Examination of Witnesses (Questions 83-113)
Mr Jonathan Hayward, Mr Stephen Kingsley, Dr Gunnar
Niels and Mr Timothy Bush
26 OCTOBER 2010
Q83The Chairman: Gentlemen, good afternoon and
welcome to the Committee. Before we start hearing evidence, as
I was unable to attend our first meeting I just wanted to make
a declaration of interest, which I think probably applies to most
people, as a director of a number of companies, all of which are
listed in the Register of Members' Interests. All of those companies
are audited by members of the accountancy profession. I think
that is a blanket cover.
This week's witnesses are consultants. Three
of those who are with us this afternoon have already contributed
written evidence and the fourth, Dr Niels, is from Oxera, which
has published influential reports such as Competition and Choice
in the UK Audit Market. They may be a bit livelier than last
week's spokesmen for the professional associations. We shall wait
to see.
I will take the first question and then pass
to my right. I am taking the chair today in the absence of Lord
MacGregor, Chairman of the Committee. Copies of any other Members'
interests have already been declared and are shown in the Register
of Interests. Two Members of this Committee, Lord Currie and Baroness
Kingsmill, are not taking part in this inquiry.
You are all very welcome and thanks to those
of you who have already supplied written evidence. I would be
grateful if you could kindly speak loudly and clearly as this
session is being webcast, and for the benefit of the shorthand
writer. When we reach the questions we will be happy, in order
to save time, to take silence from the other three of you as agreement
with the first to speak, but if you disagree please do not hesitate
to say so.
Would any of the four of you like to make an
opening statement? If not we will go straight to questions.
Dr Niels: Just very briefly, if I may. It's
a pleasure to be here. As you have mentioned already, I directed
Oxera's work for the FRC and the DTI and also the study we did
later for the European Commission. I'm hoping to help the Committee
this afternoon with insights on the topics covered by those studies,
competition and choice, in particular the microdynamics of how
competition and choice in the audit market work. I'm probably
less well placed to comment on some of the other topics that you
cover in the inquiry.
Q84 The Chairman: Thank you. I will
take the first question and then I will pass to my right and we'll
go round the table. The question I would like to ask you is—and
I see this sitting on the board of a number of companies—there
seems to be a view that only the mega audit firms with huge background
knowledge and deep competencies are really able to audit companies,
say in the FTSE 350. Do you consider that is overblown? I think
it would be very helpful to the Committee if you could let us
have your views on that.
Mr Hayward: I think it is overblown, certainly,
and I can answer it in two parts. Within the FTSE 350 there are
some relatively straightforward companies. Property companies
are a case in point. Even FTSE 100 property companies are, as
organisations, relatively small. They may have huge balance sheets,
but in terms of the number of people they employ and the amount
of activity that goes on they are not big organisations. They
tend to be largely domestic. Medium-sized audit firms have plenty
of experience of auditing property companies; they would be able
to audit those companies. However, no audit committee chairman
of a FTSE property company that I know of is particularly interested
in changing to a medium-sized audit firm because there is lots
of downside and no upside for an audit committee in doing that.
That example is the easy one. If any companies were going to change
it could be those, but they don't.
Less obvious are the multinational companies
with more complex businesses, where again, I think, the dependence
on a large international network is overstated. It arises because
of the presumption, which is now embedded in the system of auditing,
that a multinational audit will be done by auditing all the separate
statutory entities around the world and adding up the results.
That was a very good way of doing an audit when accounts were
written down and then sent by steamship to head office in London,
but in days when companies run an SAP system that manages data
all over the world it's obsolete. Companies need to manage the
way they operate globally in a different sort of way and it is
perfectly possible to audit a company by working through the way
in which it manages and evaluating whether or not it actually
has a decent grip on the information within the business. That
would be perfectly possible and it would mean that a different
resource model could be employed. You would require fewer but
much more expert auditors. It's only the fact of doing statutory
audits all over the world which means that you require lots of
statutory auditors in all jurisdictions. You then end up with
a situation where having those auditors available to management
is very useful to management because it's a resource pool that
is available for them to call on when required.
So what we have now is a system that works quite
well. It suits the audit firms, it suits the management and it
usually gets the right answer, but it is not the only way in which
you could audit a large multinational company and other ways do
not require those resources.
Mr Bush: I am slightly concerned that the regulatory
regime itself might overly identify with the larger firms and
therefore by default squeeze out some of the competencies that
are in smaller firms. Certainly when I qualified there was effectively
a Big 10 and some firms that were quite small specialised in certain
aspects of insurance; my firm I trained with, Ernst & Whinney,
audited very large banks. I think there is a regulatory sense
that big is best and I have an example that I think is quite interesting
of a small firm in Ireland that identified that the accounting
standard FRS 26 did not comply with the Credit Union Act and concluded
it was imprudent and did not apply it. The Irish credit union
regulator then flagged the fact that the standard didn't agree
with the law and I'm not aware of any Irish credit union collapsing
due to making insufficient bad debt provisions. Now, that is a
freedom that seems to have come from a small firm in Belfast that
I don't think was subject to a very strict regulatory regime that
is effectively forcing auditors to follow standards even if they
disagree with them. So I think that there are some issues between
the best way of delivering what the law requires and what some
of the standards are giving. That is a bit of problem.
Dr Niels: On that question of the mega audit
firms, 90% of the audit committee chairs that we surveyed thought
that the mid-tier firms were perfectly technically capable, but
if you then look at the three main products that in essence audit
firms offer to the companies that they audit there are three aspects
and on each of these three the Big Four have perceived or real
advantages over the rest of the market. The first one is the technical
audit itself where it is often perceived that, especially for
the larger companies, you do need the international coverage,
the depth and the sector knowledge, so they are better placed
than the smaller firms. The second aspect is the value added services
over and above the audit itself. That is a service highly valued
by the audit committee chair and by senior management, and again
the perception is that the Big Four are better placed, capable
of providing those services. And then the third one is, of course,
the reputational advantages of having a Big Four as your auditor,
which you have discussed already at previous meetings. Again,
that is where the Big Four have this advantage over the smaller
firms.
The Chairman: Mr Kingsley, did you want
to add anything else?
Mr Kingsley: No. I shall adopt your silence
protocol, on this one anyway.
Q85 Lord Lawson of Blaby: My greatest
concern in this area is over the auditing of banks, to which I
know that Mr Bush in particular has given a lot of thought. Reflecting
on what we've been through with the banking meltdown, it has been
discovered that banks were either taking excessive risks or they
were taking risks they didn't understand or they were taking risks
that they thought they had laid off, either through securitisation
or through insurance and in fact they hadn't. It was a complete
mess and it has been a major cause of the difficulties that the
world economy and the British economy are in at the present time—not
the only cause, but a major one. So I have some questions and
I think your answers will be very helpful to us.
