Examination of Witnesses (Questions 114-151)
Mr David Herbinet, Mr Steve Maslin, Mr Simon Michaels
and Mr Russell McBurnie
2 NOVEMBER 2010
Q114The Chairman: Good afternoon and welcome
to the Economic Affairs Committee. This is the fourth hearing
in our inquiry into Auditors: market concentration and their role.
I have just one or two points to make before we start. Copies
are available of the Members' entries in the Register of Interests
and of declarations of interest relevant to this inquiry and one
or two Members may declare something again today. Two Members
of the Committee, Lord Currie and Baroness Kingsmill, are not
taking part because of conflicts of interest.
Can I welcome the four gentlemen from the various
accountancy firms? Thank you all for coming and thank you very
much for your very helpful written evidence. Before we begin with
you, can I just make it clear for everyone else in the room that
we are stopping at 4.45 pm for a quarter of an hour in private
session, but mainly to enable us to set up the video link with
Australia? Then we will be resuming at 5 pm with the Institute
of Chartered Accountants in Australia, who are getting up at 4
am to attend this hearing.
I would be grateful if you would speak loud
and clear for the webcast and the shorthand writer. When we do
have the questions we would be very happy, in order to save time,
if one of you kicks off in answer and all the others simply agree.
Don't all feel that you have to come in each time, but please
do if you want to. Would anyone like to make an opening statement
or shall we go straight into the questions? Good, thank you very
My first question is a very general one to set
the tone. We have had a lot of concerns and one of the reasons
for setting up the inquiry was the domination of the Big Four,
in terms of auditing. I'd like to ask you what you feel are the
dangers in having the Big Four in such a dominant position in
relation to present lack of competition. I refer to the comparatively
rare testing of auditors, which has come through in some of your
evidence; to the number of tendering occasions and the number
of changes that are made, which are very few; and so on. Who would
like to kick off with an analysis of why you feel this is a worrying
Mr Michaels: I'd be happy to kick off, if I
may. The position we have at the moment is a market that is heavily
dominated by four large firms. Those firms are very internationally
focused and also domestically focused but they have a significantly
high share of the market, particularly the top end of the market;
the FTSE 350 is an example. Because the market is so concentrated
I feel that, in the event that one of the Big Four were to exit
the market, there is a risk of systemic failure with the profession
being unable to provide the market with the services that need
to be provided.
So I get to the position that something needs
to change and the market has tried to come up with market-led
solutions for some time as a result of significant work that has
been done over the last few yearsthat has particularly
been led by the FRC and a group they formed the Market Participants
Group. But that has not led to the market driving real change
and, therefore, without intervention it's unlikely that that change
is going to come about in at least the medium term and potentially
the longer term as well.
Q115 The Chairman: Does anyone else
want to add to that?
Mr Maslin: We share that view and would say
that in order to effect change in the marketplace we do think
that would take a little bit of time and, therefore, in our written
submissions we've said we think the start place for changing the
market structure would be the FTSE 250. If changes were brought
about there over, let's say, the next three years that would provide
a more solid platform for more firms to be able to challenge credibly
in the FTSE 100 market.
Mr McBurnie: I would agree with the comments
and merely add that, in terms of the negative impact on what I
would see in terms of auditor stagnationlack of movement
in that area in terms of the Big Fouris that what you get
is a lack of added-value service from bodies who feel they don't
need to go the extra mile to prove that they should have the audit
again. One of the dangers of stagnation is a lack of a fresh pair
of eyes over a set of numbers or over a business that is always
useful in driving business forward and helping with the controlled
environment in general.
The Chairman: I think that is one of
the reasons for our inquiry and you mentioned FRC. Clearly some
of the solutions haven't really worked. So we'll be interested,
in this session, to hear what solutions you have. Lord Tugendhat?
Q116 Lord Tugendhat: Can I ask a
supplementary to that? Do you regard the audit as a transaction
between the auditor and the company that is being audited much
like any other service that a company receives or would you regard
an audit as a public good from which all citizens gain or lose?
Mr Maslin: Shall I make a start on that? I think
audit is a unique service and it's really incumbent on auditors
to remember that their primary client is the investors as a whole.
Therefore, while much of the interaction is with a company's management
team and with its audit committee, the ultimate beneficiary of
the assurance that derives from audit is the owners of that companyso
the shareholders of that companyso we must always bear
in mind that they are our primary client.
Q117 Lord Tugendhat: Could I press
you a bit further? I agree that the owners obviously have an interest,
but surely not only the owners. The fact that a company's accounts
are auditedobviously what I am saying applies with more
force to bigger companiesis a matter of significance to
the owners but it's also a matter of significance to the investment
community as a whole and to the regulators in those industries
that are regulated. Indeed, could one not argue that the investment
community as a whole and the regulators rely on the audit to as
great an extent as the owners of the company?
Mr Maslin: I think it is a very fair comment,
Lord Tugendhat, that there are other stakeholders that do place
reliance on the audit and I think of particular relevance here
is in the context of groups like the bank supervisor. One of the
issues that our firm has spent a lot of time on since the financial
crisis is working with the Bank of England to try and learn lessons
from the financial crisis. Our view at the moment is that the
biggest contribution the audit profession could make, coming out
of the crisis, is to improve the way that we talk to the banking
supervisor and that is why we have been spending time with the
Bank of England.
Lord Tugendhat: Thank you.
Q118 The Chairman: This is a question
we were going to ask you, so let's deal with it now. Would you
like to say a bit more about that and where you are at and what
you think the bank involvement should be?
Mr Maslin: One of the things we have been trying
to do with the Bank of England at the momentI think it's
been a very constructive discussion so faris to think about
the various ways in which it would be appropriate for the bank
auditors to have formal and informal communication with the banking
supervisor. That could be done in a number of ways. It could be
bilateral and trilateral meetings that involve the individual
bank audit team and the Bank of England. It could deal with specific
issues with regard to specific banks and financial services companies.
