Written evidence submitted by Crowe U.K. LLP (FOA0010)
1. Introduction
1.1 Crowe is one of the top 10 audit firms in the UK by audit fee income. It is ranked eighth in the Advisor Rankings of stock market auditors both by number of clients and by market capitalisation of audit clients. Most of the clients within these numbers are listed on AIM with a number listed on the main market. Crowe is the leading auditor to charities, having led the rankings with most audit clients for 10 successive years, and is an acknowledged specialist in auditing large pension schemes.
1.2 The firm is the UK member of Crowe Global, the eighth largest international accounting network with revenues of approximately US$3.8bn, around 45% of which is derived from audit. Crowe Global is a member of the Forum of Firms.
2. Overview
2.1 In summary, we are supportive of proportionate measures that will improve competition and quality within the statutory audit market.
2.2 We are broadly supportive of measures proposed by the Competition and Markets Authority (CMA), particularly those in relation to mandatory joint audit for the FTSE 350 companies.
2.3 Crowe made a submission to the CMA study into the statutory audit market and, in that submission, we stressed the need to ensure that any proposed remedies are focused on the issues of competition and quality that have been raised in what is, by number of entities, a very small part of the statutory audit market.
2.4 There is a very large part of the statutory audit market (including that which relates to SMEs, charities and non-profits, and pensions schemes for example) where we believe competition is effective and there is no evidence of widespread lack of quality. In our view, it is imperative that any proposed remedies should not have an adverse impact on these elements of the UK market, which are so vital for the economy.
2.5 We have also noted the recommendations arising out of the ‘Independent Review of the Financial Reporting Council’ (the Kingman Review) and, again, are supportive of many of the proposals. An effective regulator is not just important for the confidence of companies and investors but also for the audit firms. Crowe responded to the ‘call for evidence’ in the Kingman Review.
3. What is the relationship between competition and quality in the audit market? How should reforms in one area complement the other?
3.1 Having audits that are performed to an appropriate level of quality is imperative. A market where there is effective competition should result in improvements in audit quality provided that is how the performance of the auditor is being assessed.
3.2 If competition is going to be ‘effective’ then those selecting auditors must have adequate choice. The current criticism is that for large listed companies that choice is limited to four firms and if one or more of those firms is conflicted from taking part in any tender exercise, then the choice is narrowed possibly to two firms or potentially even one. It is then very difficult to argue that competition is able to drive audit quality.
3.3 We recognise that there are both supply-side and demand-side barriers to increasing the competition between audit firms but we fully support the moves to bring more participants into the market. On the supply-side, the so-called ‘challenger firms’ need to ensure that they can demonstrate that they have the appetite, resources and capability of dealing with large, listed companies and, on the demand-side, audit committees need to be prepared to think outside of the Big Four.
3.4 We believe in particular that some of the reforms proposed by the Competition and Markets Authority (CMA) can provide an effective manner of increasing the level of participation in the market. The proposal for mandatory joint audit is particularly interesting as it will necessarily bring in more participants but also mean that audit committees will be forced to engage with the challenger firms.
3.5 Of course the challenger firms need to make sure they achieve appropriate standards of quality and the role of the regulator (the Financial Reporting Council) in this regard will be critical. A number of mid-tier firms have, in the past been reluctant to enter the large, listed company market and we understand that the regulatory environment has been one of those factors. We believe the reforms proposed through the Kingman Review may address some of the concerns from the past but an important factor for the FRC (or any replacement) is to be viewed as an improvement regulator.
4. Do you agree with the CMA proposals (when published)? Will the remedies proposed be likely to increase quality and trust in audits? Are there any potential unintended consequences?
4.1 We contributed to the CMA’s initial study and will be providing a full response to their proposals in due course. We are broadly supportive of its proposals but do not agree with every element.
4.2 Remedy 1 – Regulatory scrutiny of Audit Committees: In our submission to the CMA we commented that “audit quality is aided by a well-functioning and robust audit committee and board where there are high standards of corporate governance”. Accordingly, we are supportive of the CMA’s proposed remedies.