The auditors were the dog, or one of the dogs,
that didn't bark. Was this because they were unaware of the problems
that I've just mentioned? If so, what have you to say about that?
Were they aware of them but they were not required by law to make
anything of it? Did they nevertheless privately warn the management
and the boards of these banks of their concerns, even though they
were not required to do anything on paper or publicly? If these
auditors who were disquieted warned the board and the management
and they didn't feel that the board and the management were taking
sufficient notice of what they were saying, did they say to the
regulatory body, for example, "I'm worried about this practice
that's going on. You might like to look at it"? If not, why
not? Did confidentiality, as it were, trump the wider public interest?
I'm sorry to ask so many questions but they're all interconnected.
Finally, what changes, if any, would you think would be sensible
in the public interest to enable auditors in future to be a dog
that does bark?
Mr Bush: To answer the question on whether they
spoke to regulators, all I'm aware of is that I think in the Banking
Act there was a requirement for auditors to have a conversation
with the regulators. I think that was the 1987 Banking Act.
Lord Lawson of Blaby: It was. It's the
Act I introduced. That's right. That's why I'm particularly interested
in it. I hoped something would come of it but it doesn't seem
that it did.
Mr Bush: I think it disappeared from the Financial
Services and Markets Act 2000. That said, I think that the biggest
factor has been the loss of prudence in accounting standards.
The principle of prudence was put in the law to protect the creditors
so that when a company makes a distribution, or basically operates,
the creditors aren't left with a bag of poor assets and therefore
every asset should be valued on a reduce-to-cash basis. There
are several problems with IFRS; I'll give just two in respect
of prudence. First of all it has a bad debt provisioning model
that is backward looking. It only requires provisioning for loans
that have already shown an "impairment event", which
is a bit of jargon in the standards. It doesn't allow you to take
a forward assessment of risk and say on an historical basis, "Customers
like that won't pay X amount and therefore we reduce our loans
by that much". Therefore there is an inbuilt imprudence in
the bad debt provisioning model. It went into the standard in
2003 at the last minute and then became operative within the UK
and Ireland from 2005 onwards.
The same standard has also excluded the general
presumption to assess and disclose contingent liabilities. So
you have a double problem within that standard of assets that
may be over valued and then revert to the mean. Also, not disclosing
contingent liabilities is a particular problem if you have had
securitisations where, say in the case of some banks, you had
make good clauses between the bank and the securitised vehicle,
therefore if the loans in the securitised vehicle went bad the
bank had to put good assets in. That's effectively a margin call.
My understanding is that one bank that failed, initially with
a liquidity problem, then had very large margin calls drawn against
its securitised vehicles and I cannot find a contingent liability
note in those accounts. If you look at the website you can find
the word "contingent" in the directors' remuneration
report but it does not appear in the note to the accounts. So
I think there is a deficiency in that standard.
That is pretty serious in itself because you're
dealing with over-valued risk on one hand and possible cash outflows
on the other. I believe that accounts that miss these things out
or overstate assets are falsely giving boards the green light,
because it's not just the process of getting the accounts signed
off, it's the due diligence and the work that goes into producing
a set of accounts and then the board understanding their risks
from reading those accounts as they sign them off. I believe that
these deficiencies are a major factor in the banks that failed
within the UK and Ireland. I say the UK and Ireland because the
UK and Ireland is a common standards area.
By a bank failure, I categorise that as a bank
that had lost 100% or more of what it had last claimed to have
had as share capital and distributable reserves. There are at
least eight banks that lost more than 100% of their capital, which
is almost unheard of in modern times. In each case the bad debt
provisioning is a major factor. I can add a ninth bank, which
is an Icelandic bank operating in the UK, and for all of them
the bad debt provisioning level sinks; for some of them it absolutely
plummets. To reduce bad debt provisions by just 1% of the balance
sheet basically increases the capital base by 20%. Certainly within
Ireland you can see the lending capacity of the Irish banks taking
off as the bad debt provisions are going down. The problem then
gives a circular macroeconomic effect: there is more money in
the economy, the collateral looks good because house prices are
going up, but as we all know in the long run asset prices tend
to mean revert. So I believe that that was a major factor.
IFRS, International Financial Reporting Standards,
came via the EU but the EU only required them to be applied for
group accounts. The UK and Ireland were relatively unique in allowing
them to be used in banking companies themselves, therefore there
is the possibility of absolutely no risk assessment whatsoever
if companies are using that standard within banking companies.
The French are using French GAAP for banking companies and banking
holding companies and you can see from looking at their accounts
that they are making prudential provisions. Sorry, it is a rather
long answer, Lord Lawson.
Q86 Lord Lawson of Blaby: It is an
extremely helpful answer. It is a very serious problem and you
have obviously very thoroughly thought about it and made a number
of interesting suggestions. I think, Chairman, it might be helpful
if we could have a short note—I know you have written about
them in various places—summarising the changes that you
propose should be put in place. That would be extremely helpful
to us.
May I ask one last quick question? You mentioned
a lot of things; all of them seemed to me to make very good sense.
One thing you didn't mention was mark-to-market accounting. Do
you feel that that needs to be re-examined?
Mr Bush: Mark-to-market is quite difficult.
We always had mark-to-market accounting for the most liquid positions
on dealing books of stockbrokers. It's the best way of accounting
for what they do. Very liquid positions were accounted for on
a mark-to-market basis I think from the early 1980s, possibly
the late 1970s. What happened with IFRS was that the general presumption
that you shouldn't mark anything other than the most liquid positions
to market was again relaxed to create a general presumption that
you could almost value anything, not only on a market basis, which
creates a problem if you have a very large volume because if you
start cornering the market you can make the price of the asset
go up. The EU Intervention Board used to do that and the Bank
of England have done it with quantitative easing. So the problem
is if you allow that as a method of recognising profit, you can
make your own profit by just cornering the market. UK GAAP required
a block discount if you had large holdings.
Secondly, there are a group of assets where
you are allowed to mark to model, so not even marking to a market
but effectively trying to guess what a market does, which I think
is quite difficult because it's very difficult for any one player
to estimate what the total demand in a market is. You actually
need to know how much everybody else is holding to even begin
to plan. I believe that that aspect of IFRS was fairly well regulated
outside of the territory of the United Kingdom because I think
it was seen as a serious problem. I think it was more of a problem
in the United States and it was certainly a problem in certain
parts of Europe but, as we know, one major UK bank went and bought
a Dutch bank where that balance sheet effectively collapsed shortly
after the acquisition. So I think mark-to-market is a bit of a
mixed bag. I've been looking at how the standards have been applied
in different territories and how that has panned out.