There is another tier of useful communication
where perhaps the bank would talk to the senior partner of the
audit firm about general issues that are coming up in the financial
services sector. There is at least a third tier, which probably
would be a meeting between the banking supervisor and the large
audit firms generally, where there could be some sharing of concerns
and pressure points that have come up in bank audits and pressure
points that the supervisor is aware of. So the audit firms can
all go into the next audit cycle armed with that information,
so that we're all sharing knowledge.
What we've been doing with the bank is to see
if we can just have a very simple dialogue framework that sets
out what are the reasonable expectations of the various tiers
of that discussion.
Mr McBurnie: I think we probably need to differentiate
between banks and other such very complex institutions in the
way they are audited because I think, in terms of the financial
structures that they have in place and some of the financial instruments
they use, they are incredibly complex and they have, internally,
people who are paid excessive sums of money potentially, but certainly
large sums of money, to come up with these ideas. Are auditors
and all audit firms capable of fully understanding them? Because
you can't audit something if you don't understand it and we probably
need to look very carefully at the expertise that audit firms
have in looking at bank transactions and whether there needs to
be special accreditation that is regulated by the ICAEW to look
at these sorts of areas. When you think about how long it is going
to take the Lehman's insolvency to be unwound, because it is such
a mammoth beast, imagine having to audit that and whether people
can understand that in order to give a proper opinion on those
Q119 The Chairman: Do you think members
of audit firms, in doing the audits, are still looking at this
as systemic risk and all those sort of financial and banking implications?
Mr Maslin: I think that's a fair comment. With
regard to the banking financial services sector, there are very
complex issues involved and it takes very specialist teams to
consider those matters. Some of the specialists at the large audit
firms are capable of dealing with those issues but it's certainly
something that my firm would always be very careful of before
taking on any new type of audit. It would only do so if it felt
it had the appropriate skills and the appropriate depth of those
skills. Clearly banking and financial services companies, the
largest banks, are very complex beasts.
Mr Michaels: Mr Chairman, can I come back on
a broader point, and I'll also deal first with the point you raised
there. One of the things that adds to some of the difficulties
in the marketplace is simply the extent to which financial reporting
has become so complex, particularly in relation to those financial
institutions. While there is a public interest element in terms
of the audits that are undertaken, there are gaps in perceptions
around what is the role of audit. Other assurance could be provided
to investors and it makes sense to also review how one might establish
what the purpose of an audit really is and the nature of corporate
reporting to reduce complexity. I think that is something we would
favour being led, primarily by the FRC but also with significant
input from the investor community. Without really understanding
exactly what it is those investors need and want, additional levels
of complexity are not really helping them make informed decisions
about the risks that are being taken.
There is also an argument, I think, for a greater
level of disclosure in relation to some of the key areas and judgements
that are being made, again to help investors understand the decisions
that they are making. So I think there is a much wider piece in
relation to the role of audit, and a much wider piece in relation
to complexity of corporate reporting.
I want to add just one more layer, if that's
okay, which is the market is segmented in a number of ways. BDO
focuses primarily on the mid-market. We have a lot of fully listed
larger clients and we deal with that complexity as well. But intelligent
auditing means that you have some businesses that are smaller
caps or privately owned; that don't need the level of complexity
or auditing that some of those larger, more complex, businesses
need. I think there is pretty strong argument to have a fundamental
review of what the market needs and wants and what is being provided
by the profession.
The Chairman: Thank you. Lord Tugendhat?
Q120 Lord Tugendhat: Can I go a bit
further down this road? We've received a lot of written evidence,
as I'm sure you know, and, in their submission, Ernst and Young
basically say that there is no reason why other people shouldn't
be able to do the big audits; that it's a mistake to think that
only the Big Four are able to do so. Would you feel happy if a
major FTSE 100 company came along and asked you to tender for
their audit and would you do it and would you feel that, if you
did do it, you would stand a sporting chance of success?
Mr Herbinet: Can I take this one? I think the
answer to that question, from our point of view, is unequivocally
"yes". The reason why I am saying "yes" is
because we are already doing it. But let me take a step back.
We understand that the prime concern of yours is the issue of
systemic risk in the markets and the risk were a Big Four firm
to fail. Therefore, we've looked a little bit more into this issue
of systemic risk and, when you look at it in more detail, I think
you come up with essentially three parts of the market where systemic
risk is greatest: one is banks, two is other similar financial
institutions and three is the FTSE 350 market.
There are some interesting statistics on that,
in that 95% of the UK market capitalisation is with FTSE 350 companies.
Within that, 80% of the market capitalisation in the UK is with
FTSE 100 companies. Therefore, if you are serious about addressing
the issue of systemic risk, in our view it is in that segment
of the market that something needs to happen because that is where
essentially the value of British PLCs is. At present, only one-tenth
of 1% of audit fees in the FTSE 100 is not earned by a Big Four
firm; that's my friends from BDO. That is one-tenth of 1% of the
fees in the market. Therefore, we think if a solution has to be
found to reduce systemic risk it is in that market that we need
to concentrate our efforts.
That leads me straight into one of the questions
that you may want to raise later on, on joint audit. Mazars, my
firm, are already the joint auditors of Europe's third largest
bank, which is BNP Paribas, and a number of other top European
listed companies. If you look at our client base, 13 of our clients
would feature in the FTSE 50 in the UK, i.e. would be among the
50 largest UK companies. This has been achieved through joint
audits. So I think our view is that the FTSE 100 market is where,
in our view, something needs to happen and we believe that there
are ways to address this issue of systemic risk in this market.
The Chairman: Lord Smith?
Q121 Lord Smith of Clifton: We are
really moving on here quite logically on what follows. We are
talking about size and capacity. How much investment is needed
for mid-tier firms to compete for audits of large companies and
financial institutions and in what areas is investment most needed?
