Published July 2013. Under measures proposed by the Competition Commission, UK issuers will be required to tender their external audit every five years, and submit the audit committee’s report to an advisory shareholder vote annually; however the provisional announcement backs away from calls for mandatory rotation of audit firms.
The Competition Commission has been looking into the UK audit market since late 2011, when the Office of Fair Trading referred the statutory audit service market for large companies for review. In February 2013, the Commission issued a provisional finding that the existing market structure created an adverse effect on competition and suggested a range of possible remedies, including mandatory rotation of audit firms. However in its announcement of provisional remedies, this measure was rejected based both on costs and the potential weakening of competition if the incumbent firm were excluded from a tender process.
Instead, the Commission has proposed mandatory tendering every five years, with the duration intended to align with the Financial Reporting Council’s finding that lead audit partners (within the audit firm) should be rotated every five years. By contrast, current guidance in the UK Corporate Governance Code encourages issuers to consider a tender every decade, with no formal requirement. The tender could be deferred for up to two years in exceptional circumstances. Other proposed remedies focus on increasing the auditors’ accountability to the audit committee, rather than executives, through restrictions on engagement; and in turn the committee’s accountability to investors, principally through a non-binding advisory shareholder vote on the sufficiency of the audit committee’s disclosures.
In addition, the Commission has proposed to prohibit from loan agreements any restrictions on the issuer’s choice of auditor, intended to open the market beyond the big four firms; and to beef up regulation by requiring an FRC-led audit quality review of every FTSE 350 issuer’s engagement every five years on average. The Commission notes that increased regulation would require an expansion of the FRC’s brief and funding, and the FRC has already expressed “…serious doubts as to the remedy’s likelihood of success.”
The Commission’s proposed remedies will likely be seen as too weak by certain investors due to the lack of mandatory firm rotation or caps on provision of non-audit services. Glass Lewis shares these concerns; however we believe shareholders should be encouraged by the proposed changes, which go beyond existing UK Code guidance, and the broader current focus on improving audit quality, competition and engagement.