21.In September 2020, Sir Tony Redmond reported to the Secretary of State for Housing, Communities and Local Government, that it was clear from his independent review of the effectiveness of local audit and the transparency of local authority financial reporting, that the local audit market was very fragile. The London Borough of Hackney was also concerned that the additional pressure, due to the COVID-19 pandemic, had exposed an already fragile system which was no longer sustainable. The Ministry for Housing, Communities & Local Government (the Department), and Public Sector Audit Appointments Ltd (PSAA), accepted that there were serious and pervasive challenges in the local authority audit market and the Department recognised that it needed to take action to tackle the underlying weaknesses in the market.
22.All parties agreed that the market was not currently competitive, and that one measure needed for the market to become effective was to have more audit firms in the market. Only eight audit firms are accredited to audit local authorities. Of these eight, EY and Grant Thornton together carry out around 70% of local authority audits. Grant Thornton considered that audit firm KPMG’s exit in the last contract round in 2017 left the remaining firms in the market with insufficient capacity to take on the additional audits. EY warned that audit firms that had left the market would no longer have the necessary specialist teams in place, if they ever considered re-entering the market.
23.We pressed the Department on what it was doing to encourage a greater number of audit firms to carry out audits of local authorities. The Department agreed that maintaining capacity in the market for auditing local authorities was a serious matter. It reported that it kept a close watch on the audit firms supplying the market for auditing local authorities, to monitor the situation and ensure that audit firms provided the necessary capacity. It added that it was in regular dialogue and meetings with the audit firms. The Department felt that, in taking the actions which Sir Tony Redmond had recommended in his review, this would provide the confidence that the market needed, and to ensure that there was sufficient capacity.
24.PSAA is the organisation responsible for appointing audit firms to audit those local authorities which have opted into its arrangements, for an initial five-year period to 31 March 2023. It has a legal obligation to ensure that there is sufficient capacity in the market for auditing local authorities, and that local authorities have access to auditors. PSAA recognised that there were many problems in the market for auditing local authorities, and considered that it would take time to sort them out. PSAA wanted to make the market a more attractive one for existing audit firms to stay, and for new firms to enter. It also wanted to have long-term viable contracts with the audit firms. We asked if there would be a fundamental problem if one or more of the large audit firms did not bid in the next contract round, and we sought assurance on whether any contingency was in place if any firms dropped out. PSAA explained that if any audit firms were minded to leave the market after the end of the five-year period, it had a safety net in that it could extend the current contracts for two years, forcing the audit firms to keep auditing local authorities beyond 2023.
25.PSAA recently commissioned research into the market for auditing local authorities which found challenges and barriers to audit firms looking to come into the market. New firms have to invest in their staff over time to build the specialist knowledge and accreditation needed to carry out audits. A member of staff who leads an audit must also gain individual accreditation to become a key audit partner. EY added that key audit partners must have at least three years’ experience of oversight of delivering audits within this market. The Institute for Chartered Accountants in England and Wales (ICAEW) also felt that the requirements on key audit partners acted as a barrier to new entrants, even where audit firms did have audit partners with the experience that would make them eligible to apply.
26.For the next procurement round for audits of local authorities from 2023, PSAA is looking at measures to reduce the barriers to entry for new audit firms. One measure proposed is for firms to enter the market while carrying out relatively small packages of audit work. PSAA is also open to consortia, in which an accredited firm would work with an unaccredited firm, to enable it to learn the ropes and gain experience of the unusual aspects of auditing local authorities. PSAA told us that it had consulted audit firms to gain their views on gaining accreditation and entering the market to audit local authorities. This included the option of working in consortia with accredited firms. It was also in contact with firms which had left the market to take soundings from them on returning to the market. PSAA explained that its strategy was to convince audit firms that auditing local authorities was an attractive market in which to work; one which would be worth their while; and worth their investment in training their staff. However, PSAA accepted that audit firms had a choice of audit markets and that it faced a challenge in making the offer attractive enough to audit firms. The Local Government Association also told us that the attractiveness of auditing local authorities had declined for audit firms, as the demands of the audits had increased. The ICAEW also expressed a view that the market for auditing local authorities was not attractive and that there was a risk that audit firms could withdraw from the market.