Mr Maslin: May I pick this one up? Again, the
way that our firm has looked at this question, Lord Smith, is
to say that our recommendation is that if changes are made in
the audit market structure, it's about building greater presence
in a more vibrant audit market in the FTSE 250 and we would suggest
starting there. But if you look at the average size and audit
fee size in the FTSE 250if you elect to move 20% of the
audits away from the four largest firms to one or a collection
of other firmswe estimate that that size of market would
be about £25 million to £30 million. Certainly our firm
and some others believe we have the cash reserves that we would
be able to make the investment to serve the entirety of that market
So if we're talking about making a significant
change in the FTSE 250 and then building a more stable platform
to look at changing the structure in the FTSE 100, we don't think
it's a question of lack of investment capacity. Our firm has signalled
the fact that if there were a change in buying patterns in the
FTSE 250 we would be prepared to invest more in that market.
The reality isand it's shown by, I think,
the lack of success of the FRC in recent yearsthat typically
buying patterns are such that it tends to be just four firms that
are successful in that FTSE 250. So we really don't think it would
require our firm to raise additional capital, even probably to
get additional bank lending, to make a significant change in the
FTSE 250. We would start there as a firm because we would be nervous
about starting at the very largest companies in the FTSE 100 because
we think that would give us a danger of an unstable business model
where, too quickly, we could become dependent on one or two companies
and we would not feel comfortable with doing that.
Q122 Mr Michaels: If I could
add, from BDO's point of view investment is not holding us back.
We are a substantial international network. We audit one of the
FTSE 100. We audit six of the FTSE 250. It is about us building
our reputation, gaining the experience and getting the scale to
be able to take on more of those opportunities which, as Steve
Maslin has said, don't come around that often. So we don't see
investment is the issue. The issues are much more, we think, around
some of the institutional prejudice that exists there; that size
and revenue in terms of size is seen as a proxy for quality and
maybe that it's a safer bet to buy the Big Four rather than buying
one of the mid-tier firms.
Mr McBurnie: Can I just pick up on scale and
expertise? From RSM Tenon's point of view we couldn't do a bank
audit. We freely admit that; we do not have the expertise. I think
it's very important that whatever comes out of discussions today
and in the future ensures that what we don't do is force companies
to have audits from people who aren't capable of doing the job
properly, because that is the other end of the scale and a clear
risk here. From our point of view, top 100 companies would probably
be out of reach in terms of scale. While we would have the expertise
to do ones that weren't bank-led or bank-related, I thinkvery
much like my colleagues herewe would have issues in terms
of the sheer scale and volume that a single job required. Investing
in that and then potentially losing that audit and then having
a surplus of staff would cause us issues.
While we don't see our main competitors as the
Big Four and our target market is not the top 100 or indeed the
top 250, we see that mid-tier firms would relish, in certain cases,
the opportunity to compete. But that has to be very real competition.
There is no point in investing to be an also-ran; there is no
point in investing just to knock the price down or cause price
pressure on the Big Four. It has to be about real competition
and if that is not going to be the case then I don't think firms
would choose to invest.
Q123 Lord Smith of Clifton: Do you
think there is any likelihood of further mergers among mid-tier
companies in order to up the threshold and the capacity or is
that a leading question?
Mr McBurnie: It would certainly be a potential
shortcut for dealing with the perception issues in terms of scale.
The biggest thing that the mid-tier firms have to get over is
the perception issue; that is, the perception of the banks and
the perception potentially of investors, of brokers, of audit
committees and of finance directors.
Mr Michaels: I don't think that a shortcut of
merging mid-tier firms is an appropriate solution. If you combined
the revenue value of firms 5 to 10, you don't reach the size of
the smallest of the Big Four. It doesn't deal with your reputation
as well. You get a collection of mid-tier firms. In fact the investment
has to be more sustained, it has to be co-ordinated on an international
basis and it really has to be about gaining the experience and
the scale in a very measured way and building your reputation
such that people feel comfortable making different buying decisions.
I should say we also act in an advisory capacity, so a non-audit
capacity, for about 30% of the FTSE 350. So the buying decisions
are slowly starting to come through but we're taking a medium
to long-term view because nothing is going to happen in that audit
market for some time unless there is intervention.
The Chairman: Lord Forsyth and then Lord
Maclennan. Lord Forsyth?
Q124 Lord Forsyth of Drumlean: I
wanted to pick up on Mr McBurnie's point where you said you wouldn't
be able to audit a bank and you wouldn't take on a bank audit.
Is that because you wouldn't invest in the people and the expertise
because you would have no chance of getting a bank audit? Isn't
it a bit chicken and egg?
Mr McBurnie: I wouldn't disagree; there is a
chicken and egg situation there. I think what I'm talking about
is our current capacity and where we are now, we couldn't do it.
Q125 Lord Forsyth of Drumlean: That
is not going to change, is it? If you think you have no prospect
of getting into the banking market you're not going to recruit
Mr McBurnie: Absolutely. My next point really
was that firms will invest if they see that there is potential
for real competition and not being on a tender list for an audit
to drive the price down, but if they have a real chance. You do
have this "chicken and egg" thing. For example, we are
trying to break into the market on large university audits and
you will get audit committees coming back to you and saying, "Yes,
we really liked your tender; yes, we thought you could do the
job. But you do not have any experience of that area, so we're
going to go with someone who has experience". Well, how do
you get experience of that area unless you change the market?
Q126 Lord Forsyth of Drumlean: Yes.
Jut to follow up: the word "prejudice" was used; the
prejudice in the market. Is it prejudice or is it just the old
adage: no one was fired for buying Goldman Sachs?
Mr Michaels: I used the word and I think there
is an element of that, no one was fired for buying IBM. But also
the NED community that services the FTSE 350 is very well networked
with the Big Four. The FDs of those FTSE 350, inevitably would
have been trained at the Big Four. So it is quite deeply ingrained
and, therefore, to break throughwhich you can doit
just takes an awful lot of time to give people that confidence.
Q127 Lord Forsyth of Drumlean: Sorry,
you said most of them would have been trained. Are you suggesting
it's patronage rather than prejudice; the old school tie?
Mr Michaels: No, I'm not saying it's that explicit.
