Memorandum by Grant Thornton UK LLP (ADT
20)
1.1 We welcome the opportunity to respond
to the call for evidence.
1.2 Grant Thornton UK LLP is a leading financial
and business adviser operating from 28 offices. Led by 215 partners
and employing nearly 4,000 of the profession's brightest minds,
we provide personalised assurance, tax and specialist advisory
services to over 40,000 individuals, privately-held businesses
and public interest entities.
1.3 Specifically in respect of public interest
entities:
we audit 271 companies listed in the
UK of which 186 are on AIM and 85 on main market;[9]
we work with one in six of the FTSE 100
in providing non-audit services;
we audit 25 local authorities as a chosen
supplier to the Audit Commission including Manchester City Council
and three London Borough Councils;
we are also a leading assurance provider
to the National Audit Office; and
we publish the FTSE 350 Corporate Governance
Survey.
1.4 We are a member firm of Grant Thornton
International Ltd, one of the world's leading international organisations
of independently owned and managed accounting and consulting firms.
Clients of member firms can access the knowledge and experience
of more than 2,500 partners and 30,000 professional staff in over
100 countries and consistently receive a distinctive, high-quality
and personalised service, wherever they choose to do business.
1.5 Given our capabilities in the public
interest sphere, we believe we are well placed to provide the
Select Committee with our perspective on market concentration
and the role of the auditor.
1.6 We believe the questions posed by the
Committee fall into two broad categories (i) market concentration
and (ii) lessons from the financial crisis on the role of the
auditor and we summarise our main comments on these two areas
below:
2. MARKET CONCENTRATION
2.1 We are not aware of any evidence that
the presence of four large firms has led to excessive fees being
charged or had an adverse effect on audit quality in the markets
that we serve. The current audit market structure is not viable
in the long term, because the failure of another large firm would
leave the market with too few firms and could lead to the exit
of other firms. Market confidence would be significantly dented
and the resulting market structure could create the further moral
hazard that the remaining firms are perceived to be "too
big to fail". This would reduce price competition and lessen
the pressure to maintain audit quality.
2.2 If this is accepted as a premise, in
view of the international structures within which we and the other
large audit firms operate, and absent global regulatory intervention,
the only viable solution is forcibly to drive greater competition
and choice as a medium term contingency plan. If one of the largest
firms failed under the current market structure, an orderly transition
would be difficult to effect and it is unlikely that people with
requisite skills would choose to move to the next largest firms
such as Grant Thornton and BDO, for example, because of differentials
in partner remuneration.
2.3 The soft touch initiatives promoted
by the FRC have demonstrably not worked. While there is no "silver
bullet", we believe that regulatory intervention could achieve
meaningful changes in the structure of the audit market to widen
and deepen participation beyond just four firms over, say, a five
year period.
2.4 For this reason, we are calling for
the following:
a regulatory code of conduct or an unequivocal
statement from investors promoting the wider use of firms outside
the four largest; in the first instance this might be as auditors
of subsidiaries within large, public listed groups;
placing tapered limits on the market
share of firms measured by the number of appointments held over,
say, a five year period, monitored by representatives from regulators
and investors;
prohibition of contractual restrictions
that prevent companies from appointing firms other than the four
largest for audit and/or related services.
2.5 There are helpful lessons which could
be learned from the UK public sector audit market, where there
is less institutional prejudice, audit quality is high and where
there is a widespread view that audited entities receive value
for money. In this market, independent appointments bodies monitor
audit appointments, audit quality, value for money and tenders.
2.6 The ultimate aim should be, within the
medium term, to create a vibrant, competitive but sustainable
market for large listed company audits since healthy competition
is a long term driver of both innovation and quality. Both capital
markets and audit quality would benefit in the long term were
a more level playing field to exist between firms which are part
of global networks.
2.7 There is widespread concern that four
dominant firms are too few, and in particular that the market
is unduly exposed to systemic risk from the collapse of another
large firm. This has led to studies on audit market concentration
in a number of jurisdictions, including the UK, the EU and the
US. We understand that in Japan following the withdrawal of the
auditing licence from one of four largest audit firms, the regulators
were forced to step in and oversee the creation of a new audit
firm and effect a transfer of audits. This demonstrates that this
is a tangible rather than purely an academic risk.