If I may add, in my short note I think what
I'm going to say is we need UK GAAP back. London is a financial
services centre because it has competitive advantage in a legal
framework and a trustworthy information framework of accounting
standards. For some reason we decided to go for an international
model that is potentially a race to the bottom and I do not see
the sense in the United Kingdom giving up sovereignty of accounting
standards. It's as simple as that.
Q87 Lord Forsyth of Drumlean: My
question is for Mr Bush as well and I think he may have touched
on the answer at the end there. First of all, your paper is absolutely
devastating. We had an earlier inquiry where we looked into the
financial crisis and one of the questions that remained hovering
in the air was: why did the auditors not pick this up? Why did
these very clever non-executive directors not see it coming? The
first part of the question was should we go back to GAAP, which
you have already answered. The second part of the question is,
given your analysis, which really explains why particular banks
got into particular difficulties and gives a reason and points
to the failures in the accounting system, why is this not a bigger
issue? Why is this not a great raging debate and why is nothing
being done about it? What are the forces that are preventing this
being addressed, given that we are now some way out from the crisis
and there has been endless analysis about it?
Mr Bush: It's an extremely arcane area and it's
very difficult to start a conversation on the subject. Very often
people will just freeze if you even start to mention it. Dare
I say it, it's a bit like Murder on the Orient Express.
If you start to find who was involved there are an awful lot of
people that had their go in it. It seems to have crossed various
Departments of Government; various regulators seem to have signed
up to it. Dare I say it, IFRS was really an idea from round about
the year 2000 and I think it was a bit of a gimmick. I think it
sounded good to have international standards. It sounds good,
like having one model of international law it sounds good, but
I think it has failed at the practical level.
I think it has also failed politically, because
in my view the difficult things that have been left out of the
accounting standards have been left out because they didn't suit
the American accounting profession. Things like assessing risk
and assessing contingent liabilities are things that the American
accounting profession didn't want to address and that seems to
have been the most malign factor in some of the standards in particular
being poor.
What I found interesting in looking at the law
over the years is that company law, through being connected to
the DTI investigations department, had worked out all the ruses
that people had got up to over 100 years and safeguards were put
into the legislation. What happened in 2005 was all of those safeguards
were taken out in one go. The fact this is a crisis that has been
largely caused by accounting is good news because I think we can
regain our faith in human beings. Most people were not stupid
or greedy, they were just doing what they were told to do. I think
it would be good if the narrative can move on from greedy bankers
and whatever to putting the system right and accepting that people
have failings but basically if you allow a banker to produce a
paper profit, they will.
Lord Forsyth of Drumlean: So, go back
to Old Kent Road, start again?
Mr Bush: Absolutely, yes.
Mr Kingsley: I just wanted to maybe present
a slightly different view to Mr Bush's. I have been a bank audit
practitioner for many years; I now sit on a board of a financial
institution as a non-executive. The thing that strikes me about
what has happened to accounting standards over the last 35 years
is that they have become extremely complicated but they seem to
be set and framed in a way that is divorced from reality. Taking
fair value accounting as a very good example of that, the standard
setters, almost using economic principles rather than principles
of prudence and reasonable reporting, have come up with a set
of standards that companies, banking companies in particular,
are required to adopt. The profession has almost slavishly had
to follow the guidance that has been given through these accounting
standards, almost right or wrong. And so, when I was a kid there
was a great store set on the truth and fairness of accounts, which
could be roughly translated as, "Do these accounts make sense?"
That seems to have gone out of the window and been replaced by
something that says, more or less, "These accounts comply
with accounting standards", regardless of whether they make
sense. That is clear from the comments of the Lehman examiner,
Mr Valukas. That was over in the United States, but I think similar
concerns can be levelled here too.
As to your dog barking, I found that intriguing.
I think if we get to the stage where we have to rely on the external
auditors to flag fundamental issues in banking institutions, I
think we're in a bad place. You may be shocked by that, but I
think the problem is much deeper than that and you are almost
asking the wrong question, as it were, because they reflect an
expectation gap as to what external auditors are really capable
of doing.
Q88 Lord Lawson of Blaby: Let me
make clear, I did not say—
Mr Kingsley: No, I am not criticising.
Lord Lawson of Blaby: No, I am just clarifying,
and you're perfectly entitled to criticise anyway. I was not suggesting,
for a moment that the only failure—if there was a failure—was
on the part of the auditor. I don't think there is any way in
which auditors should bear the whole burden of reducing systemic
risk, or whatever you like to call it. The question is whether
auditors have a role to play. It seems, from what Mr Bush said,
that he accepts that auditors could play—with the sort of
changes that he was advocating—a useful role, even though,
of course, there is no question that they can bear the whole burden
of improving the system.
Mr Kingsley: I think you're absolutely
right, which sounds strange given what I have just said. I think
the issue is that auditors are spending far too much time on trying
to deal with accounting standards, disclosure issues, and all
that kind of detailed stuff, and are not stepping back and seeing
the wood for the trees. By which I mean that if the auditors of
some of the more unbalanced banks in this country, in terms of
management or balance sheet or risk, had stood back and looked
at the business, looked at the people who were running at it,
looked at the degree of oversight provided by the finance function,
by the compliance function, by the risk function, by the NED,
and so on, they might have thought, "Well, wait a minute,
this thing is going to go wrong".
Now you can say exactly the same about the supervisors,
you could say the same about the analysts, but the auditors are
pretty close, they're in there and they can see it—not every
day but pretty regularly—and they can see, because they're
there over a long period of time, how it is that risks and balance
sheets and businesses are evolving. The truth I think is that
for some of our banking institutions, the size and complexity
got away from the capability of management process and systems
to cope and identifying that is something that I think the auditors
could and should have contributed to.
Q89 Lord Tugendhat: May I ask two
questions? The first is that it has been said, by a number of
people, that non-executives of banks did not always understand
very clearly the complexity and the underlying principles of what
the business was engaged in. To what extent do you think that
accusation could be levied at auditors? Of course these are highly
trained people; of course they have a considerable technical knowledge
of the technical subjects they are dealing with, but to what extent
do you think that sometimes they were quite simply out of their
depth in understanding the implications of some of the activities
that they were looking at?
Mr Kingsley: Sorry, I don't mean to monopolise
the conversation. There is no doubt, I think, that you're right.