27.We challenged the Department on the sustainability of firms auditing £100 billion a year of spending by local government while relying on only a few hundred auditors with the requisite skills. The Department and PSAA recognised the challenge which audit firms faced in having sufficient people to take on all the work required in auditing local authorities. The Department had heard directly from audit firms that a shortage in specialist skills was a factor in their delays to completing audits. PSAA had seen that, within the four largest audit firms, some key audit partners had moved away from auditing local authorities to internal audit consultancy. Such moves had put additional pressures on the numbers available to lead audits of local authorities.
28.PSAA highlighted that the age profile of key audit partners was a factor likely to increase the challenge which audit firms faced, in having sufficient staff. EY confirmed that it was facing a retirement issue for its key audit partners, with most having been in careers in local audit for 30 years or so, and in Grant Thornton the vast majority were aged over 50. EY was aware that when this cohort retired, it faced a risk of too few people coming behind them to take on their roles, and it considered that there was a generation of key audit partners missing. The Local Government Association also told us that among the relatively few accredited audit firms in the market, there were too few key audit partners to ensure the resilience of the system.
29.Sir Tony Redmond highlighted that his review found that the lack of career prospects and opportunities produced a real challenge for trainee accountants when considering whether to go into public sector accounting and auditing. He believed that audit firms needed to give more attention to career progression and training schemes for people to encourage them into public sector auditing. Sir Tony thought that the Department, accountancy institutes, and audit firms could be involved in developing a training scheme that encouraged people to pursue a career in public sector audit. ICAEW told us that the struggle that audit firms have in finding sufficient qualified and experienced individuals to deliver local authority audits could, in part, be due to low margins on the audits, which limited the ability to offer higher pay, and in part, be due to less attractive career paths. It added that pressure put on audit staff to work intensely over such a short period of time exacerbated staffing issues.
30.The Department reported that it was working closely with the Financial Reporting Council (FRC), the Chartered Institute of Public Finance and Accountancy (CIPFA) and others to ensure there were enough skilled auditors to meet the needs of the market. It noted that the FRC was leading a working group with stakeholders to look at factors affecting the supply of audit staff, such as entry criteria and skills development. The Department wanted to make the process for auditors to gain key audit partner status as slick as possible to encourage more people, but it also recognised that increasing the supply of people with the necessary skills would be a long-term issue.
31.PSAA noted that the audit firms carried out extensive training programmes for their staff, but that it was important to ensure these programmes covered training on the specific aspects for audits of local authorities. Grant Thornton informed us that it was the largest trainer of students through CIPFA, but that it took a long time to train people from joining the firm to becoming public sector specialists. EY added that the ICAEW was looking urgently at the requirement for people to have at least three years’ experience of oversight of delivering audits of local bodies before they could gain accreditation as key audit partners.
32.In 2019, the previous Committee reported on the reduction in fees for auditing local authorities. The Department accepted that audit fees had become insufficient to reflect the increased challenges in auditing local authorities. Sir Tony Redmond confirmed that audit fees in real terms had dropped significantly in recent years. He considered that the fall in fees had dissuaded a number of audit firms from bidding in 2017 for the current contracts to audit local authorities. The audit firm EY felt that the connection between the underlying cost of the audit and the fee had been lost, and that the fee regime was no longer fit for purpose.
33.EY and Grant Thornton highlighted that the amount of work which firms were required to carry out in auditing local authorities looked nothing like that required in 2017, for example, in the additional work involved in valuing assets supporting pension funds and of investment properties. Grant Thornton referred to additional work required to reflect changes in auditing standards, in systems regulation, and in following the revised audit code of practice, and considered that these changes were introduced without recognition of the impacts on the costs to auditors. EY also noted that the contracts signed in early 2017 were different to the audits which auditors had to carry out when they started to deliver work against these contracts in 2019. The London Borough of Hackney said that the decline in audit fees had put pressure on audit firms, such as in trying to field a suitable number of experienced auditors, and that this mirrored a deterioration in audit performance over recent years.