2.8 Grant Thornton has a successful
and well regarded business model and is now widely seen as the
leading firm in the privately-held business and small listed company
sectors. We are part of Grant Thornton International, a global
organisation, which is responding to the market demand for more
choice and has encouraged significant investment in its member
firms. In terms of audit services, the global breadth and depth
of our resources now means that Grant Thornton International member
firms have the capability today to audit most large listed companies
around the world. What holds us back is a misguided belief that
big is better. The pervasive use of the term Big 4 inadvertently
perpetuates the belief that there are only four global audit players
with the capability to audit large listed companies. Despite the
increasing evidence from independent audit inspections, the term
Big 4 continues to be used as a short-cut for quality and it is
this IBM effect (the perception of there being no recognisable
upside to appointing a non-Big 4 firm but considerable perceived
downside risk for individuals who make appointments) which remains
the biggest barrier to entry for us in this market.
3. THE ROLE
OF THE
AUDITOR
3.1 We are proud of the role that audit
plays in underpinning capital markets by providing investors and
potential investors with confidence in the reported performance
of quoted companies. We do, however, recognise the risk of the
perception gap; the difference between what investors may believe
an audit delivers compared with what is actually delivered. We
would suspect that any perceived shortcomings in auditing in relation
to the financial crisis are more likely to have arisen as a result
of the current limitations on what constitutes an audit as opposed
to failures to perform those tasks that presently are required
as part of an audit.
3.2 The Policy and Regulatory Group ("PRG")
which represents the six largest UK firms on public policy issues,
and which we chair, has made the following recommendations to
the FRC:
a publication to be prepared by the ICAEW
to raise awareness of what a modern audit entails and how auditors
discharge their duties to ensure audited financial statements
give a true and fair view;
the establishment by the FRC of a working
group, including preparers, investors, auditors and BIS, to develop
a framework which would enable large listed companies to provide
enhanced and more relevant disclosures in areas such as the business
model, risks, and management estimates and judgments; in due course
these enhanced disclosures might encompass controls reporting
and sustainability;
the establishment of a further group
to develop a framework for the provision of assurance reports
on these enhanced disclosures.
We have also urged the FRC and BIS to consider
safe harbour provisions for preparers and auditors who publish
enhanced disclosures and assurance statements diligently.
3.3 As a member of the ICAEW Financial Services
Faculty, we support the Faculty's June 2010 Report on an enhanced
role for the auditors of banks. Among the key policy proposals
it contains are:
more frequent bilateral and trilateral
meetings between the prudential supervisor and audit firms on
both generic pressure points within the sector and bank specific
matters;
specific, targeted reports to the supervisor
by bank auditors, or another audit firm, on regulatory returns,
control activities and governance;
views on how to establish a coherent
framework which would enable banks to provide high quality disclosures
on matters such as more detailed explanation of the business model
and identification of key risks, a detailed going concern statement,
a capital statement and benchmarking. These disclosures would
be reported on by an auditor.
3.4 Should, as has been proposed, a further
working group be established to develop a framework for provision
of assurance reports on the enhanced disclosures, then this could
be designed in such a way to permit the involvement of a firm
other than the statutory auditor to opine on these disclosures.
We see no reason why the provision of this opinion need be restricted
to the largest four firms and could see this as a possible method
for delivering the benefits of multiple auditors to stakeholders,
companies and audit firms seeking a foothold in the large listed
market.
3.5 On the following pages we provide brief
answers to the questions raised by the Committee. In the interests
of brevity, we have grouped some questions together and provided
one response which addresses all the questions in that group.
3.6 We commend the Committee for its interest
in these vital areas of auditor concentration and the role of
the auditor.
24 September 2010
APPENDIX
4. RESPONSES
TO INDIVIDUAL
QUESTIONS
Question 1: Why did auditing become so concentrated
on four global firms? For example, do economies of scale make
it too difficult for smaller firms to compete?
4.1 At the end of the 1980s, following a
period of radical change and significant growth in the profession
as well as a series of mergers and acquisitions, the market started
to refer, for the first time, to a Big 8. Grant Thornton made
a decision to focus on owner-managed businesses, as that segment
of the market where we could legitimately claim to be the leader.
Following the advent of the Big 8 firms by the late 1980s, subsequent
mergers within this group resulted in a Big 6 by 1989 and it was
the combination of Price Waterhouse with Coopers and Lybrand in
1998 followed by the demise of Arthur Andersen in 2001 that saw
six become four.