Because if management was out of their depths then either the
auditors had to second guess them or they were just as, if you
like, blind as their audit client.
Q90 Lord Tugendhat: Another thing
that has arisen, when one looks at some of the banks that got
into trouble—the Royal Bank of Scotland, Northern Rock,
Lehman Brothers, and I suspect Anglo Irish would come into this
category—you have the phenomenon of a very strong chief
executive; a very dominant character. We have seen, in some of
the banks I have mentioned, these people who have dominated their
colleagues—both executive and non-executive. To what extent
do you think we've seen the phenomenon of the very dominant chief
executive dominating the auditors as well?
Mr Kingsley: If you like I can monopolise the
conversation. I don't think you can run a financial institution
effectively without a lot of balance around the place, particularly
in the boardroom and particularly in the executive group. By which
I mean that there are people in the executive group who are charged
with running the business—delivering profit and value to
shareholders—and there needs to be a group that provides
some challenge and oversight internally, and that is the finance
function, the risk function, the compliance function and the internal
audit function. If those functions are either not present in the
executive committee room, or they're not listened to, or they
aren't up to the challenges of the particular institution, then
the management of that institution will become unbalanced. The
reason that is important, and why that is different in banking
from most other industries, is that banking is a very agile industry.
It's a virtual industry with virtual products and it can expand,
both in terms of size and in terms of complexity, very quickly.
If you compare it to a supermarket chain, if I want to double
the size of a Tesco or a Sainsbury's, it's going to take me a
long time to do that. Even if I could get the planning permission
it would take me a long time. If I want to double the size of
a bank balance sheet it's not going to take me very long, provided
I can acquire the capital to allow me to do it.
That, combined with the virtuality of the products
that they sell—most banking products are accounting entries
wrapped up in a legal contract, which is why they can be so complex—means
that a bank is capable of great complexity and capable of great
agility, which makes it all the more important that there is challenge
in the boardroom; not just between the non-executives and the
executives, but within the executive group. If the challenge isn't
there within the executive group then the effectiveness most of
the external governance will likely be lost.
Dr Niels: A brief related point. In our study
there were basically two sectors that stood out as particularly
complex to audit, which were insurance and banking. It was, I
think, common knowledge that in banking there were only three
of the four audit firms that do audit banks, so in the banking
sector that reduced choice by one. In addition you then have the
special rules on conflict. So you have a banking relationship,
so that firm cannot also be your auditor or you can't audit that
bank. So in banks the whole problem of choice has always been
even worse, if you like, than in many other sectors.
Mr Hayward: If I may just come back. I think
Lord Tugendhat has identified one of the fundamental weaknesses
of corporate governance, in relation to the dominant chief executive.
It's not fashionable to say so but my experience of corporate
governance, which is now the field in which I work—10 years
ago I was a bank auditor but now I work in corporate governance—is
that it is to a very large extent dependent on the extent to which
the management wish to make it work. If the chief executive does
not want corporate governance to work, it's very difficult for
non-executives to do anything other than acquiesce or fire him.
A chief executive is able to be dominant because he is successful,
almost always. They're not always bullies; sometimes they are
very subtly dominant and, therefore, being successful, can be
extremely difficult for non-executives to deal with.
I don't think there is a very easy way around
that. It is a fundamental weakness in corporate governance. I
raise it now because sometimes you hear corporate governance being
talked about by regulators, for example, as if it were self-regulation.
The expectations of corporate governance for preventing corporate
disaster are very high. I don't think that corporate governance
is always up to meeting the expectations that are placed upon
it. Sometimes they are, and corporate governance can make a good
situation better, but one of the ingredients necessary to make
corporate governance as good as it can be is a good dose of humility
on the part of the chief executive. Not very many chief executives
get to that position by practising humility, so there are some
real human problems in here and we should be careful how much
we expect from it.
Q91 Lord Best: What about corporate
governance being proved, and would the power of a dominant chief
executive be moderated if we had a different system of appointment
of external auditors? Could we strengthen the independence of
those auditors from either the management or the board? I'm thinking
particularly about the change that I know exists in America, where
it's a statutory requirement for major companies for the audit
committee to appoint the auditor. Would that help in the UK and,
indeed, in the EU?
Mr Hayward: I doubt it. In practice in this
country, the audit committee would have a veto on the appointment
of auditors. In practice, in America, the audit committee requires
the management to do the leg work on managing the process of selection
of auditors. In either case, both management and audit committee
are involved. Where the formal responsibility lies I don't see
as making an immense amount of difference.
Dr Niels: Just to add to that, my impression
is that the audit committee clearly has a role and is playing
a good role, and management also has a role in inputting into
that. The other side of the choice could be to give more of a
role to the investors themselves. So, for example, the appointment
of the auditor could be made a more prominent item at the AGM,
or there could be more ongoing discussion or questions from the
investors to the audit committees about a choice of auditor.
Q92 The Chairman: Mr Hayward, were
you suggesting that, in the US, the non-executives would expect
the management to do most of the leg work, as you put it, to recommend
the choice of auditor but that isn't the case in the UK?
Mr Hayward: No, that is the case here. The difference
is that in the US it is formally the audit committee that makes
the appointment.
The Chairman: But that's a formality?
Mr Hayward: It's a formality, yes.
Mr Bush: Right, can I just—
Q93 Lord Lipsey: Mr Bush, I hope
this question will be such as to enable you to come in with whatever
you were going to say. Another way of skinning the cat might be
to insist that the firm changes auditors every five or seven years,
or if you weren't going to be that draconian you could insist
that it at least puts audit out to tender every five or seven
years. Do you think that would help the situation? And are the
costs involved so high that we should, nevertheless, rule it out?
Mr Hayward: The problem you have to deal with
here is that you have, on the one hand, a presumption that longevity
reduces objectivity, which might or might not be a valid presumption.
On the other hand, you have the distinct probability that newness
will bring ignorance. So you have to choose between the possibility
of impaired objectivity versus the great likelihood of reduced
competence through ignorance. The only academic research I'm aware
of on this comes from Italy, about 10 years ago, where they did
a study of audit rotation; Italy being one country where they
do require mandatory audit rotation. That concluded that the risks
of audit failure in the early years, after a change, were greater
than the risks of audit failure in the later years.
Mr Bush: Can I add, I think this audit independence
issue coming from the US is slightly addressing the issue in the
wrong way. In America, the role of the finance director doesn't
exist. They have the chief financial officer and they're very
much lower down the food chain than the chief executive. Certainly,
when I was in practice the finance director was the key, and the
test of auditor independence was whether the finance director
had captured the auditors, rather than the chief executive had
captured the auditors. Therefore, this is a debate about auditor
independence from a regime where the chief executive is all. There
is nuance, of who's captured who, which I don't think is necessarily
picked up. I think the risk to the public, and the shareholders,
is if the chief executive has captured the finance director and
then the finance director has also captured the auditors, and
it seems to me you need that level of failure. But generally,
within the UK, I don't think that audit independence is a significant
issue.
