Supplementary letter from Mr Robert Hodgkinson,
Institute of Chartered Accountants in England and Wales (ADT 8)
I write in response to the request made by Lord
Lawson at the Committee's session on 19 October 2010. At the end
of the session, Lord Maclennan asked "If there were one measure
you would propose that would most assist in widening choice in
the audit market, what would it be?" I replied "Oblige
regulators to consider how regulation affects availability of
choice. Make it a criterion for regulatory action because it is
clearly of public interest."
Lord Lawson requested a brief note on what I
was proposing and how it would work out in practice. I summarise
these matters below and also take this opportunity to set out
the various actions that ICAEW is taking to follow-up on our Financial
Services Faculty's report "Audit of banks: lessons from
the crisis", which Lord Lawson referred to earlier in
the session.
THE PROPOSAL
AND ITS
PRACTICAL APPLICATION
All regulators involved in the audit market
should be required to consider the consequences of their actions
on the public interest objective of increasing choice in the audit
market.
My proposal is that audit regulators should
include the issue of choice in their regulatory principles. Where
relevant, they would consider choice in each aspect of their work
such as framing new or revised regulations and standards, or reporting
on monitoring and enforcement activities.
In so far as practical application is concerned,
I suggest that at the outset of a piece of work the regulator
would formally determine whether the output might affect the availability
of choice in the audit market because of its impact on potential
providers and purchasers of audit services. If it might do so,
then the regulator's internal processes would require the regulator
to confirm that in deciding on a course of action it had given
full consideration to the impact on choice in the audit market.
There would also be reference to choice in the impact assessments
that accompany the regulator's output.
One benefit of this suggestion is that future
inquiries into choice in the audit market would be better informed
about practical experience of trade-offs between choice and other
public interest issues, including audit quality.
It may help the Committee if I provide a little
background to this proposal.
BACKGROUND INFORMATION
Choice in the audit market is, in the first
instance, currently driven by company boards and their audit committees
who choose who should be put forward for appointment as auditor
by shareholders. As a possible result of the work of your Committee
and that of the European Commission, shareholders may in future
take a more active interest in the appointment and reappointment
of auditors. One consequence of increased scrutiny from shareholders
might be that audit committees are even more attracted by the
perceived safety of choosing one of the four largest firms. Against
this backdrop it will be very challenging to widen the listed
company audit market.
Over the past few years the Financial Reporting
Council (FRC) has undertaken specific work to try to actively
influence choice. In particular, its Market Participants Group
(MPG), whose membership consisted of investors, companies and
audit firms, published a report in October 2007 report entitled
Choice in the UK Audit Market. Of the report's 15 recommendations:
— 12 focussed on increasing choice of auditor
for public interest entities;
— two were about reducing the risk of an
audit firm leaving the market without good reason; and
— one sought to reduce uncertainty and
disruption costs in the event of an audit firm leaving the market.
Of the 12 recommendations on choice, some looked
at supply-side measures intended to encourage firms other than
the four largest to offer audit services to large public interest
entities. Other recommendations referred to demand-side measures,
including making boards more accountable to shareholders and reducing
the perceived risks to directors of choosing a smaller audit firm.
In the period between October 2007 and June 2010, the FRC published
five progress reports on the 15 recommendations. In their written
submission to your Committee, the FRC states that the majority
of the MPG's recommendations have been implemented but to date
have had minimal impact on market concentration.
However, in addition to these specific initiatives
to help widen choice, the FRC and its subsidiary boards undertake
many on-going, broader activities such as framing new or revised
financial reporting, auditing and ethical standards and reporting
on monitoring and enforcement activities. In my opinion, the outputs
of these broader activities are very likely to influence the perceptions
of, and the choices made by, audit committees and shareholders
as well as audit firms. My proposal seeks to address this matter.
Audit regulators need to consider the consequences of all their
relevant actions on perceptions of key participants in the audit
market.
Currently the words "choice", "concentration"
and "competition" do not feature in the FRC's document
"Regulatory Strategy: Our Role and Approach"
(Version 4) dated April 2009. By way of contrast, the Financial
Services Authority (FSA), in pursuing its functions under the
Financial Services and Markets Act, is required to have regard
to additional matters that it refers to as "principles of
good regulation". There is a competition principle which
states "The need to minimise the adverse effects on competition
that may arise from our activities and the desirability of facilitating
competition between the firms we regulate." The FSA states
that one of the aims of its principles is to avoid unnecessary
regulatory barriers to market entry or business expansion. It
goes on to note that competition and innovation considerations
play a key role in its cost-benefit analysis.
Thus, my proposal is that relevant regulators
(particularly the FRC) should include the issue of choice as one
of their principles for regulation and ensure that, where relevant,
it is considered in each aspect of its work not just in relation
to the specific recommendations of the MPG.
FOLLOW-UP
ACTIONS TO
ICAEW REPORT ON
THE AUDIT
OF BANKS
Finally, I would like to take this opportunity
to follow up on my oral comments to the Committee by summarising
a number of initiatives ICAEW is undertaking as a result of our
report "Audit of banks: lessons from the crisis",
which Lord Lawson referred to in the session on 19 October 2010.
We:
— have established the Financial Services
Faculty Auditor-Investor Forum to highlight and discuss key risks
across the financial services sector. The Forum will meet for
the first time on 22 November 2010 with the aim of promoting wider
understanding of the key areas of focus of auditors of financial
institutions in the upcoming reporting season and potential difficult
issues in preparing annual reports, including any systemic risk
concerns. This should promote greater confidence that auditors
will be considering and addressing these issues;
— have established a working party to develop
good practice guidance for communication between auditors and
audit committees in financial institutions. The objective of this
initiative is to provide better information to audit committees
and to encourage better disclosure by audit committees about their
dialogue with auditors. We aim to publish draft guidance before
the end of 2010 and final guidance after the next reporting season;
and
— have assisted the Bank of England and
the FSA in establishing a working group to examine and revise
protocols for dialogue between auditors and supervisors. This
will look at both the information that auditors should share with
supervisors and the information that supervisors should share
with auditors.
We believe that each of these initiatives will
promote important incremental improvements that can be made relatively
quickly. While there may be debates to be had on more fundamental
changes to auditor responsibilities, such wider changes can be
complicated by potential unintended consequences which mean that
they take much longer to agree and implement.
I would be happy to brief Lord Lawson and any
other members of the Committee on the matters covered in this
letter or any other matters arising from your inquiry if that
would be useful.
28 October 2010
| 