4.2 Grant Thornton has the global breadth and
depth of resources to audit all but the very largest of the listed
companies around the world. We believe that it is a common misconception
that there are only four global audit players with the capability
to audit large companies. In the large listed market, the biggest
barrier to entry we face is not economies of scale but the relative
strength of the brand names of the Big 4. This culminates in the
IBM effect whereby few audit committees want to risk appointing
a firm without such an established strong brand for fear of personal
criticism for being out of step with market thinking. The point
at which economies of scale would prove a bar to our competing
is very high, perhaps the upper reaches of the FTSE 100. If there
were genuine opportunities to grow our presence in the large listed
market, we would invest further in this market.
4.3 The significant differentials in partner
incomes between the four largest firms and the next largest firms
is a likely barrier to the partners from a collapsed firm joining
such a firm, instead they would seek to join one of the three
remaining largest firms leading to an audit market concentrated
on just three large firms. This would create a further moral hazard
to the detriment of capital markets since these three firms might
be considered de facto to be too big to fail. To date, the soft-touch
initiatives promoted by the FRC have demonstrably not worked,
hence we are calling for direct intervention forcibly to drive
greater competition and choice in the large listed audit market
which we are confident would at least maintain audit quality.
4.4 We submit that in order to protect capital
markets from the inevitable chaos that would descend were four
to become three, policy makers and regulators should give serious
consideration to the case for regulatory intervention. The firm's
current medium term strategy is to provide large corporates with
advisory services in sectors where we can demonstrate credibility
with a view to showcasing the global capabilities of our organisation
such that we will in the future be invited as genuine contenders
to tender for the provision of audit services.
4.5 We encourage investors and policy makers
to consider other markets where audit quality is high but concentration
low, such as the public sector audit market in the UK. Notably
this market exhibits the following features; periodic audit tenders,
independent bodies which monitor quality and determine appointments
and fees, and a broader audit scope to encourage bold assurance
and value for money statements.
4.6 Consultation should be sought as to
whether there is support among investors for an independent body
monitoring appointments and fees and/or the introduction of tapered,
over a five year period say, restrictions on the market share
of audit firms in order to reduce concentration in the large,
public listed audit market and lessen the impact of any collapse
of one of the largest audit firms. This should be supported by
initiatives to encourage large, listed companies to explore the
benefits of using firms other than the four largest to provide
non-audit services and using multiple audit firms to carry out
the audit work on groups, for example, using an alternative audit
firm to audit components of the group. At the same time, intermediaries
such as banks should be prohibited or discouraged from including
contractual restrictions that limit audit or related appointments
to the four largest firms.
Question 2: Does a lack of competition mean clients
are charged excessive fees?
Question 3: Does a narrow field of competition
affect audit objectivity of advice provided?
Question 4: Alternatively, does limited competition
make it easier for auditors to provide unwelcome advice to clients
who have relatively few choices as there is less scope to take
their business elsewhere?
Question 9: If need be, how could incentives to
provide objective and, in some cases unwelcome, advice to clients
be strengthened?
4.7 We are not aware of any evidence that
audit fees are excessive in the markets in which we operate. Audit
fees are negligible in comparison with the market capital values
of the audited companies. Nor do we consider that greater concentration
has reduced audit objectivity or quality. All firms would recognise
that reputational risk is so great that, like an airline, we simply
cannot afford any crashes. For this reason, whatever the field
of competition, no firm can afford to be anything less than fully
robust in terms of the objectivity of the advice provided. This
desire of audit firms to safeguard their own reputations is augmented
by a strong, independent inspection process, the results of which
are now published. We consider that these are adequate safeguards
of audit quality and strong incentives to provide objective advice
to clients even where it may be unwelcome. We and other firms
have in place procedures to prohibit the acceptance of audits
where we suspect that management are so-called "opinion shopping"
or seeking to find alternative advisors who will sign up to a
proposed accounting treatment that their current advisors have
refused to endorse. We think that the FRC already has the tools
it requires to ensure that we and the other large audit firms
maintain a healthy degree of scepticism when conducting their
work and that this remains the most effective regulatory approach.
Question 5: What is the role of auditors and should
it be changed?
