Written evidence submitted by Mazars LLP (DAR0025)
Mazars, the integrated international audit, accountancy and advisory firm is pleased to submit evidence to the above inquiry. Our main points are summarised below.
1. Wholehearted integrated implementation of the three reviews needed
This needs to happen without any further delay on meaningful audit reform and to prevent future avoidable corporate or audit failures especially at this critical time for our economy.
2. Support for CMA’s recommendations including joint audit
We support the CMA’s recommendations. We are, in particular, supportive of the recommendations related to introducing joint audit for FTSE350 companies with at least one of the companies involved being a challenger firm, except in limited cases approved by the regulator or where a challenger firm is appointed as sole auditor. This would build market resilience, enhance audit quality and ensure a reasonable transfer of market share such that challenger firms’ combined share of the FTSE350 audit market, by share of fees, would be at least 20% after around five years, which at that level would then still only be equal to the then average share of each of the four dominant firms. We also support CMA’s proposal for a peer review normally where one of the dominant firms remains sole auditor.
Managed shared audit as proposed by the FRC would not bring the same benefits as joint audit. In the short term, however, it could perform a helpful role as an escalator to enable challenger firms to become joint auditors of the largest most complex companies at the upper end of the FTSE100. This could take place over a period of up to 5 years.
3. Need for a proportionate, improved and prevention-orientated regulator
The FRC should be replaced by a new regulator fully accountable to Parliament with a strong focus on corporate governance as a whole, and within that on audit quality, and on preventing problems arising through the timely and appropriate supervision of both boards and auditors. The new regulator should be called the Corporate Governance Authority.
4. Support for key Brydon Report recommendations
The implementation of the Brydon Report’s recommendations would lead to the necessary sharper focus on the need to enhance the scope of audit, for example with regards to sustainability and fraud detection. We also endorse its support, and that of the Kingman Report, for directors being held accountable for the effectiveness of controls on reporting and consider this should apply with regards to those for non-financial as well as financial information. These recommendations and a number of others in the report would benefit from further stakeholder consultation on how best to implement them.
5. Legislate where it will achieve better outcomes and to determine regulatory discretion
An appropriate balance needs to be struck between implementation of the recommendations in the three reviews by legislation and by other means. Legislation should be preferred where it would lead to a fuller adoption of the recommendations. It will be important to decide the extent to which the desired outcome should be set out directly in the primary legislation and, alternatively, when the regulator should be given discretion over how they introduce particular reforms.
We welcome the FRC’s recent initiative on the operational separation of the audit practices of the four dominant firms from the rest of their UK activities as a useful first step in this area but consider the transitional period for the proposals to be too long. The CMA’s proposals were also stronger in relation to the oversight of transfer pricing as between the audit and non-audit parts of the business.
6. Holistic approach to corporate governance with strengthening of directors’ responsibilities
More consideration is needed on the role of regulation and legislation in corporate governance and on the responsibilities of directors in ensuring companies are well run. Until now promoting good governance in listed companies has been largely left to the corporate governance code and to investors to ensure it is applied appropriately. Legislation and regulation on board responsibilities has not changed much in recent decades and a review is overdue. As part of an approach focused on preventing governance problems arising, there would be merit in strengthening regulatory oversight of boards.
On specific proposals contained in the three reviews on boards’ responsibilities, we support:
- regulatory oversight of the audit committee of FTSE350 companies (CMA)
- holding relevant directors responsible on reporting issues regardless of whether they are -members of a professional accountancy body (Kingman)
- making directors responsible for internal controls on reporting (Kingman and Brydon)
7. Strengthened Stewardship Code to encourage greater shareholder engagement
In addition to enhancing the role of directors in corporate governance, that of investors should also be strengthened through the Stewardship Code with more engagement encouraged on corporate governance matters including in relation to audit tendering and auditor selection. Collective action by institutional investors on governance matters should also be facilitated where needed.
8. PIE definition should not be extended too widely to private companies
The focus of the PIE definition should be on companies above a certain financial threshold that are also major employers, have substantial defined benefit pension funds, or are important to the national or a regional economy. Moreover, smaller PIEs should not be subject to the same requirements as their larger counterparts.
9 A commitment to make substantial investment if meaningful reform introduced
Mazars, nationally and internationally, is committed to making the substantial investment necessary to grow our audit practice in the UK, especially with regards to audit appointments in the FTSE350, if a meaningful programme of reform is introduced.
Further discussion of matters in our response
We would be happy to discuss any matters in our response to this Inquiry with your Committee. Please do not hesitate to get in touch if we can be of further assistance.
Yours sincerely
Phil Verity
Senior Partner
BEIS Committee Inquiry on Delivering Audit Reform- response to detailed questions
1 Do the proposals from the three reviews of audit fit together as a coherent package that can deliver meaningful reform?
