Reforming the Audit Market

The EU has published a draft paper detailing proposed reforms to the audit industry, geared at improving quality and diversifying the market.

At their heart is a challenge to the dominance of the ‘big four’ auditing firms, and to the assumption that an auditor’s size equates to quality.

The reforms have been put forward by Michel Barnier, the EU internal market commissioner, in response to the banking and financial crises of recent years and the UK Office of Fair Trading referring the market for providing audit services to large companies to the Competition Commission.

One of the key changes, would prohibit contract causes requiring an audit to be undertaken by one of the ‘big four’ firms. Typically used by banks, these have restricted opportunities for businesses to engage a firm better suited to their needs, and crucially one that is more cost-effective.

The proposed reforms recognise the valuable role that medium-sized auditors play in delivering quality and independence, and in creating choice within the marketplace.

If adopted, they would in fact put choice at the centre of the auditing industry – giving businesses a set of processes that would allow them to be truly selective about their supplier.

Significantly, the proposals consider mandatory rotation of audit firms and new rules for audit tendering.

Key changes and the opportunities they present

Public companies would be required to hold a fair and transparent tender process when selecting a new auditor. The audit committee would be required to invite at least one ‘smaller’ firm to tender.

The tender process gives audit committees an ideal way to access value for money, and to select an auditor truly in touch with their business needs.

The maximum length of time that any audit firm could be exclusively engaged by a client would be six years, and there would have to be a four-year hiatus before re-engagement.

While rotation is not something that should be done for its own sake, a review of potential auditors – the chance to re-evaluate the skills, experience and service levels they can bring to your business - should always be seen as an opportunity.

Perhaps one of the most significant elements of the proposed reforms is the encouragement of ‘joint audits’. If auditors join together they could be engaged by a client for up to nine years.

Audit firms would be prohibited from providing non-audit services to their auditing clients. In addition, large firms would be required to separate audit activities from non-audit activities in order to avoid conflicts of interest.

What happens now?

Barnier says these proposals will help to improve industry standards and are long overdue.

“We need to restore confidence in the financial statements of companies and address the current weaknesses in the EU audit market, by eliminating conflicts of interest, ensuring independence and robust supervision and by facilitating more diversity in what is an overly concentrated market, especially at the top-end."

The draft paper needs to be approved by the EU member states and the European Parliament, which could take up to 18 months.

In the meantime, Buzzacott continues to see the benefits of businesses choosing auditors appropriate to clients’ needs and the uncertainties they face, offering all the benefits of quality and independence that a more personal auditor can provide.

If you would like further information on the information covered in this article please contact Simon Wax.