Letter from Deloitte (ADT 29)
1. We are pleased to respond to the Call
for Evidence issued by the House of Lords Select Committee on
Economic Affairs in July 2010.
2. Our view is that the audit profession
has discharged its responsibilities with care and diligence throughout
the financial crisis. In relation to market concentration, our
experience has been that the audit marketplace is fiercely competitive
and transparent. The quality of auditing in the United Kingdom
is higher than ever and we take very seriously the trust placed
in us by market participants.
3. In our view, the underlying accounting
principles and the respective responsibilities of regulators and
auditors are not well understood and warrant consideration. There
is consequent need for reflection as part of the journey of continuous
improvement. We are working closely with clients, investors and
regulators towards a common objective of mitigating the risk of
a future crisis.
4. The principal points which we would make
are as follows:
(i) Economic factors demonstrate the competitive
nature of the audit marketplace: for example, the high levels
of investment we make in winning and retaining clients and the
comparable levels of profitability in our audit and non audit
(ii) Auditing today is a demanding profession,
requiring high levels of investment and commitment in order to
deliver the quality expected by audit committees, regulators and
(iii) We have chosen to compete in this market,
and have grown our FTSE 100 market share significantly from four
clients in 1995 to 22 today. It is a dynamic market without insurmountable
barriers to entry.
(iv) It is not our most profitable market, and
carries the highest levels of risk and regulation. However, it
also defines our reputation and is at the very heart of our business.
(v) We have seen no evidence of anti competitive
behaviour and our experience is that the listed company audit
market is one of the most competitive. The recommendations of
the FRC's Market Participants Group are intended to promote greater
competition in the longer term.
(vi) We welcome the discussion regarding the
evolution of certain aspects of accounting standards. We are also
closely engaged with the Bank of England, the FSA and the FRC
in exploring where auditors may be able to give further objective
(vii) The accounting requirement to record losses
when incurred, and not when expected, is generally not well understood.
The different responsibilities of prudential regulators and auditors
also appear unclear to some investors and commentators. Auditors
do not write the accounting, auditing or regulatory standards,
their role is to give assurance that they have been applied objectively.
(viii) The debates around auditor competition,
scepticism and ethics are all largely driven by these considerations.
The issues are largely of perception and disclosure, not substance.
(ix) The global liquidity crisis was not anticipated
by companies, investors, regulators and government alike. Similarly,
it is not the role of the auditor to foresee the unforeseeable.
(x) Companies may wish to disclose the rigour
applied by audit committees in assessing audit quality and value.
Similarly, audit firms' transparency reports could describe how
the firms respond to that rigour and competition, and the significant
investment made in winning and retaining their clients.
5. We have responded to the detailed questions
raised in the Call for Evidence in appendix 1, attached.
24 September 2010
RESPONSES TO QUESTIONS RAISED IN THE CALL
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?
1.1 Auditing large companies requires global
reach, a robust approach, the highest quality, and a pristine
reputation. The audits of multi national groups require networks
with firms in many countries. Clients expect audit teams to comprise
the best people, with technical excellence, industry expertise
and an enquiring, questioning mindset. To respond, audit firms
need the scale and appetite to enter a demanding and higher risk
market. Such firms are also likely to be better placed to challenge
their larger clients.
1.2 Over time, audit firms have variously
made their decisions as to how to respond to that market, and
in which segments to compete. Regulatory reporting indicates that
it is now harder for smaller firms to deliver quality and respond
to the needs of larger, listed companies. However, this is not
a market phenomenon; it is the result of firms making different
decisions regarding investment, scale and target markets. This
then has the effect of driving client choices and hence firms'
1.3 There are many other markets where there
relatively few participants and where no competition concerns
arise. The transparency of the audit market should offset any
impact of there being fewer participants. Further, the recommendations
of the FRC's Market Participants Group
are intended to promote competition in the longer term.
2. Does a lack of competition mean clients
are charged excessive fees?
2.1 We have not found the market to be uncompetitive.
Our experience is the reverse: we make less profit from auditing
listed companies than from other parts of our business. Our audit
business as a whole has a slightly lower profit margin (29%) than
the rest of our business (33%). We have preserved that margin
during the financial crisis by investing appropriately, controlling
costs and negotiating fair fees.
2.2 The margin on major listed company audits
is lower than audit as a whole, showing sustained fee pressure
in this market, despite the unlimited liability that such work
carries. We invest significant time and costs in bid opportunities,
and in relation to major listed companies, the opportunity costs
of such an investment reach well into six figures and more, with
high levels of attention devoted to retaining existing relationships.
The fact that large companies tender their audit only infrequently
reflects those intense efforts to retain clients. This evidences
the competitive nature of the market.
3. Does a narrow field of competition affect
objectivity of advice provided?
3.1 We have seen no evidence that the field
of competition is too narrow or of a lack of objectivity from
auditors. The primary focus of the auditor is the truth and fairness
of the financial statements. Auditors are bound by rigorous ethical
standards that preserve their independence and objectivity, regardless
of market or competition considerations.
3.2 The auditor's principal role is not
to provide objective advice on the appropriateness of the business
model. This would be likely to breach independence as the auditor
would then be at risk of assuming a management role or of self
3.3 Whilst auditors will give consideration
to the business model, it is not their place to tell management
how best to run the company, nor to tell investors where best
to invest their money. These are judgements for others, based
on their appetite for risk.
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?