Yes.
Wholehearted integrated implementation of the three reviews needed
If implemented wholeheartedly in an integrated way the recommendations from the reviews would lead to meaningful reform and create a modern audit market that meets the needs of the business community and wider society. Audit reform is essential for protecting jobs and ensuring economic recovery.
Support for CMA’s recommendations including joint audit
The CMA report is meeting the most resistance with extensive lobbying to dilute its proposals to reduce longstanding excessive concentration in the audit market and a lack of competition and choice. The current market situation has resulted in a significant minority of FTSE350 companies having a choice of no more than two of the dominant four firms as their auditor. This is due to conflicts that would be encountered by the others as a result of tax, or other advisory or consulting work with the companies concerned.
The Big 4 firms currently have 100% of FTSE100 appointments. Their market share has increased in recent years, and they have a broadly similar dominance of the FTSE250 market especially in terms of their share of market fees. For meaningful reform, the undue barriers to entry that exist for other audit firms must be removed so that challenger firms are able to secure a reasonable market share. We consider challenger firms should have at least 20% of the FTSE350 market, by audit fee, 5 years after the reform is implemented. Even then, at that level the collective market share of the challenger firms would still only be equal to the average market share of each of the four dominant firms.
The undue market concentration also needs to be addressed in order to strengthen resilience at the upper end of the FTSE100 market. There would potentially be systemic risk to the stability of the capital markets were one of the dominant firms to cease being auditors in that part of the listed market for whatever reason. It is less than two decades since the collapse of Arthur Andersen, one of the then major players, which arose from the failure of Enron in the US. This is therefore a completely practical concern. If one of the four dominant firms were currently to leave the market, this would result in a number of leading listed companies being left without an auditor; in the three remaining dominant firms having an even larger market share which would pose insuperable problems for the regulator; or to a combination of these two unacceptable outcomes.
We support the proposals of the CMA. If implemented, they would achieve meaningful reform. The necessary reforms they would bring about would enhance competition and choice, reduce concentration, strengthen market resilience and improve audit quality.
The CMA’s central proposals include that companies in the FTSE350 should be jointly audited by two firms, with at least one of them being a challenger firm. This would be subject to limited exceptions to be agreed with the regulator or where a challenger firm were appointed as sole auditor. Where the regulator agreed a dominant firm could remain as sole auditor, at least for a period, there would generally be a peer review. The involvement of two firms in the joint audit of leading listed companies would enhance resilience and audit quality as both firms would be engaged in planning the audit; reviewing each other’s work considering the key areas of focus and agreeing on the audit opinion. Any alternative proposals to those of the CMA in relation to the audit market should be judged on whether they would provide assurance of the necessary transfer of market share to challenger firms over a specified period and whether they would increase resilience at the upper end of the FTSE100 audit market.
In addition to joint audit and peer review, the CMA is proposing the operational separation of the audit practices of the four dominant firms from the rest of their UK businesses and enhanced oversight of audit committees both of which we support and would contribute to meaningful reform.
Support for a proportionate, improvement and prevention-orientated regulator
The proposals at the centre of the Kingman Review to establish a new regulator with increased powers and which is fully accountable to Parliament are also an essential component of meaningful reform. The new regulator should be set up without further delay. A discussion is, however, needed on the nature of future regulation to enable it to be effective in raising standards of corporate governance as a whole and with a strong focus within that on audit quality. As set out in the Kingman Report, it is essential that the new regulator is an improvement regulator, committed to all stakeholders in auditing- including auditors, company boards and especially their audit committees, investors and regulators- working together to strengthen the system continually. This should be achieved through quickly learning lessons from when problems arise and by sharing relevant information including emerging challenges and best practice in dealing with them. The regulator also needs to be proportionate with most emphasis focused on systemically risky businesses.
The anomaly highlighted by Kingman, whereby directors of companies can currently only be held accountable for problems relating to their accounts if they are members of a professional accountancy body, or in certain instances an actuarial body, also needs to be addressed. This should form part of a broader review of the responsibilities of boards, including those of audit committees, in relation to choosing their auditors and exercising oversight over auditing issues, the latter as recommended by CMA. It will also be important to implement the proposal in Kingman relating to the auditor’s proposed duty to alert shareholders to concerns in certain circumstances.
Support for the Brydon Report with further engagement on implementation
Sir Donald Brydon’s review contains important proposals to enhance the quality of audit and make it more relevant. This includes those relating to more engagement by auditors with shareholders, more informative reporting by auditors and extending the scope of auditing in relation to matters linked to sustainability and the detection of fraud. Sir Donald also indicates to BEIS his support, similar to that in the Kingman Report, for an approach requiring directors to confirm that they have an effective system of internal controls on reporting in place. We consider such a system should extend to non-financial as well as financial information given the former’s importance to a proper understanding of the business. In addition, the Brydon Report calls for a new auditing profession which is related to our call for the professional accountancy bodies to develop a chartered auditor qualification for senior auditors. Further engagement with stakeholders on a number of the Brydon proposals will be helpful in getting them ready for implementation.