Dr Niels: On the question of rotation, there
are clearly switching costs and there is investment required,
in time and money, for a new audit firm to get to know the company.
That can take several years in some cases and, indeed, in the
early years things may go wrong. Therefore, perhaps one question
to ask the firms themselves is: you already have rules on audit
partner rotation and practices on mandatory audit partner rotation.
You could ask them how that is working. Has that already produced
systems where you can, internally within the firm, overcome switching
costs? Are there systems in place that things can be handed over
to the new auditor quite easily? So it may well be, if that is
the case, that the transition to mandatory audit firm rotation
is not that big a step change.
Q94 Lord Lipsey: I take the point
that research suggests there may be audit failure in the early
years. However, you also need to ask whether there could not also
be audit success in the early years. That is to say, a new firm
comes in and it spots something that has been going on for years,
which is dangerous to the company. You could have both an increase
in failure and an increase in success, and then you'd have a difficult
judgement: whether it was worth paying the price of the former
for the latter.
Mr Hayward: That is a possibility. But there
are very few instances of accounts being restated following a
change of auditors, which suggests that there are not really material
discoveries of the sort that you suggest.
Q95 Lord Hollick: We have seen suggestion
that there is very little to choose between one audit firm and
another. They have to comply with the IFRS, so therefore they
have little discretion. They are technically competent—we
hope—so price is possibly the only thing upon which they
compete. Is there any evidence that if you change auditor there
is in fact a saving for the company?
Mr Hayward: If I may, I think they compete on
two things at an audit tender—and remember audit tenders
happen very infrequently, so you only get market competition between
audit firms at very infrequent intervals. When they do they compete,
it is on two things: one is price and the other is the quality
of service, which is service to management.
Q96 Lord Hollick: Which, I think
we've seen from some of the papers presented today, could lead
to a position of conflict, where the auditor has already provided
advice and is then auditing the advice it has provided.
Mr Kingsley: With respect, I think it is a bit
worse than that. Auditors find it, I suspect, very difficult to
maintain what is almost a schizophrenic position, in that on the
one side they are responsible to the users of the accounts—primarily
the shareholders—but on the other side the people that they
relate to every day is the management. Therein lies, I think,
a difficulty. I think what is curious to me is that there is a
big variation. We talked about the differences of different firms.
There is one difference, which is that some firms can take anything
up to £1.10 in non-audit fees for every £1 in audit
fees, and others are taking 25 pence. Given the size of the firms,
relative to each other, which means they are relatively similar,
this isn't a statistical aberration. There is something going
on here, in terms of internal rules and guidelines or possibly
some firms not being very good at cross-selling their services.
I don't know which it is but it is curious, nevertheless.
Dr Niels: There is evidence that the greater
the concentration in the sector and the less the switching the
higher the audit fees are. I think it is worth distinguishing
between two types of competition concern, so one is a narrower
concern about: this is a concentrated market, is there price competition,
quality competition, between the Big Four? It's the kind of concern
that you would expect the OFT or the Competition Commission to
look at. Of course the two are not unrelated but there is a wider
concern about choice, as such, and the systemic implications of
this lack of choice. That is perhaps less to do with the audit
fees which, at the end of the day, are a small percentage of a
company's costs.
Q97 Lord Forsyth of Drumlean: I wonder
if we could pursue this idea of the alignment of the auditors
with the board or the top management team, and I wonder what you
think about the ideas that have been put forward by Joshua Ronen,
the professor of accounting at the New York Stern School of Business,
of having some kind of financial statements insurance approach—which
I must say was a completely new idea to me—which does have
the advantage of at least aligning the shareholders' interests
with the auditors'. I don't know what your view is on that.
Mr Kingsley: Can I take that? I have always
been fascinated by it. I came across this concept about 15 years
ago. It's been around for a while, believe it or not, although
being arcane it has probably been buried under a lot of cobwebs.
I think it is interesting, in the sense that when something goes
wrong in an audit the audit firm becomes an insurer. Yet it doesn't
act like an insurer in the work that it does particularly. It
doesn't set its fee levels in relation to risk by way of example,
which is what an insurance company would do.
If you track back and think of what the accounts
are and who is responsible for them, they are management's accounts.
You read the audit report, that's what the audit report says,
"These are management's accounts". The rules and regulations,
in particular the law, are very explicit in laying responsibility
on management for producing the right numbers, with requisite
punishment if they don't. That I think that would start a chain
of thinking which might lead you down to say, "Well, maybe
we don't need mandatory audits of companies where there is external
capital participation, where there are shareholders, et cetera.
In those circumstances, you would go down a number of steps, one
of which would be, "Okay, if management doesn't necessarily
need external audit they do need internal audit". I think
that's almost a sine qua non. You then have to establish very
clear events of claim and responsibility, so that you know what
kind of insurance policy you're writing, and obviously you can
still permit management to have external audit because they can
elect to do so. Obviously they would then have to justify those
costs to their shareholders, but they could still do it, and then
you have an insurance policy of some kind. I suspect the pool
of money, in terms of audit fees, would fund quite a decent policy.
I've never looked at it and I'm not equipped to look at it, but
it certainly is something that is worth exploring.
Mr Bush: That is very interesting because, about
six years ago there was a debate about auditor liability. Some
investors looked into this and in 1929 there was a proposal from
Scottish Widows that they were going to insure financial accounts,
rather than the accountants doing it. Then in fact the accountants
decided to offer unlimited liability as their trade-off. I think
they worked out that if the insurers did it, the insurers would
end up employing the auditors; therefore, the auditors decided
that it was a better proposition to go for a model that tried
to avoid problems developing, as a fire alarm rather than fire
assurance, I think, is the way of putting it. I think it is an
interesting proposition. My understanding is that the core statutory
proposition is that, because a company has unlimited liability,
there is the risk of inherent corruption of whoever is running
it defrauding the creditors, and that is right at the root of
the law, which is why, other than some of the very small companies
that have been exempted, most companies in Europe now do need
statutory audits to protect the creditors, irrespective of whether
they are listed or not. I'm not sure whether the insurance companies
could provide that, but they probably could.
