Auditors: Market concentration and their role - Economic Affairs Committee Contents

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 businesses.

    (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 other stakeholders.

    (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 assurance.

    (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



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' market share.

  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[1] 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 review.

  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 and commentators.

  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[2]. 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 or mitigated?

  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[3]. 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 enhanced?

  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 are effective.

  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 the key.

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 benchmarking analysis.

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