4.1 The auditors' primary role is to audit
and form an opinion on the financial statements. Any advice offered
is in the context of ethical standards and not a substitute for
proper governance and management by their clients.
4.2 Auditors provided an effective challenge
during the financial crisis; as evidenced by increased levels
of modified audit reports. This is despite the competitive nature
of the market and is a function of the firms' relentless commitment
to quality and their reputations, the rigorous governance and
expectations of audit committees and the presence of an effective,
transparent regulatory framework.
5. What is the role of auditors and should
it be changed?
5.1 The auditors' role is to provide reasonable
assurance that the financial statements are free from material
misstatement, comply with statute and show a true and fair view.
5.2 This is fundamental to the capital markets,
as it gives comfort that the numbers in use by the market are
reliable, thereby avoiding a risk premium or reluctance to trade.
There is little evidence that the assurance provided was flawed
and we welcome discussions with stakeholders regarding further
objective assurance from auditors.
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 a contributory factor?
6.1 The financial crisis was unforeseen
and without precedent. In our view, comments regarding auditor
scepticism arise from issues of perception. The accounting requirement
to record losses when incurred, and not when expected, is not
well understood by some investors or regulators. It was not open
to banks to provide for future losses, nor was it open to auditors
to permit (let alone advise) such treatment. The different responsibilities
of prudential regulators and auditors appear unclear to some investors
6.2 See also 5.1 and 5.2. It is open to
regulators and investors to consider any further information they
require and the basis on which it should be prepared. That information
could be sought from the company and, if appropriate, objectively
assured by the auditor.
7. What, if anything, could auditors have
done to mitigate the banking crisis? How can auditors contribute
to better supervision of banks?
7.1 The responsibilities of auditors are
set out in our response to question 5. The systemic collapse of
the global capital markets was not foreseen by any market participants,
including investors, regulators, Government and auditors.
7.2 Looking forward, there is scope for
auditors to provide further objective assurance, and we welcome
discussions with investors, clients and regulators as to how best
to do so. Frameworks for this reporting have been in existence
for many years, and we encourage investors and regulators to discuss
their information needs with the profession.
7.3 We welcome the indications from regulators
that they are willing to share information more freely with auditors
and to engage in dialogue regularly.
8. How much information should bank auditors
share with the supervisory authorities and vice versa?
8.1 Open, ongoing dialogue between auditors,
clients and banking supervisors is important to each party's responsibilities.
The points made in our responses to questions 5, 6 and 7 are relevant
here as is the ICAEW's analysis of lessons from the crisis.
Prior to 1997, there was greater information flow from supervisory
authorities to auditors.
8.2 Two further points: (1) financial information
prepared and used for statutory financial reporting purposes may
have been prepared on a basis that is not appropriate for the
(different) needs of prudential regulation and (2) the auditor
is available to provide objective assurance at least on some of
that regulatory financial information.
9. If need be, how could incentives to provide
objective, and in some cases unwelcome, advice to clients be strengthened?
9.1 Our response to 3.2 is relevant here.
The existing framework of ethical standards, audit committee scrutiny,
regulatory transparency, reputational and litigation exposure
and firms' transparency reporting all safeguard deliver auditor
objectivity. Increased dialogue with regulators will help both
the auditors and the regulators to have a fuller perspective on
all of the issues surrounding the regulated entity.
10. Do conflicts of interest arise between
audit and consultancy roles? If so, how should they be avoided
10.1 Threats to independence may arise,
and are addressed by ethical standards. These have extensive prohibitions:
for example, auditors cannot act as management, review their own
work or act as the client's advocate in a dispute. The standards
follow a principles-based approach requiring auditors and audit
committees to identify potential threats and address them with
appropriate safeguards. Remuneration and objective setting for
individual auditors cannot refer to the sale of non audit services
to their audit clients.
10.2 Our response to the Auditing Practices
Board's consultation on this topic is relevant.
The APB's data shows just 4% of firm's revenues is generated from
the provision of non audit services to FTSE 100 audit clients.
There is a perception issue here, and we consider more complete
disclosure would be helpful.
11. Should more competition be introduced
into auditing? If so, how?
11.1 The audit market, particularly for
listed companies, is already fiercely competitive. This is one
of the principal barriers to entry. Overcoming that barrier requires
significant investment, commitment and the willingness to operate
in higher risk markets. There is no appreciable current demand
or economic incentive for a new market participant, although we
do not discount it as a future possibility, and indeed would welcome
it. The market structure largely reflects the demands of that
market: for quality, scale and global reach. The liability exposures
faced by auditors may also act as a further disincentive.
12. Should the role of internal auditors
be enhanced and how should they interact with external auditors?
12.1 The new UK Corporate Governance Code
provisions relating to risk will require an element of change
by internal auditors in order to respond effectively. Interaction
with external auditors is addressed by existing auditing standards
and works well.
13. Should the role of audit committees be
13.1 The new Code also requires greater
consideration of the risks in the company's business model. Refinements
to audit committee guidance on non audit services will assist
with perception issues, but the principal interactions with auditors
13.2 Overall, the business model of the
company is assessed by analysts and, indirectly, by the market.
Clear disclosure of that model and of business performance is
14. Is the auditing profession well placed
to promote improvement in corporate governance?
14.1 Yes. The reports provided by auditors
to those charged with governance (eg audit committees and boards
of directors) typically contain valuable insights. Auditors are
also well placed to provide industry and market contexts through
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