Q98 Lord Smith of Clifton: Do audit
firms still "low ball"—that is to say, cross subsidise—on
their charges for audit work, in anticipation of additional and
perhaps higher fees they expect to receive from their audit clients
for non-audit work; or is this a thing of the past? You did say,
just now, that the ratio between the audit income as opposed to
the non-audit income varies. Could we have your comments on that,
please?
Mr Bush: I believe it is a thing of the past.
In fact, I think that the change in the regulatory and the accounting
standards framework has been very profitable for the firms. I
think they probably don't need to cross-subsidise or low ball
in the way that they were, and I think that the accounting regulatory
regime has basically worked that problem out of the system. That's
my view.
Mr Hayward: That has been largely my experience
also.
Q99 Lord Lawson of Blaby: Leaving
aside the cross-subsidisation problem there is also a kind of
conflict of interest, which I was referred to by one of our witnesses,
in terms of the management versus shareholders' interests conflicting
to some extent. Do any of you feel that there is a conflict of
interest problem to some extent, when an accounting firm will
both be the external auditor and do advisory work for the same
company or, alternatively, doing external and internal audit?
Do any of you feel that there might be some sense in saying, "You
can't do that"; saying, "You can either be the auditor
or the advisor" to a particular firm? They can obviously
do advisory work for other firms but not for the same one.
Mr Hayward: I have a rather unfashionable view
on this: I think there is certainly an issue of perception but
I think the perception is not particularly grounded in the reality.
I have seen some excellent audits done by audit partners, who
provide lots of extra services to their clients, but they were
intent on helping that client do the right thing and do it well.
I have seen very second-rate audits done by audit partners who
had no advisory work and weren't very interested in the client.
The attitude of the auditors is much more important than any number,
or ratio, that you put on the non-audit fees. This is a human
issue not a simple mechanical one of, "If I get 75% of your
audit fees and non-audit fees, I'm okay, and if I get 125% I'm
corrupted". It doesn't work like that.
Lord Lawson of Blaby: Could we hear whether
any of the witnesses take a different view, or whether you all
agree with what has just been said?
Mr Kingsley: I take a different view despite
the fact I've known Jonathan for a long time. I think it is an
issue of culture and it depends—there's almost a question
that underlies the question you've posed which is: what are audits
for? What do we expect from these processes? If you take the view
that public auditing is a public good, it's a public service,
then I find it difficult to see how you can have a culture of
public service sitting side by side with a culture of strong commercialism,
as it were. Not that commercialism and the public service are
necessarily incompatible, but I think that the culture of auditing,
if it was seen as a service to the public and not as a service
to companies and management, would lead you quite clearly down
a path of saying, "Firms that do auditing shouldn't do other
stuff". So the question in my mind comes back to saying,
"What do we expect of audits and auditors?
Dr Niels: Yes, in a way that would be
not a demand side role, that if you audit a firm, you can't provide
that company with consultancy services. You can also look at it
from the supply side, which is you have to be an audit-only firm
and I think that is a question that hasn't been debated as much
as the demand side restrictions. I think it is worth thinking
about.
Mr Hayward: But it is a very difficult question,
because what lies behind that is the question of what you want
an audit to accomplish. If we make it completely independent,
then you're saying, management do their own thing and the auditor
comes along afterwards and passes judgement on whether it's acceptable
or not. That is an entirely separate, distinct and potentially
negative role. Alternatively, you have the role that auditors
currently occupy at its best, which is a "right first time"
role, to ensure that companies get their accounts into a condition
where they can deserve a clean audit opinion. The majority of
companies do get clean audit opinions and that doesn't mean that
the auditors are blasé. A lot of those will have had a
great deal of negotiation behind the scenes to get them to that
stage, and that is a useful audit output that I wouldn't want
to dismiss. I think if we are going to have that sort of audit,
the right first time sort, then doing advisory work can improve
the auditor's ability to do it, because he has a better understanding
of the business and of the motivations and pressures of management.
It places a great deal of importance on the attitude of the auditors
and the culture of the firm. If you go to the other extreme and
have it as an entirely independent thing, you're now into a different
situation. You are going to have a more confrontational relationship
with management, which will not necessarily produce a better audit,
in fact. So I think there's a very basic distinction here between
two fundamentally different approaches to audit.
Q100 Lord Best: Lord Lawson was making
the point or asking the question whether or not internal audit
as well as external audit could or should be in the hands of the
same auditors, or whether one should prohibit the same firm doing
the internal audit operation. Would you go so far as to say that
you wouldn't worry about that either?
Mr Hayward: I would argue differently on theoretical
and practical grounds. On a theoretical basis, I could make a
good case for saying they could be done by one firm. If you had
no internal audit function, then the external auditor would do
more work. It would look very similar to internal audit work.
In practice, if I'm a non-executive director, I would like more
than one source of assurance, and I think it would be very foolish
of me as a non-executive director to put all my eggs in one assurance
basket.
The Chairman: I think Mr Bush wanted
to say something on this issue.
Mr Bush: Could I just add one quick comment
on this? I think one area where I would have concern is tax and
tax compliance, because I would be concerned where there's a skeleton
in the cupboard that the auditor isn't incentivised to uncover,
and I think some tax planning can tie companies in knots for years,
and if that is audited by the same firm that advised on the tax
planning, then you're going to have a real problem, because you
can be pretty sure the chief executive won't necessarily understand
it and the problem will linger for quite a long time. So I think
I would distinguish tax as a particular area.
Q101 Lord Lipsey: I want to just
follow in, if I might, on the point I was trying to raise, because
I think you used a good phrase in saying there are human issues
involved, but the trouble is that doesn't necessarily cut the
way of your argument. I mean, the human issue involved is if you
are the auditor partner and you know that your firm has twice
as much consultancy work to take—in extreme cases, they
have audit work coming out of the firm—is that not going
to change the nature of your relationship with the finance director
and his staff? Now, you may say that might lead to—I think
you just did—a better audit, because you are so keen to
get on with him well that it leads to a better audit, but going
back to the perception issue, I wouldn't think it would be perceived
as a better audit if it was done between two people who are big
chums, because the human perception was that they were in each
other's pockets.
Mr Hayward: Indeed, and I think the reality
of this is very complex, and I think as far as perception is concerned,
it is probably a lost cause. The public will look at the simple
appearances. If the purpose of an audit is to increase the public
confidence in the financial statements, then there's not much
point in trying to fight this battle.
Mr Kingsley: Can I just go back to Lord Lawson's
point on internal audit, because I think a company that outsources
its internal audit hook, line and sinker is making a mistake,
because like any outsourcer, you need to keep control of the relationship
and direct the work that is being done. If the company gets itself
into a situation where it doesn't have anybody who is doing that,
then the value of internal audit has diminished significantly.
