Memorandum by KPMG LLP (ADT 31)
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 Independent reports from Oxera and London
Economics to the UK Government and regulators and the European
Commission underlined that the drivers to concentration were greater
capacity/international coverage to serve global/complex organisations;
technological innovation; need for industry knowledge/expertise
to serve clients, reputation and liability risk. Concentration
was exacerbated by the regulatory response to the problems of
Arthur Andersen which led to its collapse.
1.2 The market pressures continue today.
The world's major companies continue to expand both through organic
growth and consolidation demanding an ever increasing international
audit capability. At the same time diverse national regulatory
requirements continue to increase—including registration,
annual returns, inspection, disclosure and ethical standards.
This means significant investment in processes, infrastructure,
expertise and technology but most importantly in people who are
essential to quality. These factors create economies of scale
which do help firms to expand and drive a virtuous circle with
the best people joining those firms that are successful, reinforcing
that success thereby attracting the best people.
2. Does a lack of competition mean clients
are charged excessive fees?
2.1 No. Cost is an important factor in the
consideration of the appointment of auditors. A KPMG survey of
Audit Committee Chairs puts cost as the fifth highest factor in
the appointment of auditors behind issues like auditor communications,
robustness and perceptiveness. In our experience when audits are
put out to tender there is fierce competition, including on price,
across all sizes of company. Even for those companies which do
not go out to tender the audit fees are often benchmarked and
in our view an appropriate balance is normally struck between
cost and quality.
3. Does a narrow field of competition affect
objectivity of advice provided?
3.1 No, we haven't seen any evidence that
suggests that audit quality has declined since the consolidation
to fewer large firms. Quality of opinion is paramount to the reputation
of audit firms. This is backed up by rigorous training, strong
ethics and enhanced by the multi-disciplinary nature of the UK
profession.
3.2 The Snyder-Myners Report, Professional
Services Global Competitiveness Group in 2009 recognised the
world leading position of the UK profession, "The UK accountancy
profession is well respected and influential internationally.
The resilience and strength of the UK multi-disciplinary model
and the emphasis on judgement and principles are internationally
recognised."
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 No. Although it is possible that this
may have happened, we have not seen any evidence that supports
this argument. In our view the more important factors have been
the profound and welcome changes to the profession in recent years—independent
oversight, public reporting, the role of audit committees and
the introduction of a code of governance for the major audit firms.
These have all enhanced the independence of auditors and underpinned
improvements in audit quality.
5. What is the role of auditors and should
it be changed?
5.1 The auditor is currently responsible
for auditing the financial statements—prepared by management—to
provide reasonable assurance to the investors that they are fairly
stated in all material respects. The financial crisis has challenged
all the key players in the global capital markets to re-examine
their roles and effectiveness and the business reporting and the
assurance framework should be part of this re-examination.
5.2 We believe however that it is essential
to retain the existing division of responsibilities—the
company reports and the auditor provides assurances on those reports.
Within that framework KPMG is keen to engage in the debate and
find solutions that carry broad support. This might include expanding
both the nature of assurance reporting and extending its scope
beyond the financial statements and even perhaps beyond the annual
report to other forms of corporate reporting. There might, for
example, be some form of risk reporting for which auditors may
not be the exclusive provider of assurance.We have also made suggestions
as regards reporting to financial institution regulators in our
response to the recent consultation paper from the FSA and FRC,
we set out some of these ideas in our answers to question 7.
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 contributing
factor?
6.1 In our experience auditors were sufficiently
sceptical in the run-up to the financial crisis. We disagree with
recent assertions to the contrary by some in the UK regulatory
community. Such assertions of a lack of scepticism do not accord
our engagement with regulators at the time. In any event, even
if our view on professional scepticism was to be challenged we
see no obvious connection with concentration.
6.2 As the House of Lords Select Committee
on Economic Affairs Report said in June 2009 "We have no
evidence that bank auditors failed in their statutory duty to
make going concern judgement on their clients. Bank auditors should
not be required to make a more general judgement on the quality
of their clients' strategies."
7. What, if anything, could auditors have
done to mitigate the banking crisis? How can auditors contribute
to better supervision of banks?
7.1 In our view whilst the auditors can
contribute to an improved regulatory and micro-prudential regime,
they could not themselves have "mitigated" the banking
crisis. Banking as an industry is heavily impacted by the general
economic environment and asset prices in particular. This environment
is shaped primarily by politicians, policy makers and central
banks across the world. The need for change in this area is also
recognised. As the Governor of the Bank of England said recently
"We let it slip|the crisis was caused not by problems in
the real economy; it came out of the financial sector." We
welcome the new focus in the UK on financial stability and better
macro and micro prudential supervision—as auditors we stand
ready to play our part in that.
7.2 In the UK we support a new transparent
and coherent process with a clear set of principles for a good
working relationship between regulators, financial institutions
and auditors. KPMG welcomes the debate that has been started by
the FSA and the FRC on this and the parallel dialogue with the
Bank of England. We have discussed in our response to the recent
FSA and FRC consultation paper how a framework of dialogue between
those charged with governance, auditors and regulators might work.
The table below summarises our proposals.
| Meeting Type |
Objective | Attendees
| Timing |
| Micro prudential | Covering culture, risk appetite, business model, what can go wrong, key judgements and decisions, effect of macro prudential issues
| Tri-lateral: Regulators, Audit Committee and Auditors
| Semi-annual |
| Micro prudential | "Safety valve" meeting between auditor and regulator
| Bi-lateral: Regulators and Auditors | Annual or as required
|
| Micro prudential | Discussion of key accounting judgements and disclosure
| Tri-lateral: Regulators, Audit Committee and Auditors
| Pre-issuance of financial statements—could be expanded to half year/quarterly reports
|
| Micro prudential | Cross border regulator issues
| Tri-lateral: Relevant Regulators, Audit Committee and Auditors
| Annual |
| Macro prudential | FSA and auditors market issues—may require hot topic sub groups to continue discussions
| Large audit firms and regulators | Quarterly
|
| Macro prudential | Financial Stability Board/G20 agenda
| Large audit firms and regulators | Semi Annual
|
| Supervisory | Performance of audit firm (see comments on monitoring arrangements below)
| Audit firm, FRC and FSA | Annual
|
8. How much information should bank auditors share with
the supervisory authorities and vice versa?