I'm saying I think it's more subtle, I just think there is an
understanding of how those businesses work, such that the comfort
is there to buy those big brands from people they know and trust
and that making the buying decisions outside of the Big Fourunnecessarily
in my view and, I think, our viewis seen as a risky bet.
Mr McBurnie: It's a whole raft of factors that
add up to quite a barrier. So, is there a covenant in a banking
agreement that says you have to go with a Big Four firm? Does
the banking agreement say that they can say who your auditor should
be and what is a bank likely to do? Well, they might say they
want the safety of a Big Four audit. It's the attitude of investors
or the perceived attitude of investors"If I change
from a Big Four audit and go to a mid-tier audit what will that
say to the City?" It might say nothing, because everyone
sitting in this row here believes that mid-tier firms are perfectly
capable of doing audit there. But there will be audit committees
and finance directors who sit back and have that conversation
and it's breaking those barriers down.
The Chairman: Lord Maclennan?
Q128 Lord Maclennan of Rogart: Mr
Michaels, in your initial answer to the Chairman's question, which
was the broad question, you referred to the systemic risk or a
risk of systemic failure. But it does seem to me that in your
subsequent answers to the more particular questions you have been
suggesting that there is really no short term way in which that
systemic risk could be tackled because youand, similarly,
othershave said that companies such as yourselves don't
want to scale up to the level at which you could spread the risk.
I don't quite see what your
Mr Michaels: Let me clarify, if I may. The systemic
risk point, in my mind, still stands. The other observations I've
been making are that in my view things are unlikely to change
and that systemic risk will not go away but it will be brought
to the fore if one of the Big Four, for whatever reason, exited
the market. I do think there are ways to accelerate progress and
de-risk the market with intervention. I've mentioned the possibility
Q129 Lord Maclennan of Rogart: Are
you speaking about regulation?
Mr Michaels: I think the intervention could
come in a number of ways. You have the regulators, you have investors
and you have government as well. If I take the regulators to start
with, you could get a situation where the regulators had more
input into audit appointments within the FTSE 350. That would
certainly help over a period of time to de-risk it if there was
a wider choice in that marketplace. I think that is where the
greatest concentration lies. If that was tied together with much
tighter liaison with the audit committee chairs that ultimately
have the responsibility for making those decisions, I do think
you could start to de-risk the market more significantly and more
The second point I would make in relation to
regulatory interventionas the point has already been madeis
that there are restrictive covenants that exist in certain parts
of the market in terms of undertaking some of the banking work.
If those could be outlawed in some way, which would need regulatory
intervention, that would open up buying ability. The third areaand,
again, it has been mentioned alreadyis potentially approving
networks or firms to undertake certain types of work so the market
has confidence that the regulator believes those firms are capable
So in terms of the regulator, without burdening
and bureaucracy, I think there are simple things that could be
done. In terms of investors, the more investors are prepared to
engage on auditor appointments and use their influence, accepting
they're not a homogenous grouplinking with audit committee
chairs, againI think there is more of a chance to de-risk
the market. On government spending, again, a lot of government
spending goes to the Big Four and widening that market out creates
more opportunities. So I do think there are things that can be
done to speed up change but if there isn't any intervention the
market won't change in a hurry.
The Chairman: We are going to have a
round-up question towards the end, I think, about solutions and
what recommendations you would make in that respect and we will
come back to that later. Lord Hollick, did you want to come in
at this point?
Q130 Lord Hollick: Yes. I wanted
to pick up on Mr Herbinet's comment that in Europe, and I think
it was in France, you jointly audit companies that, if they were
listed in the UK, would be part of the FTSE top 30. So you have
the skills, the reputation, the heft if you like, and the experience
that could be transferred to audit those companies in the UK or
companies of similar size in the UK. As a result of that expertise,
have you been invited to tender for the audit process in the UK
for companies of that size?
Mr Herbinet: I think one of the critical issues
is that it is currently a very stagnant market. There has been
some independent research carried out that shows that, on average,
a FTSE 100 auditor can remain in place for 48 yearswhich
means that they were appointed in 1960and, on average,
I think 70% of FTSE 100 companies have not had an audit tender
for 15 years. So in that market, no matter which capability you
have, you just don't have the opportunity of showcasing it.
Q131 Lord Hollick: Do you think the
practice of a joint audit is something that could be usefully
introduced into the UK?
Mr Herbinet: That's definitely our position,
yes, and that's the position we've been putting forward for the
last 10 years. We think that would bring significant benefits
to addressing this issue of systemic risk. Very simply, in our
view, this is the only proven mechanism that has reduced concentration
in a major economy and in the segment of the market where systemic
risk exists. We've put together a short paper on joint audits,
which I would be happy to leave with you at the end, but if I
may I will highlight a few of the key points that I believe would
be worth further consideration.
There are a number of misconceptions around
joint audits. A joint audit is essentially two or more firms that
express an opinion together on the financial statements of a group.
The first misconception is that it is the audit being done twice
by two firms; it is two firms working together to jointly form
an opinion on the statements of the group. What they do is they
look at the most complex and challenging audit issues together
and, therefore, you have more input into the challenge and the
scepticism the need for which has been highlighted by you.
There are benefits and potential inconveniences
of joint audits. In terms of benefits, I think I would just flag
three points. One would be that you have the "four eyes"
principle that is quite key to regulation, whereby you have more
people looking at the complex issues. What that creates is a permanent
and inbuilt quality control during the audit on a real-time basis
and focusing on judgement more than on compliance. Point two,
and it's a critical one for addressing systemic risk, is that
it encourages new players to come into the market, because what
you do is you offer visibilitythe point that Russell was
making earlieroffering the opportunity for a return on
the investment that you make over the longer term.
The third point is that it facilitates rotation
of work and of firms over time. One of the issues that most large
FTSE companies raise is that it's a major inconvenience to change
auditors because they have to learn everything from scratch and
some argue that when you change auditors you create an additional
audit risk because a new auditor doesn't really know the business.
What you can do with a joint audit is stagger the appointments
whereby you can change one of the two without putting the whole
audit at risk. So there are some clear benefits.