There is a very big difference, at least in my view, between internal
and external auditing. Internal auditing, and particularly the
leadership of it, ought to be almost part of the management team
and provide the kind of challenge to decisions that are being
taken on a recurrent basis that an external auditor simply can't
do.
Q102 The Chairman: While we're on
the subject of internal audit, do you think it should be mandatory
for listed companies?
Mr Kingsley: I think if you want the insurance
route, for certain. For me, it's a management decision, because
it's essential for the management group to have a function that
is overseeing the quality of processing, what the CFO is doing
and what his group is doing. By and large, I would say the answer
is probably yes, but it would depend a little bit on complexity.
Q103 The Chairman: But then presumably
on that basis, internal audit could be just that, it could be
internal, without bringing in any external advisor to look at
it?
Mr Kingsley: Absolutely, and in the largest
places it should be, probably.
Q104 Lord Hollick: Can I just ask
the following? It's become clear, certainly in the financial services,
that both the external audit—which has been described in
various not particularly flattering ways by you gentlemen—and
the internal audit failed to look at and address the real issue,
which was risk and judgement around risk. Do you think the recommendations
made by Sir David Walker around the risk committee are that the
right way to address the risks in the financial services, and
is that another role for accounting firms to play a part in? Should
those be made mandatory? Should they be externally advised? Coming
back to your question about the quality and diversity of assurance,
it seems to me that's a most important part of the framework going
forward for ensuring we don't get into the same mess again.
Mr Kingsley: I think that's right, Lord Hollick,
but whilst the auditors can play a role here, the power of the
Walker recommendations goes back to something that I said earlier,
which is around the balance in the board and the amount of challenge
and oversight that's provided internally and externally. Walker
was about balance, challenge and competence for the most part,
and I think many of his recommendations are absolutely spot on,
and if they are implemented in full, we hopefully will see fewer
recurrences of what we have seen in the last three or four years.
It will happen again, but hopefully it won't happen with the same
force. The auditor's role in those circumstances I think is to
provide oversight as to whether what has been done to implement
the recommendations has been done to effect rather than to help
in the implementation, if you see what I mean.
Mr Hayward: I think you happen to have touched
on a very important point here with internal audit, and I find
it very pleasing that you have put it on your agenda, because
it's unusual to find internal audit mentioned very much. It's
hardly mentioned. Walker mentions internal audit about four times
and always to its disadvantage compared to risk management. Internal
audit is only mentioned in the UK Corporate Governance Code
as one of the things that the audit committee has to look after.
There is no real regulatory emphasis on the importance of internal
audit, and I think that is something that could usefully be corrected.
Q105 Lord Tugendhat: The FRC's Market
Participants Group was established in 2006, I think, and it has
published several reports. Do you think it has had any effect
at all, or how would you assess its impact?
Mr Bush: Can I come in? I think it's in an invidious
position. I think it's very difficult for any regulator to effectively
change the shape of the market. I'm not aware of a market being
able to unpick an oligopoly, so in terms of competition, if there's
a perceived oligopoly, I think it's one of the reserve powers
of Government and politicians to resolve. I was chairman of a
working party for about six months on this issue, and it's a very
good way of losing friends.
Q106 Lord Tugendhat: Can I approach
it from another point of view? The Market Participants Group has
a preference for market-led rather than regulatory action. I do
too, lots of people have a preference for market-led, but I think
we've established both in this discussion and in the other ones
we've had that the market doesn't lead in this area, because for
all the reasons that you have gone over and others have, the way
that auditors are appointed is not proving very susceptible to
market forces. So market-led doesn't get us anywhere. Is there
a case therefore for regulatory action in order to widen the market,
and if so, how would you see that working? Secondly, it may not
be a very probable thing, but suppose one of the auditors was
to decide to jack it in, if one of the auditors was to decide
that they were going to withdraw from a particular area of business,
wouldn't that require perhaps regulatory intervention to try to
maintain even the level of competition that we have?
Mr Bush: There is a structural problem with
auditing that doesn't seem to exist in other professions. If I
take architecture, the law, in all of those, a group of people
can pull away and set up as a boutique. The independence rules
of auditing mean that you can't, I think, have more than one client
who is more than 10% of fee revenues. It's very difficult to get
seed corn client base to be able to break away. Advertising agencies
can do, almost every other industry can have breakaway people,
but auditing seems to be one area where your staff get locked
in and the client base gets locked in. I think that's why market
solutions don't work, and I think there's nothing to stop the
whole profession just becoming one firm, if it wanted to.
Dr Niels: To be fair to the Market Participants
Group, I think yes, market-led, but what it focused on was trying
to remove certain regulatory obstacles as well to liberalise the
market and facilitate market movement, such as the growth of the
mid-tier firms, which hasn't happened. It's very difficult. One
factor is indeed the factor that Tim mentioned, but it requires
a lot of investment for mid-tier firm and gradual growth to become
a significant player. That's very difficult. It will take a long
time. On the other hand, we had a Big Eight 21 years ago and Big
Six 13 years ago. There is no reason why in principle you could
not have a market with six players or eight players who have that
required minimum scale. But we arrived here through some idiosyncratic
processes, including the approval of mergers by the competition
authorities in the past, which with hindsight were perhaps not
such a good idea, in particular the six to five merger, the Pricewaterhouse
/ Coopers & Lybrand merger. With hindsight, the European Commission
said, "Okay, we allow the six to five merger, but we wouldn't
allow a five to four merger". Well, five to four happened
of course through market forces and we are where we are, but there
is not a particular reason to try to get back to a situation where
you have six or eight firms, because then that's probably the
main way of avoiding the problem currently of lack of choice,
which leads to systemic risk, if indeed one of the Big Four were
to go out of the market, as you mentioned.
Q107 Lord Lawson: Very briefly, please,
on the audit dimension to the banking disaster, which I readily
admit is not the only dimension, but it's the only one that is
relevant to our inquiry, do any of you have any doubts and concerns
about VAR and how it operated in practice, and if so, what should
be done about it?
Mr Kingsley: The trouble with VAR is it's economically
extremely elegant and very persuasive in the way that it attempts
to model what happened in the past, produces a curve of outcomes
and therefore creates an expectation of what might happen in the
future, and that is where I think the problem is. There are two
issues. One is that in order to understand what happened in the
past, we need to go back a long way, and the models that were
used to drive VAR generally did not do that. So they didn't capture
some of the worst things that happened in the markets in the past.
Secondly it caused management to err in two bits of thinking:
one is they could almost predict what was going to happen in the
future, but secondly, there's something very beguiling about numbers.