8.1 We do not believe that there should be any significant
limitations on the client information that could be shared between
regulators and auditors and financial institutions as part of
the trilateral process that we advocate.
8.2 The difficulty is in filtering and identifying the
key issues from such a volume of information. This requires a
structured reporting framework and communication mechanism setting
out what information is required, when and in what format. This
whole area might benefit from a code of conduct or a set of protocols
which formally recognises the respective roles and responsibilities
of all the different parties.
9. If need be how could incentives to provide objective
and, in some cases unwelcome, advice to clients be strengthened?
9.1 We believe the incentives are already very strong.
It is critical to the reputation and hence success of the audit
firms that they provide objective advice, which in some cases
will be unwelcome to clients. This is supported by clear ethical
and professional standards and is an area on which the FRC already
has a clear focus with their central objective of market confidence
in high quality financial reporting and corporate governance.
9.2 Audit committees also play a key role in this dialogue
and we have commented on their role further below.
10. Do conflicts of interest arise between audit and consultancy
roles? If so how should they be avoided or mitigated?
10.1 In our view the issue is more one of perception
than reality. We fully accept however that it is important to
deal with this perception, but we believe this is best achieved
through the triple lock of strong corporate governance; a clear
Code of Ethics and the threats and safeguards approach. In addition,
the recent agreement to a Code of Governance by the larger UK
audit firms and the appointment of independent non-executive directors
will further reinforce the public interest nature of the profession.
The APB has been looking at reforms of non-audit services and
in July 2010 published the results of consultation and reported
that the "overwhelming view" was that there should be
no outright prohibition of non-audit services but further consultation
on stronger guidance to audit committees; extension of the threats
and safeguards approach and a specific look at a small number
of service areas like restructuring advice. KPMG support this
approach whilst agreeing with the view of the Synder-Myners Report
that "strong provision of other services like tax advice
is critical to the competitiveness of the corporate sector."
11. Should more competition be introduced into auditing?
If so, how?
11.1 Our Joint European Chairman John Griffith-Jones
wrote in the FT 15 September 2006, "We agree that in an ideal
world there would be more than four `big' audit firms. Greater
realistic choice for companies can only be a good thing|.the solution
lies in the creation of a successful fifth firm not the destruction
of the existing four."
11.2 In the UK the FRC—through a Market Participants
Group reporting in 2007 set out 15 recommendations to increase
choice in the audit market whilst maintaining quality and independence
eg a code on corporate governance for larger firms and guidance
to audit committees re use of larger firms. In Europe, Commissioner
McCreevy studied a variety of reforms and recommended in 2008
that there should be liability reform across the EU to improve
choice and competition. These approaches which "encourage"
rather than "require" and consider, for example, cost/benefit
and regulatory burden are consistent with the emphasis of the
new UK Coalition Government.
12. Should the role of internal auditors be enhanced and
how should they interact with external auditors?
12.1 The internal auditor is only one, albeit important,
way in which the directors and management control a company. The
range of companies and their activities is in our view too great
to set any general mandatory internal audit requirements. In addition,
within the regulated financial sector the FSA already review whether
the level of internal audit within individual institutions is
appropriate.
12.2 As regards the relationship between internal and
external auditors this is governed by the International Standards
on Auditing which in our view strike an appropriate balance between
the desire to prevent unnecessary duplication (and hence inefficiency)
with the need for the external auditor not to rely unduly on a
function which is by definition not independent. These arrangements
are subject to both company review (Audit Committees) and regulator
oversight (AIU inspections and APB review).
13. Should the role of audit committees be enhanced?
13.1 In the UK Audit Committees have a powerful role
and we have not identified any areas which need enhancing. The
UK Corporate Governance Code (which defines the role of the audit
committee) and the associated FRC Guidance for audit committees
is kept under regular review by the FRC and already goes well
beyond the recent requirements introduced by the EC Statutory
Audit Directive. It was last updated in 2008 in response to MPG
recommendations to require disclosure of how the audit committee
reached its recommendation re the appointment of the auditor (including
information on tender frequency, tenure of the incumbent auditor
and any contractual obligations that restrict the audit committee's
choice).
13.2 However, it is key that investors in particular
have confidence in the those appointed as their agents and we
remain open minded as to how this might be enhanced for example
through being more involved in the selection of non-executives.
14. Is the auditing profession well placed to promote
improvement in corporate governance?
14.1 In our opinion the knowledge gained during an audit
and the experience auditors have through auditing many businesses
ensures they are well placed to promote good corporate governance
(both in the round and for their audit clients). EU Directives
(and International Auditing Standards) require external auditors
to report to the audit committee (or others charged with governance)
on key matters identified during the audit including deficiencies/weaknesses
in internal control.
14.2 Audit firms have taken the lead in promulgating
good governance practice. For example, long-before Sir David Walker's
recommendations stressed the importance of training and development
for non-executive directors, KPMG set up the Audit Committee Institute
(now operating in 30 countries) to provide complimentary guidance
and a variety of resources designed to assist audit committee
members (and other non-executive directors) update and refresh
the skills and knowledge which are essential to their role. This
is a serious commitment with around 50 seminars, workshops and
other colloquium provided each year in the UK.
28 September 2010
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