4.3 Remedy 2 – Mandatory joint audit and Remedy 2A – Market share cap: We support the CMA’s proposal for mandatory joint audits for FTSE 350 companies where at least one of the joint auditors should be a challenger firm. We agree that exceptions may be required either for the need for a joint audit or that one of the joint auditors is a challenger firm.
4.4 As noted earlier, we believe joint audits will have a positive impact on addressing the issue of concentration within the audits of large, listed companies and provide an effective way in which the challenger firms can enter into this market. Evidence from the last few years is that challenger firms are unlikely to be successful in any great measure in being appointed as sole auditor, unless there is some market intervention.
4.5 The CMA proposals do not provide a great deal of detail on when they suggest the remedy should be introduced. We believe it should be as soon as possible whilst having regard to the practical issues this will provide, both for the challenger firms and the audit committees of the FTSE 350 who will have to conduct a tender for the joint audit assignment. Our suggestion is that the relevant companies should have joint audits from the first accounting period commencing on or after 1 January 2020.
4.6 A number of the FTSE 350 companies are approaching a point where they will have to conduct an audit tender as they may be facing a forced rotation of their current incumbent. Appropriate transitional arrangements may be required to ensure there is not an overly burdensome requirement laid on audit committees.
4.7 We agree with the CMA’s view that market share caps may be effective in introducing challenger firms into the FTSE 350 audits but concur that the joint audit approach may be the better approach with less risk to issues of quality and competition in the short term.
4.8 Remedy 3 – Additional measures to support challenger firms that [the CMA] propose to consider further: We are encouraged by the CMA’s commitment to supporting challenger firms entering the market. Aside from making comments on prohibiting or limiting the length of non-compete clauses for audit partner or staff, the CMA has not yet developed detailed proposals in respect of this remedy.
4.9 Remedy 4 – Market resilience: Similarly we support the CMA’s intention to develop a remedy to deal with this issue but it has not, at the present time, developed its thoughts sufficiently for us to comment upon.
4.10 Remedy 5 – Full structural or operational split between audit and non-audit services: We have concerns around the CMA’s proposals in this area, both in terms of a full structural split or operational split, as we believe these to be remedies that are not sufficiently targeted at addressing the problems for which remedies are sought.
4.11 We made the following comment in our covering letter to the CMA: “There is a danger that some of the remedies proposed could have consequences that are either unintended or, indeed, unnecessary for those parts of the audit market that are functioning well. Although there have been a number of high profile cases of corporate failure over the last year or so, with the resulting scrutiny on the role of the auditors, the reality is that these are occurring in a very small, albeit extremely important, segment of the whole financial reporting and audit market.”
4.12 If the CMA’s proposal for a full structural or operational split was carried out, then this would not only impact the large listed company audit clients of the Big Four firms, but all of their clients. Notwithstanding that the Big Four has nearly 100% of the FTSE 350 market in total, for all of those firms, those audits will still represent a minority of their total audit client base.
4.13 The CMA has questioned whether this remedy should also apply to challenger firms. Clearly, given our remarks above, we believe this should be resisted given that the large, listed company audit clients would represent, in reality, a very small minority of their audit client base.
4.14 We are not clear why the CMA is resistant to a simple ban on non-audit services to large, listed company audit clients but, if further measures are needed in terms of operational separation or governance, then we suggest those should be addressed through further development of the Audit Firm Governance Code (AFGC). The AFGC is a voluntary ‘comply or explain’ code issued by the FRC that applies to certain audit firms, currently based on the number of listed audit clients.
4.15 Remedy 6 – Peer review: We are not convinced by the arguments for a peer review system, especially if mandatory joint audits are introduced.
4.16 Clause 4.153 of the CMA Update Paper states that a peer review would create an additional level of activity where the first level is “the work of management would be checked by the auditor”. We believe this assertion misses a vital ingredient as the work of management should first be checked by the audit committee, which is comprised of independent non-executives.
4.17 We contend that a more effective remedy could be the Audit Quality Review team (AQRt) of the FRC carry out some functions of audit review on audits as they happen, rather than just the ‘cold reviews’ of completed audits. This approach would support the premise of the FRC acting as an improvement regulator.