A number of criticisms have been made. The first
one is that it's French and I hope that we can rise above this
at a time when we are combining our efforts in the Armed Forces.
Factually this is wrong. It's like rugby; joint audit was not
invented in France but it has found the soil to grow and develop
in France. The second criticism is that it's very expensive. There
is simply no evidence to support that criticism. The third criticism
that we hear most often is that it's a race to the bottom in terms
of audit quality. Again, it's anything but that because you have
more people looking at the complex issues. Probably the best answer
to that challenge is that most Big Four, all Big Four, are very
happy to put their name on the same audit report as Mazars, on
the companies that we audit with them. So they clearly have no
issue there in terms of quality.
There is an interesting recent report that was
produced by the French equivalent of the CBIand that report
was produced with the audit firms, including the Big Fourthat
concluded that the practice of joint audit brings more benefits
than inconveniences. That included business, Big Four and key
stakeholders in the market.
Q132 The Chairman: Is it mandatory
anywhere else other than in France?
Mr Herbinet: It is mandatory in South Africa
where they put this in place after the last major banking crisis
in the mid-1980s.
The Chairman: Lord Best?
Q133 Lord Best: Am I right in thinking
that Mazars do more than half of all of the joint audits in France?
More than half; is it getting on for 60% of all of the joint audits
are done by your firm in France?
Mr Herbinet: In France my firm audits 30% of
the CAC 40 in a joint audit capacity and, within these joint audits,
I think you will have a balance of work allocated to one or the
other firm. On balance, my firm would probably do between 30%
and 50% of the overall work on that audit.
Q134 The Chairman: We were going
to ask you about joint audits in particular. I think we've probably
covered that now but if there's anything else you would like to
add to it please do submit another paper to us.
Mr Michaels: Could I just add one thing, which
is a slightly alternate view? We're not equally sold on joint
audits. This isn't clearly a homogenous group that has a consistent
view. I haven't done the analysis on the cost piece nor the efficiency
piece, but I wouldn't want to be in a market where we're seen
as being appointed as the poor relation of the Big Four to make
up the numbers, frankly. I think what I'd rather do is try and
find a more permanent solution. So, although I can see how that
work could be helpful in some regards and might be able to reduce
the riskI do accept that pointI don't see that it
necessarily is as permanent a solution as we might need.
The Chairman: Quite quickly, because
we must move on.
Q135 Lord Forsyth of Drumlean: Before
we leave that, just following up on that point and perhaps I am
being stupid, but I thought the whole argument for joint audit
was that it would create more diversity in the marketplace. If
you are doing such a big proportion of the CAC business, why is
that not working? The argument for joint audit is that it will
give more firms, as I understood it, an opportunity to come into
the market so there is less domination. But you've just described
the French market where you are very big and where there doesn't
seem to be that diversity. So why is that not working?
Mr Herbinet: I would look at the market in a
slightly different way. In that market you have the Big Four,
you have my firm, but you have, through joint audit, the opportunity
for other firms to come and establish themselves. Practically,
at this point in time, Steve's firm, Grant Thornton, is making
very significant progress in the French market through joint audit.
Simon's firm, BDO, before their previous firm was acquired by
Deloitte, had a significant presence in the French market in key
joint audits. So what this brings in a market is the opportunity
for a firm to really go for it and make the investment and establish
themselves in the market as a key player. You have many firms
constantly coming into this market.
Q136 Lord Forsyth of Drumlean: So
you wouldn't say the difference is you have a Big Five instead
of a Big Four?
Mr Herbinet: No, I don't think so. I think it
creates a much more open market.
Mr McBurnie: Can I just say, as a representative
of mid-tier and also a finance director of a main listed company,
I tend towards Simon's view that we would not be in favour of
joint audits. I cannot see how they cannot be more costly and
inefficient, because it just seems the logic must be that. I also
worry about responsibility falling between cracks and between
firms in terms of the way the work is divided up.
The Chairman: There are a lot of other
questions we want to ask you, so I think we must move on. Lord
Maclennan, the fourth one, on the capital point.
Q137 Lord Maclennan of Rogart: One
of you said £25 million might be enough to enable the firms
to compete with the Big Four. Is that a considered view?
Mr Maslin: Yes. What I said is if one looks
at the averagethe average audit fee in the FTSE 250 is
around about £600,000. To get down from a concentration,
at present, of about 96% to 80% would involve a shift of only
about 40 audits but that would be quite a significant change in
the audit market. That suggests that the total amount of fee shift
would be about £25 million to £30 million and, as Mr
Michaels has said, our two firms would have the cash resources
to be able to invest in the entirety of that market shift. But
we would only make that investment if there was a change in buying
patterns and we felt there was a realistic opportunity of being
successful in winning those appointments.
Q138 Lord Maclennan of Rogart: What
would stimulate the change in buying patterns, as you put it?
Mr Maslin: If I were to leap ahead to possibly
the last question, we think there would be a lot of merit in the
FRC convening a group of the largest UK institutional investors
to take more of a top-down look at the audit market rather than
what happens at the moment, which is that audit procurement decisions
are a whole bunch of bottom-up decisions. We think that situation
works relatively well in the UK public sector market where you
have much lower levels of concentration and demonstrably high
levels of audit quality.
I was interested in the comment of a very well
respected fund manager from Schroders, albeit in a slightly different
context, who made the point that if the largest UK institutional
investors act together in the companies in which they invest,
they tend to get the change that they're looking for. We think
it would be a very interesting model to look at; for the FRC to
convene a group of the UK's largest institutional investors to
get some focused action on the companies in which they investand
that might be in the FTSE 250to give a very strong signal
to those companies to move more audits to firms outside of the
Big Four. Virtually all of the FTSE 250, firms like ours have
the international reach, the investment capacity and the audit
quality as measured by the public reports of the inspection units,
to do high quality audits in those areas. We think that is a model
that would be worthwhile examining.
Q139 Lord Maclennan of Rogart: The
existing investors or partners would not be concerned about the
dilution of their stake if that external investment took place?