4.8 We do recognise that there is a compelling
case for the role of the auditor to be enhanced for some or all
listed companies as well as banks. We are actively promoting debate
with investors and other stakeholders on this and other topics.
4.9 The Policy and Regulatory Group ("PRG")
which represents the six largest UK firms on public policy issues,
and which we chair, has made the following recommendations to
the FRC:
a publication to be prepared by the ICAEW
to raise awareness of what a modern audit entails and how auditors
discharge their duties to ensure audited financial statements
give a true and fair view;
the establishment by the FRC of a working
group, including preparers, investors, auditors and BIS, to develop
a framework which would enable large listed companies to provide
improved and more relevant disclosures in areas such as the business
model, risks, and management estimates and judgments; in due course
these enhanced disclosures might encompass controls reporting
and sustainability;
the establishment of a further group
to develop a framework for the provision of assurance reports
on these enhanced disclosures.
We have also urged the FRC and BIS to consider
safe harbour provisions for preparers and auditors who publish
enhanced disclosures and assurance statements diligently.
4.10 As a member of the ICAEW Financial
Services Faculty, we support the Faculty's June 2010 Report on
an enhanced role for the auditors of banks. Among the key policy
proposals it contains are:
more frequent bilateral and trilateral
meetings between the prudential supervisor and audit firms on
both generic pressure points within the sector and bank specific
matters;
specific, targeted reports to the supervisor
by bank auditors, or another audit firm, on regulatory returns,
control activities and governance;
views on how to establish a coherent
framework which would enable banks to provide high quality disclosures
on matters such as more detailed explanation of the business model
and identification of key risks, a detailed going concern statement,
a capital statement and benchmarking. These disclosures would
be reported on by an auditor.
4.11 These recommendations would further
enhance users' understanding of the entity's results and state
of health.
4.12 Should, as has been proposed, a further
working group be established to develop a framework for provision
of assurance reports on the enhanced disclosures, then this could
be designed in such a way to permit the involvement of a firm
other than the auditors to opine on this report. We see no reason
why the provision of this opinion need be restricted to the largest
four firms and could see this as a possible method for delivering
the benefits of multiple auditors to stakeholders, companies and
audit firms seeking a foothold in the large listed market.
4.13 At the same time, we would caution
that the existing arrangements remain appropriate for the vast
majority of our smaller listed companies. Therefore any expansion
of the audit scope beyond banks and the large, sophisticated listed
companies may need to be weighed carefully to ensure that it is
proportionate for those smaller, less complex businesses and does
not unduly increase the compliance burden for them without providing
any additional assurance to stakeholders.
Question 6: Were auditors sufficiently sceptical
when auditing banks in the run-up to the financial crisis of 2008?
If not, was the lack of competition in auditing a contributory
factor?
Question 7: What, if anything, could auditors
have done to mitigate the banking crisis? How can auditors contribute
to better supervision of the banks?
Question 8: How much information should bank auditors
share with the supervisory authorities and vice versa?
4.14 We believe that there should be free
and open, two-way communication between the prudential supervisor
and bank auditors. We accept that this will require the audit
firms, as well as the supervisor, to educate their people to ensure
that this dialogue is both full and frank such that it is a meaningful
and productive as possible and we are committed to doing this.
4.15 We are aware that the FSA and FRC have
raised questions around professional scepticism by audit firms
and we are participating in that debate. At present we do not
believe that firm conclusions have been reached, and we would
simply reiterate our belief that healthy competition is a long
term driver of innovation and quality. We note that the FSA has
reported that even where it disagrees with judgments made by preparers,
and accepted by auditors, it has found no cases where it believes
the 2007 (pre-financial crisis) financial statements prepared
by banks and large financial institutions failed to give a true
and fair view. In our responses to the FSA, we have made the point
that the FSA should make greater use, than was the case around
2007, of skilled persons ("Section 166") reports on
selected governance and other issues at regulated financial services
companies and that in many of those cases it would be more appropriate
for a firm other than the auditor to carry out those reports.
This is one way in which greater competition might be promoted.
4.16 Grant Thornton was the first firm to
call for publication of the results of independent audit inspections.
If there is evidence of examples of inadequate professional scepticism
we believe the FRC should be robust in dealing with them, including
reporting the firm publicly where necessary. If such a case were
felt to involve a Grant Thornton audit, we commit to dealing with
the matter and any training needs robustly. If there are examples
at other firms we do not believe we should be tarred with a broad
regulatory brush.