2 Which reforms can be delivered without legislation and what progress has the FRC made in implementing such reforms ahead of future legislation?
Legislation should be preferred where it will lead to better outcomes
With more than 150 recommendations in the three reports, we welcome the FRC seeking to move forward with BEIS in implementing those recommendations not requiring legislation. Some caution is needed, however, to avoid adopting a sub-optimal approach to making changes so as to avoid the need for legislation. Where any significant changes are being made without legislation they should be consulted on appropriately.
The FRC and BEIS should set out clearly the reforms for which they do not consider new primary legislation will be needed and therefore how they plan to implement them and those on which further consultation is proposed ahead of legislation and, in each instance, the planned date for their implementation. The resultant document should be regularly updated for progress made and the opportunity should be provided to stakeholders to comment on the proposed way forward on individual recommendations.
The CMA’s reforms should be enshrined in legislation
Proper implementation of the reforms recommended by the CMA require legislation. That is indeed why the CMA submitted their report to BEIS rather than taking action themselves.
Regulatory discretion in legislation should be at an appropriate level
Careful consideration is also needed of which issues requiring legislation should be covered directly in primary legislation and which should be given to the new regulator to adopt in the manner it sees fit and with appropriate discretion. Where significant political issues need to be decided, these should be dealt with through legislation rather than by too much discretion being given to the regulator as to which course to pursue.
Voluntary initiatives are not a substitute for effective legislation
In general, voluntary initiatives are not a substitute for effective legislation. They inevitably require concessions to make them acceptable to those implementing them and so are unlikely to be as effective as legislation.
3 Will the reforms proposed by the audit industry itself address the failings that were identified by the reviews and the BEIS Committee’s Future of Audit Report?
No.
FRC’s operational separation initiative a useful first step
The FRC’s initiative on operational separation of the four dominant firms’ audit practices from the rest of their UK businesses is a useful initial step in this area. We, however, do not see it as replacing the need for legislation. The transition period for implementing the FRC’s operational separation proposals, extending out to 2024, is too long and highlights the drawback of voluntary initiatives. The CMA’s proposals also provide more effective oversight in relation to the very important area of transfer pricing with regards to transactions between the firms’ audit practices and the rest of their businesses.
Challenger firms should be expected to adopt a similar approach to the dominant firms once they have a significant share of the FTSE350 audit market.
Greater transparency needed on voluntary initiatives
As a general point, greater transparency is needed on any voluntary initiatives put forward by the ‘audit industry itself’, or parts of it, to ensure they command widespread support among key stakeholders. If the regulator is minded to adopt them they should normally be subject to a full consultation process with an indication of who submitted the proposals.
Shared audit will need significant regulatory intervention for meaningful market share transfer
We have also been asked to comment on proposals on Managed Shared Audit. We do not consider Managed Shared Audit on its own to be an effective way forward but believe it could play a role as an escalator to joint audit. If it is to lead to a meaningful transfer of market share to challenger firms, significant regulatory oversight will be required.
Managed shared audit is not designed to lead to the full benefits for the audit market or wider society of joint audit that the CMA’s proposals called for after a thorough independent review, taking evidence from a wide range of stakeholders.
Under shared audit there is one group auditor and a different subsidiary auditor for parts of the business. Under joint audit, the joint auditors are together responsible for planning the group audit, reviewing each other’s work and determining the group opinion, providing additional quality assurance compared to the shared audit model. Critically, unless the regulator is to be very actively involved in the allocation of shared audits, such a system is most unlikely to lead to a transfer of a meaningful market share from the dominant firms to the challenger firms. Under a joint audit system this is, in effect, guaranteed to happen.
Shared audit has a role as an escalator to joint audit
Shared audit on its own keeps challenger firms in a permanently junior role and will not address the vitally important issue of resilience at the upper end of the FTSE100 market. It could, however, fulfil a helpful role in acting as an escalator to challenger firms becoming joint auditors of these leading companies. This could be achieved by challenger firms initially participating in the audits of the largest and most complex companies as a shared auditor and steadily increasing their share of the total audit work undertaken such that they could become joint auditors after a period not exceeding 5 years.
4 When will the Government bring forward its proposals and the necessary legislation where required?
Legislation needed without further delay to prevent avoidable corporate or audit failures
The Government should bring forward its legislative proposals as soon as possible. These should seek to implement the recommendations of the CMA and set up the proposed independent regulator to replace the FRC. Some of the proposals in the Brydon report will benefit from further development over the coming months but where legislation is necessary to implement them the aim should be for this to be brought forward at the same time as that for the implementation of the CMA and Kingman recommendations.