5. Do you agree with the Kingman proposals regarding the FRC (when published)?
5.1 We support a number of the proposals advanced by Kingman, particularly around the creation of a new regulator with clear statutory powers and objectives and the further recommendations that flow from that.
5.2 Further we agree with the following specific recommendations:
5.3 We were disappointed that the proposals did not feature some matters that we thought would bring benefits and which we advanced in our response to the ‘call for evidence’. Principal among these was our suggestion that there should be a separation between monitoring and enforcement activities.
5.4 In the section below we deal with the question of conflicts of interest and how they can undermine trust in audit. The same point is true for regulators and we believe that in keeping the monitoring and enforcement regime within the same regulator the perception can remain that those two vital elements are not carried out entirely independently and objectively.
6. To what extent do conflicts of interest undermine trust in audit? How best can they be removed or mitigated?
6.1 The whole premise of an audit opinion is that it is given by an auditor who is independent from the audited entity and who can give that opinion on an objective basis. If those seeking to rely on or otherwise use or take comfort from that audit opinion do not believe that these two critical features are in place then trust in that audit is undermined.
6.2 There are very stringent rules currently in place both within company law and audit regulations that seek to protect the independence and objectivity of the auditor and, as a consequence, the integrity of the process.
6.3 There does appear, however, to be a perception that these rules are not necessarily having the effect they should. It is vital that whatever rules are applied for independence and objectivity, then the auditor must not only be, but be seen be, independent and objective.
6.4 Accordingly, we can see that some further measures are necessary to enhance trust and remove any actual or perceived conflicts of interest that exist. The CMA has sought to address this issue when examining whether there should be audit-only firms and whether there needs to be structural or operational separation of the audit businesses within the Big Four firms. We have commented on this above but reiterate that whatever proposal is advanced, then extreme care must be taken to not deliver unintended consequences. We believe a straightforward ban on non-audit services for the audits of large listed companies would be a proportionate response.
7. How important to the quality of audit is the relationship between auditor and audited company? How can we ensure that there is the right level of challenge? What role should shareholders have in ensuring high quality audits?
7.1 Notwithstanding that the auditor needs to be independent of the company and to be rigorous, challenging and sceptical, it is important for an auditor and an audited company to develop a working relationship where there is mutual respect.
7.2 Arguably, both parties should have a common goal which will be for the annual report and accounts to not only be prepared in accordance with the appropriate accounting framework and legislation but be of a high quality, which are fair, balanced and understandable, and meet the needs of the users and readers of those reports.
7.3 Shareholders already have the statutory right to appoint auditors and remove them if necessary. Whether or not the shareholders of large, listed companies use or apply their rights sufficiently robustly is open to question and greater engagement may be desirable. It is a noteworthy occasion when the shareholders do not support the reappointment of the auditor in general meeting. Such a move can then present problems for a company if it finds itself without an appointed auditor but the point is made.
7.4 Audit committees should be clear in their reporting to shareholders on how they have supported audit quality. This could include describing how they have applied the FRC’s best practice guidance on conducting audit tenders which was issued in February 2017.
8. Are the proposed reforms of audit consistent with other recent reforms of corporate governance? Are there any other consequential reforms required?
8.1 Broadly we are satisfied that the reforms of audit are consistent with recent reforms of corporate governance.
8.2 We welcome the proposed reforms published by Kingman which will bring a greater degree of oversight to boards and audit committees and, indeed, a consistent enforcement regime to all board members, irrespective of whether they are qualified accountants.
8.3 We are mindful, however, that in December 2018 the FRC published ‘The Wates Corporate Governance Principles for Large Private Companies’. Given this is a very new development for private companies, we would not support any application of the proposed audit reforms to that cohort of companies until there has been the opportunity to assess the impact of the application of that new code.
8.4 In our view there does need to be some reform of how corporate governance is applied across what are regarded as ‘listed companies’ in the UK, especially in light of the current definition of what is a PIE. As noted above, we support the Kingman recommendation for a review of the definition of a PIE in the UK.
Submitted January 2019