34.We sought clarity from the Department on whether, if fees went up, it would look to reflect the increase in the settlement for local government. The Department responded that is had put in more money this year for affected bodies, rather than going directly to audit firms. The Department reported that it was taking action to address the decline in audit fees. It was consulting on changes to the regulations that set the fees for auditing local authorities to enable the fees to be set at a closer time to when the audit was done, and so that variations in fees can respond to changes in the audit work required. In the meantime, the Department was consulting on how to allocate an additional one-off £15 million towards the costs of 2021–22 audits. EY told us that the sector welcomed the announcement of the further £15 million, as this would go some way to address the imbalance between the cost of delivering the audits with the specialist skills required, and the fees earned. EY added that it was responding to the Department’s consultation with the view that £15 million be shared in an equitable way with the audit firms facing higher costs of auditing local authorities with increased complexity, rather than those auditing simpler bodies.
53 Sir Tony Redmond, , September 2020
54 London Borough of Hackney submission, para 3
55 Qq 4, 12 evidence session of 20 May 2021
56 Qq 28, 51 evidence session of 17 May 2021, Qq 5, 42, 46 evidence session of 20 May 2021
57 Q 11 evidence session of 20 May 2021
58 Q 5 evidence session of 20 May 2021; Q 28 evidence session of 17 May 2021
59 Q 28 evidence session of 17 May 2021; C&AG’s report para 1.16
60 Q 28 evidence session of 17 May 2021
61 Q 61 evidence session of 20 May 2021
62 Q 58 evidence session of 20 May 2021
63 Q 60 evidence session of 20 May 2021
64 Qq 58–59 evidence session of 20 May 2021
65 C&AG’s report, Figure 1; Sir Tony Redmond, , September 2020, para 3.2.1
66 Q 59 evidence session of 20 May 2021
67 Q 44 evidence session of 20 May 2021
68 Qq 63–66 evidence session of 20 May 2021
69 Q 11 evidence session of 20 May 2021
70 Q 28 evidence session of 17 May 2021
71 Institute for Chartered Accountants in England and Wales, page 5
72 Q 11 evidence session of 20 May 2021
73 Q 45 evidence session of 20 May 2021
74 Q 46 evidence session of 20 May 2021
75 Local Government Association submission, page 2
76 Institute for Chartered Accountants in England and Wales submission, pages 1, 4
77 Qq 12, 42, 46 evidence session of 20 May 2021
78 Q 43 evidence session of 20 May 2021
79 Q 46 evidence session of 20 May 2021
80 Q 12 evidence session of 20 May 2021
81 Qq 29, 30 evidence session of 17 May 2021
82 Local Government Association submission, page 2
83 Q 53 evidence session of 17 May 2021
84 Q 54 evidence session of 17 May 2021
85 Institute for Chartered Accountants in England and Wales submission, page 4
86 Q 42 evidence session of 20 May 2021
87 Qq 43–44 evidence session of 20 May 2021
88 Q 55 evidence session of 20 May 2021
89 Q 28 evidence session of 17 May 2021
90 Committee of Public Accounts, , Ninety-Seventh Report of Session 2017–19, HC 2077, May 2019, paragraph 20
91 Q 8 evidence session of 20 May 2021
92 Q 52 evidence session of 17 May 2021
93 Q 19 evidence session of 17 May 2021
94 Qq 19, 38 evidence session of 17 May 2021
95 Q 19 evidence session of 17 May 2021
96 London Borough of Hackney submission, para 7
97 Q 9 evidence session of 20 May 2021
98 Qq 6, 10 evidence session of 20 May 2021; C&AG’s report, para 1.16
99 Q 15 evidence session of 17 May 2021