Mr Maslin: In terms of our firm?
Lord Maclennan of Rogart: Yes.
Mr Maslin: That's what I'm saying. We wouldn't
need to dilute the ownership stake of the partner. We have the
cash reserves to make that level of investment and we've demonstrated
that we've been prepared to make investments of that size. Three
years ago we invested about £40 million acquiring Robson
Rhodes to increase our size and we're on public record as saying
that we would be very enthusiastic under the right conditions
to invest in taking a substantial part of the Audit Commission
work, which currently runs to several hundred million pounds.
We're very happy to make those levels of investment but we will
only do so if we think there are realistic opportunities of that
getting a payback in terms of winning a reasonable number of appointments,
but we are able to do it without diluting a partner.
The Chairman: Mr Michaels?
Mr Michaels: If I could just build on that point,
if I may. Equally, lack of investment isn't an issue; lack of
capital is not an issue. But we've had support from investors,
very visible support, previously. When we roll the clock back
to when the Oxera report was done for the FRC and the DTI on competition
and choice in the audit marketplace a number of investorsand
I have the letter heresent a note to a particular business
that they don't believe there is an issue with appointing a non-Big
Four firm. So I think in that sense the investor community are
generally supportive and I think more engagement and more intervention
on their part, with some encouragement, might bring about some
reasonable change as well as in the other areas.
The Chairman: Lord Lipsey?
Q140 Lord Lipsey: I can see all the
advantages to your firms of broadening out this market but I would
like to try and get a finger on the advantages to the people who
I suppose this Committee, in a sense, represent who are investors,
the firms themselves, and the wider public interest. Is this really
about priceyou have a conflict in your evidence because
BDO says the Big Four monopoly does push up prices, Grant Thornton
in their evidence say there isn't any evidence that it doesor
is it about quality? Is it about radical new approaches to audit?
What are the advantages for Joe Public in widening this market
out so you can get more business?
Mr Maslin: Shall I lead on that? The start point
I think of all of these discussions is that audit quality must
be maintained and Mr Michaels' firm and my own have consistently
over a long period called for publication of the results of the
independent audit inspection into the large audit firms because
we would only wish to compete in any market on the basis of quality.
I think the FRC missed an opportunity in December 2009 in not
doing a better job of publicising the results of the respective
levels of quality of firms such as ours in comparison with the
largest four. So the start point must be that quality is at least
maintained and we believe in the longer term you need a vibrant
audit market to drive quality innovations.
I think, in terms of the public interest benefit
elsewhere, we've never particularly seen concentration as our
issue. Our firm will grow very significantly and if there are
not opportunities to grow in the FTSE market we will find other
areas of the market and other businesses to grow. Over a long-term
period it's investors in this country and regulators around the
world that have recognised the risk of forced exit of one of the
largest firms. The policy proposals we've put forward might be
argued as having some self-interest there but we think there are
practical measures that would go some way to addressing those
concerns that have been raised by other stakeholders, by regulators
and investors. Does that help to answer your question?
Q141 Lord Lipsey: Yes. I think your
answer is, "We will produce very good quality". I suppose
the difficulty with the quality argument always is assessing it;
whether a company can assess it, an investor can assess it. It's
very hard for a layman to know what is a good audit and what is
not a good audit, isn't it?
Mr Maslin: Again, that is whyI'm sure
Mr Michaels has the same viewwe were very frustrated in
terms of the way the AIU findings on the firms in 2009 were presented.
One of the things that the AIU does is to publish a table grading
the individual quality of the files that it has inspected and
over the last two years it has inspected, I think, something like
183 large audits of what it calls the major firms. Within that
table, Mr Michaels' firm and mine, in December 2009, were the
two firms that didn't have any audits criticised as requiring
significant improvement. I'm not complacent and I'm sure Mr Michaels
isn't complacent about that and we will have files criticised
in future. But we thought there was a real opportunity there for
the FRC to demonstrate that audit quality isn't confined to four
firms. What it actually did was present those findings in a way
that has enabled many commentators to think that any firm outside
of the Big Four doesn't have the capability of producing quality.
It was very frustrating to us.
Mr Michaels: The other aspect to build on, taking
on some earlier points, is in a way it's a shame but there's not
a lot of evidence to say that investors assess audit quality in
whichever form. I think maybe it's time that they did because
if they took more interest in that again it would help.
The other point that I made earlier, about revenue
or size being seen as a proxy for quality, is a consistent frustration
because there's a feeling that is where you get your reputation
from. Our global network has revenues of $5 billion, yet we're
not seen as big enough to service some of those largest companies.
It seems ridiculous. So it's going to take some time and I think
the more effort that can be put into articulating what quality
really is and how that is recognised in the market such that it
starts to influence buying decisions, the better. But I think
we both go back to the point, and others as well, where we've
said that without some sort of intervention the market is not
going to find that solution in a hurry itself.
The Chairman: Lord Hollick?
Q142 Lord Hollick: Staying with the
question of quality for a moment, one of the things that the Institute
of Chartered Accountants said to us was that the audit has become
largely an audit of compliance. It has ceased to have, or it has
much less than it used to, the question of judgement around the
quality of the accounting, the quality of the business model,
and obviously this goes to the problems of some of our financial
institutions. In a world where the audit process itself has become
compliance, how do you differentiate yourself? How do you win
business when it would appear that it is being robbed, denuded
if you like, of its original purpose of giving a true and fair
and prudent view?
