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


The Economic Affairs Committee's inquiry into Auditors: market concentration and their role aimed to look into two main issues:

  • the dominance of the Big Four and its effects on competition and choice; and
  • whether traditional, statutory audit still meets today's needs.

As the inquiry unfolded, the Committee also focussed on two other important issues:

  • the effect on audit of the adoption of International Financial Reporting Standards (IFRS); and
  • how banks were audited before and during the financial crisis and what changes there should be, including in auditors' relationships with financial regulators.

This report addresses all of these issues.

Identification of the shortcomings of the large-firm audit market is easy enough. It is clearly an oligopoly with all the attendant concerns about competition, choice, quality and conflict of interest. It gave no warning of the banking crisis. The narrowness of the assurance it offers is much criticised. Its regulatory structure, in the UK and internationally, is complex and unclear.

Yet investors, regulators and commentators regard rigorous and reliable external audit as an essential underpinning of business and the capital markets which finance it, in Britain and elsewhere. The assurance offered by audit is especially needed in the case of banks, with their attendant risks and where loss of confidence can imperil the financial system. The importance of audit is recognised by the legal requirement that medium and large-company financial statements should be audited and by the size and prosperity of the audit business, which is dominated in Britain and globally by the Big Four: Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers.

The Big Four's domination of the large firm audit market in the UK is almost complete: in 2010 they audited 99 of the FTSE 100 largest listed companies, which change auditors every 48 years on average. In bank audit in the UK there is only a Big Three, since Ernst & Young are not active. This report highlights the risk that one of the Big Four might leave the audit market, leading to an even greater and wholly unacceptable degree of concentration unless preventive action were taken.

The Committee's concerns about the Big Four's oligopoly of large firm audit were intensified by their failure to give warning of trouble in the run-up to the financial crash. Clearly bank auditors cannot express concerns openly about banks' finances without undermining confidence and risking a run. But the Committee was highly critical of the fact that, as our evidence revealed, confidential dialogue between auditors and bank regulators had fallen away before the financial crisis so that there was no pooling of information or concerns which might have given warning or allowed some action to mitigate the worst effects. This failure to maintain dialogue seems to the Committee a dereliction of duty.

The Committee also heard evidence that audit standards had been lowered by the adoption of International Financial Reporting Standards (IFRS). These became mandatory for EU listed companies in 2005 and are intended to pave the way towards common accounting standards around the world including the US. The Committee heard that IFRS were more rules-based than previous national standards and leave less scope for the auditor to exercise prudent judgment and as necessary to override a box-ticking approach in order to reach a true and fair view of a given financial statement.

The Committee considers that good audit is essential to business and finance. It welcomes the Financial Reporting Council (FRC)'s efforts to improve competition and choice in the audit market and to streamline the regulatory framework but shares the FRC's view that they have not led to any great improvement. The Committee recommends several measures which should be of benefit in reducing the dominance of the Big Four but concludes that these in themselves are unlikely to be enough.

The Committee makes three main recommendations:

  • first, a detailed investigation of the large-firm audit market by the Office of Fair Trading, with a view to an inquiry by the Competition Commission so that all the interrelated issues surrounding concentration, competition and choice can be thoroughly examined in depth and in the round. The Committee recognises that the global reach of the Big Four and of their clients goes beyond the scope of a national competition authority. But when London is both the incubator of at least some of the Big Four and one of the world's leading financial centres, it seems right for the UK to take a lead;
  • second, that prudence should be reasserted as the guiding principle of audit;
  • third, the new framework of banking supervision should provide for bank audit to contribute more to the transparency and stability of the financial system, in particular through two-way dialogue between auditors and supervisors about the financial health of banks.

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