If you can reduce something to numbers, like risk, you think you
have it licked. You think that you have it under control.
Lord Lawson: It's the illusion of certainty.
Mr Kingsley: Yes, and I think that is the biggest
problem, so management would be presented with VAR numbers. They'd
see, "Tomorrow we're at risk of £25 million. Tick"
and the fact that it might be £125 million because of some
black swan or whatever it happens to be wasn't today's problem,
it became tomorrow's problem. So it's the illusion of certainty,
as you absolutely put it.
Q108 Lord Lawson: So what's the solution?
Mr Kingsley: The solution is to use VAR as part
of a more balanced approach to the management of risk, of which
judgement and common sense ought to play a large part, and I suspect
didn't in some institutions.
Q109 Lord Lawson: Do auditors have
a role here?
Mr Kingsley: I think they have a role in observing
the quality of decision-making that is being made. It's back to
standing back and looking at the quality of the institution. One
of the problems about being an auditor is that you're only as
good as your client, at the end of the day.
Q110 Lord Forsyth of Drumlean: Sorry
to interrupt, but isn't the issue that if there's a shedload of
money to be made, then common sense and this balanced approach
goes out the window and the auditors are thinking, "Well,
if we stand up against this, we're going to get fired"?
Mr Kingsley: That applies to a number of issues
that have appeared as a result of the credit crisis, including
the idea of macro-prudential supervision, which has exactly the
same problem attached.
Lord Forsyth of Drumlean: Your answer
to Lord Lawson's point is not much help.
Mr Kingsley: No, not that in that sense. I had
forgotten the human factor, but that's not fair. I shall double
back. If in the boardroom there were voices of challenge through
the CRO, the chief risk officer, through the internal audit function,
through even the finance function, that said, "Look, these
risks are oversized compared to our capacity to control them,
and the balance between risk reward and capital that we're now
facing isn't a safe one" then if that discussion takes place
in a balanced way, you might not get, if you like, the greed overtaking
the rationality. So your question runs to the core of some of
the things that went wrong three and four years ago, and the need
to introduce more balance into financial institution decision-making.
Mr Bush: My former chairman, the late Alistair
Ross Goobey, had a very simple test as to whether there was an
economic problem. It was the number of cranes he could see from
his office in the City. Whatever the value at risk formulas are
doing, I used to say, if there were two free newspapers outside
the tube station in the morning, and when one is called The
Daily Deal it is definitely indicating a bubble. Just talking
to estate agents who are telling you that people are going through
a sealed bid process is definitely a sign that there's going to
be a bubble. So I think there are definitely more empirical factors
out there that you can use to apply in a commonsense way, rather
than some quite complicated mathematical theory that might work
in biological systems, but I don't think it necessarily works
in financial markets.
Q111 Lord Best: Assuming that it
would be a good thing to have wider choice in the audit market,
what would be the one thing that each of you would suggest to
achieve that?
Dr Niels: I think the option of structural separation
is worth exploring more than has been so far. Structural separation
can be done in two ways. One is to have audit-only firms and the
rest. The other one is more a break up of the Big Four audit firms
into smaller, but still large, audit firms. I'm not advocating
that at all as a solution, but I'm saying that that is worth considering.
Mr Hayward: In the paper that I submitted as
written evidence, I outlined how this is a very systemic problem,
there are all sorts of things that work together to give you a
system that works quite well on its own terms. Unfortunately,
those terms don't meet the expectations of those of us who are
not auditors. But the problem with a systemic failure like that
is that you don't fix it very easily by adjusting one single thing.
So I think you can either do something outside it, the Florence
Nightingale approach, ignore the War Office's approach to nursing
and enlist The Times to create an entirely independent
system alongside it. That's one approach when you have a systemic
failure. The other approach is to do something dramatic that is
such a shock to the system. A major audit firm failing would be
a shock of that sort, but I wouldn't recommend it. I think the
single shock that could be voluntarily imposed, that might have
the most advantageous effects, would be to prevent group auditors
from being the auditors of statutory subsidiaries around the world,
because that would force them to adopt a different business model
for the audit of large multi-national groups, and that different
business model would increase the opportunities for smaller audit
firms.
Mr Bush: I agree with Jonathan on that absolutely.
There's a distinction between being a director of a holding company
and being a director of each company group, and I think one interesting
example of a bank that was quite successful with that model was
HSBC, which operates a pure holding company model. What Jonathan
says I think might focus people's minds on which bit of the group
has the risk, because I believe—I perhaps shouldn't say
in this Committee—you can combine retail banking and investment
banking under the same brand, provided you have proper firewalls
between the retail bit of the bank and the investment bit of the
bank.
Lord Lawson: No, I am just observing,
sorry. Sotto voce, firewalls are fine in theory, but they don't
work in practice.
The Chairman: Lord Tugendhat.
Q112 Lord Tugendhat: In an earlier
meeting, we were talking about the French system, where they have
joint audits. As a result of that, the Big Four have a significantly
lower proportion of the total French market than is the case in
many other countries. Now, obviously that would be a regulatory
intervention and I imagine that in the first instance it would
add to audit costs, but if it is believed—and I say if it
is believed—that it would be desirable to have a widening
of choice, would this be an appropriate way to bring on new talent,
as it were?
Dr Niels: I had the impression that when you
discussed it at the previous hearing there was a slightly negative
view on that option.
Lord Tugendhat: Yes.
Dr Niels: I think I have been more positive
about that option. Certainly, yes, it adds to the cost, but it
is a good way for the mid-tier audit firms to get to know the
companies, the bigger companies, to build a corporate CV, if you
like, and then gradually gain more business. That is I think precisely
the reason why in France the issue of concentration is slightly
less marked than in the rest of the world.
The Chairman: Mr Kingsley, did you want
to add anything else?
Mr Kingsley: No, I don't.
Q113 Lord Best: There was one suggestion
to the House of Lords in Question Time on 14 October that the
Audit Commission's future might be as the fifth major audit firm
entering the corporate sector and giving others a run for their
money. Did that idea appeal to anybody?
Mr Hayward: Personally, I would prefer the Audit
Commission to carry on doing what it has been doing rather well
up until now.1
The Chairman: Gentlemen, thank you all
very much for your contributions this afternoon. You have given
us some very clear advice and views, and we're very grateful to
you all.
1 Note by witness: If corporate clients
are currently unwilling to choose, for example, Grant Thornton
as their external auditor, it is hard to see why they should be
more keen to appoint the Audit Commission. The fact that the Audit
Commission exists is not in itself sufficient to overcome the
barriers to entry in this market.
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