Mr Maslin: I think different firms would clearly
respond to that in different ways. In our firm one of the things
we try to do to differentiate ourselves is to think about the
way we're delivering services, which is very much to try and focus
specifically on what are the needs of an individual audited entity
rather than saying, "There is a generic Grant Thornton way
of delivering an audit and that's what you get". Certainly
we've had some very favourable feedback in terms of audits that
we have won from some very large companies. I think it goes too
far to say that there are no judgements in the modern audit and
certainly when I ran our audit practice for seven years there
were at least four occasions when, as a result of judgement disagreements
with some of Grant Thornton's largest firms, we decided that we
would resign, and sometimes in very public situations, from those
situations. So I think it goes too far to say that there are no
I mentioned the work stream we had with the
Bank of England earlier on but a second work stream with the bank
and with the FRC goes to this issue as to whether more colour
around judgements and the quality of judgements that are made
by auditors and the volatility of valuations that are inherent
in values in the balance sheets could be provided in the financial
statements and the auditors could be responsible for giving some
sort of statement on the fairness and reasonableness of those
disclosures around judgements. I think there is a pressing need
coming from investors for that type of disclosure. Interestingly,
I think that that would help audit firms to compete on the basis
of quality because the quality and robustness of our challenge
to management and audit committees would become a matter of public
Mr Michaels: You talk about differentiation.
One of the areas that we focus on very heavily is the service
quality plus technical quality as well. So, while we put an awful
lot of investment into the methodology on an international basis,
into the IT, into the training, we also put a huge amount of investment
and time into the service experience that our clients get because
we think that is a way of differentiating and building an overall
impression of quality that goes beyond the pure function of an
There is another piece as well that I alluded
to earlier, which is that I think again there is a wider debate
to be had about the purpose of audit and the complexity of that
corporate reporting and really asking investors what it is they
need and want from the market, not assuming it means extending
audit services. It is about looking at the wider level of assurance
that can be provided to the market and what is appropriate for
the relevant companies that are either investing or providing
services to those businesses, where they seek to place a reliance
on what is being produced by the profession.
The Chairman: We are covering a lot of
ground but we have only another just under quarter of an hour
and there are some other questions we want to move on to, but
you're being very helpful. Lord Moonie?
Q143 Lord Moonie: Thanks, Chairman.
I should declare an interest at this point that I'm the chair
of an audit committee of a company whose audit is carried out
by BDO. Just in passing, I assume that you don't think that the
size affects the quality of the audit, the size of the company
Mr Michaels: The size of the company doing the
Lord Moonie: Yes. It is not aligned with
Mr Michaels: No. As I said before, I think it's
a red herring but the perception is that it is an issue.
Q144 Lord Moonie: What effect does
lack of choice in the market for large firm audit have on audit
price and quality? Are there any other effects?
Mr Michaels: Yes. In our submission, the Oxera
study that was done for the DTI and the FRC in 2006 did suggest
that, following the PricewaterhouseCoopers merger in the late
1990s and following Andersen's exit from the market in the early
2000s, price did increase. BDO also funded an independent study
by the LSE a few years ago that said that a 10% reduction in concentration
in the market would lead to a 7% reduction in price. It's very
difficult to say that is the case until you're there doing it
but certainly there is a suggestion that price, in our minds,
would be impacted. There is no suggestion, however, that the concentration
in the market leads to a lack of quality.
Mr McBurnie: I've benchmarked prices because
I've had to make decisions about who does our audit and the Big
Four are quite simply more expensive, pound for pound, in terms
of doing the job than other mid-tier firms. We do need to be careful
about balancing price with quality. Audit cannot become a commoditised
service. If it is too cheap there is the risk that it is not done
properly and one of the jobs of the audit committee is to make
sure that a proper price is being charged for an audit. So, for
example, I see my job as a finance director potentially to beat
up my auditors on price but the audit committee has an overview
on that price and signs off on it and it says, "Is that job
being done at a reasonable price to ensure that they can do the
job that they need to do properly in terms of coming to their
In terms of choice, the other impactsnot
just on price and on quality but more on the service side, which
we've already sort of discussedis the fact that if you
have stagnation, if you have lack of movement, if you have a firm
doing the same audit for 48 years, what sort of onus is there
on that firm to provide the value-added services; to look at the
financial accounting controls and report on them, which they should
be doing as part of their job, if they don't need to in order
to maintain that audit? It's those sorts of areas. It's the value-added;
it's the fresh pair of eyes; it's that sort of thing that you
don't get if you have the same audit firms doing the same audits
over and over again.
Q145 Lord Best: Isn't it true that
you have chosen one of the Big Four to be your auditor?
Mr McBurnie: That is correct. However, let's
be clear who I think our main competitors are. They are the mid-tier
firms. Therefore, I use a Big Four firm because we don't compete
with the Big Four. I know people can talk about independence but
I put it to you that if Tesco sold audits, Sainsbury's wouldn't
buy one from them.
The Chairman: Lord Forsyth?
Q146 Lord Forsyth of Drumlean: I'll
resist the temptation for once. I think I know what the answer
to this question is going to be. Some people have suggested that
internal audit should be mandatory for UK-listed companies rather
than explain why you don't have internal audit procedures, if
that is the case. What do you think about that?
Mr McBurnie: I think for the right size of firm
internal audit should be mandatory. I wouldn't put it for all
companies. You might say it's the top 100, it's the top 250, but
it has to be internal audit that is written very clearly with
clear guidelines: what are they going to report on, what are they
going to do and a framework within which they work very closely
with the external auditor as well in order to get the best value
Mr Maslin: Could I offer a variation on that
view? It comes back to the concept of the FRC perhaps convening
a group of leading institutional investors to look at audit appointment
issues but audit issues more generally. I note earlier this week
there was a study released by Deloitte in which a number of internal
auditors of large companies expressed some concern that their
internal audit functions weren't as well resourced as they would
I think it's easy to have a regulatory intervention
that says, "Do something, have an approach" and someone
can tick off a box and say, "Okay, we never used to have
an internal audit function. We now have a part-time person doing
internal audit". I think a more effective way of looking
at concerns around internal audit and all sorts of other governance
issues would be to get a dialogue going so that if there were
a concern like that it could be assessed and evaluated by institutional
investors together and if they felt there was a weakness in the
market they could bring pressure to bear on the companies in which
they invest to bring about improvements.
Mr Michaels: I agree. I wouldn't make it mandatory.
I think the FRC guidance is adequate and I think it depends on
the complexity of the business and the need for the appropriate
checks and balances to be provided rather than should be driven
by the regulator.
Lord Forsyth of Drumlean: That wasn't
the answer I was expecting.
