual.
If this proves to be unviable, merger with another audit firm
outside the Big Four would be our second preference. Failing both
of these, the audit practice should be broken up so that capability
is spread to a number of other smaller firms. It would be entirely
unacceptable for the practice to be bought by one of the existing
Big Four as this would further reduce the already-limited choice
and competition. DCLG must also carefully consider the transitional
arrangements and ensure that the necessary assistance and stability
is provided to assist the audit practice through this period,
particularly if the practice is established as a mutual.
Audit fees
67. Lower audit fees are, according to the Government's
consultation document, one of the four key design principles of
the Government proposals.[107]
The minister told us that, with local appointment and without
the 20% overhead charge added by the Audit Commission, he was
confident that the overall cost of audit fees would come down.
By contrast, the Audit Commission pointed out the savings that
it had been able to deliver as a result of centralised purchasing
of audit services over a long period. The NLGN report, drawing
on international experience, found limited evidence on which to
predict how fees will change; it found both positive and negative
examples of decentralisation of audit and fees. Its UK research
found opinion divided over whether fees would rise or fall.[108]
We heard concern that fees may rise, both in general and in particular
for small or remote councils. Auditors Grant Thornton expected
that fees would fall in areas such as London but rise in more
remote areas such as Cornwall and Cumbria.[109]
68. The proposals for local government contrast
with the situation in central government, where the NAO is reducing
the percentage of work that it contracts out to private audit
firms:
Our percentage is low, because we use the private
sector to supplement what we do. For completeness of disclosure,
it's probably becoming even a bit less [than 20%], because as
we work more efficiently and use our resources better, we find
it cheaper to work our in-house resources.[110]
69. Developing a fully competitive market will
be an important element in achieving lower overall audit fees—a
key design principle of the Government's proposals. All local
authorities should be required to publish annually their audit
fees, showing separately the cost of the mandatory (code) audit
and any additional audit or consultancy work. The figures should
be published in a consistent way that allows comparison and analysis.
70. It has been suggested that,[111]
without the indemnity provided by the Audit Commission, private
audit firms will have to purchase their own indemnity to cover
costs that may arise from PIRs or other litigation and that audit
fees may rise as a result. This, however, seems unlikely to be
significant. The cost of undertaking the PIR has always been charged
to the audited body. The Audit Commission indemnifies the private
firms with whom it contracts against costs arising out of their
statutory audit functions. The indemnity does not protect against
negligence. The frequency of litigation appears to be low. Over
the past five years, only one call on this indemnity has arisen
and the Audit Commission has faced only three cases of litigation.[112]
Moreover, audit firms are accustomed to working in the private
sector, which is more litigious than local government and where
the amounts of money at issue are often very high. In the case
of Westminster Council, had the Audit Commission lost its appeal
to the House of Lords, it stood to lose £12million[113]—a
substantial sum but not enormous by private sector standards.
92 Q 209 Back
93
House of Lords Select Committee on Economic Affairs (2011), Auditors:
Market concentration and their role, HL Paper 119-I, para
33 Back
94
House of Lords Select Committee on Economic Affairs (2011), Auditors:
Market concentration and their role, HL Paper 119-I, para
53 Back
95
NLGN Show me the money-accounting for localism, April 2011,
p 35 Back
96
Audit Commission, The Future of local audit: issues for consideration,
September 2010, p 19 Back
97
Ev 228 Back
98
http://www.communities.gov.uk/newsstories/corporate/1889668 Back
99
Qq 568-577 Back
100
HC Deb, 17 May 2011, col 145W Back
101
Ev 169 Back
102
Qq 287-293 Back
103
Q 290 Back
104
DCLG press notice, The Audit Commission-appointment of new
commissioners, 10 November 2010 Back
105
Qq 284-285 Back
106
Q 282 Back
107
DCLG consultation document, para 1.17 Back
108
NLGN, Show me the money-accounting for localism, April
2011, Chapter 3. Back
109
Ev w49 Back
110
Q 514 Back
111
Q 26 Back
112
Ev 171 Back
113
Follow the money, p 506 Back
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