4.17 We have raised a concern that the FSA,
the current prudential supervisor in the UK, operates within certain
legal constraints that it believes limit the amount of information
it may share with the auditors of a bank or other financial institution.
If so, we believe it would be timely for such legal constraints
to be re-examined.
Question 10: Do conflicts of interest arise between
audit and consultancy roles? If so, how should they be avoided
or mitigated?
4.18 Indisputably conflicts of interest
can arise between audit and consultancy roles. In our experience
the existing principles already result in the decline of appointments
that would result in a genuine conflict of interest. Those that
remain are largely a matter of perception, and this view has been
echoed by a number of large UK institutional investors we have
spoken with. We would not support any further prohibitions on
non-audit services provided by auditors since we believe that
this would likely result in additional costs to companies for
little or no benefit.
4.19 We do, however, support robust mechanisms
to preserve both the appearance and actuality of auditor independence
and specifically the IFAC Code of Ethics which is accepted by
a large number of countries around the World. In the UK, the Ethics
Standards which govern the ability of audit firms to provide non-audit
services to their audit clients and the Smith Guidance which governs
the way audit committees of listed companies oversee provision
of other services by their auditor are monitored by the AIU. We
are satisfied that the current guidelines are sufficient for these
purposes provided all firms honour the principles of the standards
and do not seek to treat them as rules which can be bent to permit
undertaking assignments that may in fact be contrary to the principles
of the standards. We support the recommendations of The Institute
of Chartered Accountants of Scotland that audit committees of
listed companies should provide clearer information about their
policies to avoid conflicts of interest arising and reasons for
involvement of auditors in providing substantial non-audit services.
Question 11: Should more competition be introduced
into auditing? If so, how?
4.20 We believe that it is of paramount
importance that more competition and choice be introduced into
the large, listed audit market in order to mitigate the catastrophic
damage that could be caused by the collapse of four into three
large firms. We are calling on policy makers and regulators to
consider regulatory intervention. We suggest examination of other
markets (such as the public sector market in the UK) where audit
quality is high and concentration is low and consideration of
the following:
a regulatory code of conduct or an unequivocal
statement from investors promoting the wider use of firms outside
the four largest; in the first instance this might be as auditors
of subsidiaries within large, public listed groups;
placing tapered limits on the market
share of firms measured by the number of appointments held over,
say, a five year period, monitored by representatives from regulators
and investors;
prohibition of contractual restrictions
that prevent companies from appointing firms other than the four
largest for audit and/or related services.
Question 12: Should the role of internal auditors
be enhanced and how should they react with the external auditors?
Question 13: Should the role of audit committees
be enhanced?
Question 14: Is the auditing profession well placed
to promote improvement in corporate governance?
4.21 Internal audit is an important aspect
of a company's governance and risk management. It is the responsibility
of management to put in place a system of internal control appropriate
to the size and complexity of the business and internal audit
plays an important role by enabling management to monitor both
the design and operation of internal controls. We believe it is
essential that there is no blurring of the lines between internal
and external audit but instead a full and open dialogue between
internal and external auditors.
4.22 We believe that audit committees have
a key role in bringing about the enhanced disclosures we have
suggested in our covering letter. We are proposing that listed
company financial statements should include an audit committee
report which provides clear disclosures on the business model,
risks and critical management judgments and estimates and that
the auditor or another audit firm provides a fairness opinion
on that report. A framework for the provision of this additional
assurance will need to be agreed so that the responsibilities
of management and the auditor are clearly defined and understood
by all parties.
4.23 The auditing profession is well placed
to promote improvements in corporate governance. Providing assurance
over governance statements and advising on this subject are at
the heart of the skill set of large audit firms. It is already
a part of the audit of a listed company, since the auditor is
required to report on parts of the Governance Code. Many of the
large audit firms have substantial specialist teams that deal
with governance advice. For example, Grant Thornton has produced
the FTSE 350 Corporate Governance Survey which sets out a seven
year trend of compliance with the Governance Code by the UK largest
listed companies and our specialists were consulted last year
by Sir David Walker and the FRC in their respective reports on
governance reform.
9 Source: The Hemscott Rankings Guide May 2010. Back
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