The Chairman: We're coming to the big
mop-up question, I think. Lord Best?
Q147 Lord Best: I chair an audit
committee that uses BDO and I chair another organisation that
uses BDO for its internal audit. So I declare that interest.
The big question is what is the one single measure
that each of you would suggest in order to widen choice in the
audit market? Perhaps you could set that in the context of the
fact that the consultation that goes on with the profession through
the Financial Reporting Council, the FRC, is almost entirely with
people who have a self-interest, a vested interest, in the outcome
of that consultation. I think about 85% of those consulted are
in the profession themselves. But, even with that backdrop, what
would be your suggestions for change to give us more choice in
the audit market?
Mr Michaels: I don't think there is a silver
bullet that solves this in one go but I do think this is a once-in-a-generation
opportunity, if you like, to grasp the nettle and do something
about it. For me that single issue is around intervention, around
the regulators, around investors and around government as well
in terms of spending. Building on that point of intervention,
I think, without it becoming bureaucratic, there is an awful lot
you can do to speed up the de-risking of the market and creating
more choice for investors and making sure absolutely that the
market is providing them with what they need and want as opposed
to a solution that isn't necessarily appropriate for their means.
Mr Maslin: I would go back to something I've
said a number of times, which is that the ultimate user of audit
services is the investor community and that's why I quite agree,
Lord Best, that the valid views here are from the investor community,
not from Grant Thornton and other audit firms. But I do think
there is a role for a strong steer to be given to the FRC to convene
a grouping of large institutional investors to take on some of
these issues and I think that would be the most effective way
of getting the market and the investor community to bring about
change in the audit market structure for the companies in which
The Chairman: Mr Herbinet.
Mr Herbinet: I was a member of the market participant
group that the FRC put together to try and come up with market-led
solutions and we are where we are today with very little impact
from the recommendations made. So I would totally agree that regulatory
intervention, in my view, is needed as part of a programme of
reforms. If you ask me to select one measure I don't think anyone
here would be surprised that I would recommend joint audit; in
particular for banks and other listed companies posing a systemic
risk to the market, the economy and society at large. All firms
will be looking at it and all stakeholders will be coming at it
with an element of self-interest. I think it's down to people
like you to assess whether the recommendations would have an impact
on this issue of systemic risk.
Mr McBurnie: I would tackle the audit committees,
because that's where the decision-making in terms of audit choice
lies. I would strengthen the role of the audit committee. I would
ensure that members of the audit committee had proper and clear
qualifications in order to be able to do their job properly and
I would insist that there was greater transparency. So there should
be some words in the audit report that forced the audit committee
to report on performance review of the auditors, retendering timetable,
pricing, reasons for their choice of auditors, what work they
undertook with audit planning, the work undertaken to review what
the auditors did as part of the audit committee, review of key
judgemental areas affecting the figures, why they've chosen not
to retender the audit. That has proven to work in the public sector
because by having a very open tendering process you can have audits
based on quality assurance rather than just price and perception.
Mr Michaels: May I make one more observation,
a very short one, which is that there is an EU Green Paper out
at the moment on audit policy, which I'm sure you're aware of?
I think the solutions that one might seek to impose in the UK,
given the international nature of business and given the international
nature of the investor committee as well, it's going to be very
important that they are, where possible, done on a much more co-ordinated
basis; much as certainly we would like to see the UK taking the
lead in that.
Q148 The Chairman: Can I just come
back to the tendering point? There has been increasing pressure
in the last 10 to 15 years, in corporate governance to retender
in all sorts of areasfinancial advisers, in the pension
world, actuaries and so on and so forthand there is a fairly
standard process for a lot of us now in doing that every five
years. You've mentioned that a lot of firms haven't changed their
auditor in over 48 years. Do you think that retendering should
be made compulsory?
Mr Michaels: No.
Mr McBurnie: No, but I think
Q149 The Chairman: Would you like
to get it more consistent?
Mr McBurnie: What I would like to see is a very
open decision-making process on why they decided not to retender.
I don't think you should force a company to retender and go through
a process if they have the right set of people doing the right
job. That seems to me to be creating bureaucracy for bureaucracy's
Q150 The Chairman: You're putting
a heavy weight on the chairman of the audit committee then to
take the view instead.
Mr Michaels: Yes. I think the linkages with
the investor community are absolutely vital to make those decisions
but the point I would just add to it is there is a study, which
we would be more than happy to share with the Committee, that
says that mandatory rotation compounds the concentration issue.
This is because, while audits are put out to tender, those that
are done so by the non-Big Four firms are generally sucked up
by the Big Four and it's very difficult for the non-Big Four to
win them back. So I wouldn't favour mandatory rotation in that
sense and I will share the research so you have that as a reference
The Chairman: I would be grateful if
you would let us have a note on that. That would be very helpful.
Mr Maslin: If I could say very quickly that
more regular tendering is necessary clearly to effect change in
the audit market but, of itself, if there is no change in the
buying behaviours as a result of that, then I don't think it gets
us anywhere. So I agree with Mr Michaels.
The Chairman: Lord Forsyth?
Q151 Lord Forsyth of Drumlean: It
is a slightly rude question but is it the fear that you would
lose business to the Big Four if there was such a process? Is
that part of the thinking behind it?
Mr Michaels: I would build on the point Steve
Maslin made, which is unless the buying patterns are going to
change on a permanent basis mandatory rotation could be a one-way
ticket. So I think there's a combination of factors in it.
Mr McBurnie: My view is based on what the company
is doing, what is best for them, because it makes no difference
to our firm at all whether there is mandatory rotation in the
top 100 and 250 because it's simply not a market we're competing
in against the Big Four. So we have nothing to gain or lose, as
The Chairman: Gentlemen, you have given
us a fascinating afternoon with a different perspective, which
is exactly what we expected and you've certainly fulfilled our
expectations. So thank you very much indeed for coming.
We will now adjourn for 15 minutes and then
be on the line to Australia, and it will be an open session at
5 pm. Thank you.