There has already been a significant delay in implementing the recommendations for audit reform. Well over a year has now passed since the publication of the Kingman Report in December 2018 and the CMA’s Report in April 2019. Further delay risks avoidable corporate and/or audit failures with the risks of substantial negative impacts on employees, pensioners, investors, taxpayers and other key stakeholders in businesses, and wider society.
5 Will audit reform help track progress made by companies in meeting the UK’s Sustainable Development Goal commitments and in particular Net Zero?
Improved reporting and auditing would lead to better tracking of progress on sustainability
Audit reform in the appropriate areas would help track progress in meeting the UK’s Sustainable Development Goal commitments and, in particular, Net Zero in a more effective way than occurs at present.
This should be achieved through requiring improved reporting by companies, especially listed companies. Their performance and future plans on sustainability issues should be reported in a fair and balanced way in their annual reports and there should be a requirement that the whole of the annual report should be subject to audit in the same way as the financial statements are at present.
6 How will audit reform fit with wider corporate governance reform?
Holistic approach to corporate governance needed with strengthening of directors’ responsibilities
More thought is needed on the role of regulation and legislation in corporate governance.
Sir Adrian Cadbury in his leading report ‘The Financial Aspects of Corporate Governance’ in 1992, which led to the creation of the UK Corporate Governance Code, emphasised that effective corporate governance involved striking the right balance between enterprise and accountability. This remains true today subject to it being clear that this is in the context of promoting sustainable development.
Greater consideration needed of the respective roles of all key stakeholders
An effective system of corporate governance needs to look at the respective roles of directors, auditors, investors and regulators not just with regards to auditing but more broadly considering their overall responsibilities to the company and society. The primary emphasis in each of the current three reviews is on auditing issues whereas it would be helpful to take a more holistic corporate governance perspective and ask how can a preventative approach be adopted to stop problems arising at a company through appropriate action by key stakeholders. This includes the effective regulatory supervision of boards, especially in relation to listed companies and other public interest entities. Until now, the oversight of boards has been largely left to investors but, with the proportion of domestic investors falling in major UK companies and the rise in passive investing limiting the time for engagement by investors, some increased regulatory involvement is now needed.
Merit in strengthening regulatory supervision of boards as part of a preventative approach
Where regulatory supervision highlights substantial concerns with regards to how a board is functioning, the regulator needs to be able to intervene early in a timely and proportionate manner when successful remedial action is able to be taken. At present, the primary action against directors, who are not members of a professional accountancy or actuarial body, generally seems to be the right of the Insolvency Service, after the event, to seek to disqualify a director of a failed company from holding another directorship for a given period. A new approach is overdue.
Strengthening the Stewardship Code to encourage greater shareholder engagement
There would also be merit in strengthening the Stewardship Code to encourage greater engagement by investors on corporate governance matters including those related to auditing. Consideration should also be given to whether any legislative or regulatory changes are needed to facilitate more collective action on governance matters, especially by institutional investors, without this being considered to have led to them forming a concert party for Stock Exchange purposes.
Corporate governance system should be proportionate and promote an improvement culture
Overall, as well as promoting a preventative approach, the corporate governance system needs to promote a learning and improvement culture. A proportionate approach is also needed with more rigorous expectations of the boards of leading global systemically risky businesses compared to those of small listed companies, a fraction of their size. In companies where problems have been identified in the boardroom, greater regulatory supervision should also be expected.
PIE definition should not be extended too widely to private companies
Proportionality also needs to be to the fore in deciding on any extension to the definition of Public Interest entities (PIEs). Additional non-listed businesses should not generally be brought within the scope of the PIE definition by virtue of their size alone. Other factors such as the number of employees and/or pensioners, or size of pension fund, and a company’s importance to the economy, in regional or national terms, should also be taken into account. Moreover, there may be additional expectations and requirements in relation to larger PIEs as compared to those for their smaller counterparts. Once the new definition of PIEs has been determined, the regulator should avoid, in effect, adding to them, as a consequence of their maintaining other categories such as Other Entities of Public Interest (OPIEs).
Holistic strategic view needed of corporate governance legislation
The Kingman review seems in essence to have adopted a modular approach in its review of FRC. It has looked at the problems in each part of the current regulatory system and makes recommendations to address them rather than taking a more holistic strategic overview of the core requirements for a legislative model that has not substantially changed for decades. We would express caution in having the audit committee subject to far more intensive regulation than the board as a whole as they are a committee of the board and answerable to it and such an approach may well lead to many board members seeking to avoid serving on the audit committee.
The new regulator should be called the Corporate Governance Authority
Given our strongly held view that reporting and auditing are integral parts of the corporate governance system, the new regulator would more simply and accurately be called the Corporate Governance Authority.