The next head of the UK accounting regulator will take over a more professional organisation than the “ramshackle house” inherited by Sir Jon Thompson in 2019. But a conundrum remains: can the watchdog drive up audit quality at the same time as increasing competition in the sector?
Under Thompson, who will leave this summer after being appointed chair of the HS2 rail link, the Financial Reporting Council has been swift with the stick. It has admonished auditors for poor work, meted out heftier fines and beefed up day-to-day supervision of the big accounting groups.
Initially, Thompson’s team focused on the Big Four — Deloitte, EY, KPMG and PwC — which hold an iron grip on the FTSE 350 audit market, collecting 98 per cent of fees.
Recently, the regulator has paid more attention to smaller firms. BDO and Mazars have been singled out for criticism in inspections. After a run of fines, Grant Thornton has reduced the number of public interest entities (PIEs) — large listed companies and regulated banks or insurers — it audits.
If the audit market was once a wild west, rife with cosy relationships and low standards, some in the profession feel the regulatory pendulum has swung too far in the other direction, potentially discouraging smaller players from stepping up.
For firms like BDO and Mazars, tighter regulation makes their aim of auditing more large listed companies costly and painful ahead of reforms that would require FTSE 350 companies to have part of their audits done by a non-Big Four firm.
“The regulatory pressure is becoming unbearable,” says a senior auditor at one mid-tier firm of the demands from FRC supervisors.
The increased regulatory burden means the FRC is “cementing the oligopoly” of the Big Four, says a senior partner at another firm, lamenting the resources required to respond to constant requests from the watchdog.
The regulator’s gaze has also widened beyond the very largest mid-tier firms to smaller players. Of the 14 publicly announced audit investigations launched by the FRC in the past two years, nine have been against firms outside the Big Four, including smaller “challengers” such as Shipleys, MHA MacIntyre Hudson, Crowe and Saffery Champness.
More stringent regulation creates barriers to entry for small firms that carry out only a handful of PIE audits, which attract stricter oversight than their other work. These include spending on systems and experts to carry out the work and investing time and resources to comply with FRC inspections.
The firms also fear fines and reputational damage if things go wrong. Their concerns are well-founded given that FRC inspections have found work by auditors outside the top seven are of lower quality.
The Big Four’s decision to ditch smaller or riskier clients coupled with government plans to redesignate about 600 companies as PIEs under long-awaited reforms, was expected to lead to work cascading down towards smaller accounting firms. But if smaller firms opt out, these companies will need to find auditors elsewhere.
“That resource has to come from those firms who are . . . outside the Big Four. You need to encourage more into the market,” says Martin Muirhead, chair of the Association of Practising Accountants, a group of midsized firms.
Top 15 accounting firms Saffery Champness and Evelyn Partners (formerly Tilney Smith & Williamson) were not among the 30 private firms named on the FRC’s recently introduced register of firms authorised to carry out PIE audits.
Sarah Rapson, FRC deputy chief executive and head of supervision, says the watchdog is willing to “help”, including by launching a “scalebox” initiative to educate smaller firms on what it expects of them.
Rapson insists there is “not a trade off” between increasing audit quality and improving competition. Regulation will be “proportionate” to firms’ size but she argues that audit quality “is the single most important thing” and will ultimately become a basis for better competition.
Tougher scrutiny of the auditors who sign off companies’ accounts was overdue after years of bad practice. But the FRC faces a difficult balancing act. If it reaches for the stick too often, its welcome push for high standards risks squeezing smaller firms out of the market entirely.