Global menu

Our global pages


Audit market reform: more choice or more complexity?

  • United Kingdom
  • Corporate
  • Financial services disputes and investigations
  • Litigation and dispute management


Restoring trust in corporate governance and audit

The latest in our series of briefings examining the UK Government White Paper on financial reporting reform -Restoring trust in audit and corporate governance (“BEIS Paper”) looks at the Government’s proposals to promote competition, choice and resilience in the audit market including managed shared audit, operational separation and increased powers to monitor audit firm resilience. The proposed reforms are in response to the Competition and Markets Authority’s statutory audit services market study (“CMA Report”) and feedback received on the CMA’s recommendations.

Audit market reform: more choice or more complexity?

Perhaps one of the greatest challenges of the Government’s reform agenda for financial reporting relates to its objective of increasing the resilience of the audit market by reducing the dominance that the Big 4 have over listed company audits. Rather belatedly, at the time of publication of the BEIS Paper in March 2021, the Government also published the responses to its consultation on the CMA Report. The responses showed very mixed reactions to the CMA’s proposals and a concern that they would not achieve the desired outcomes. In response, the Government has not fully adopted the CMA recommendations but it is not clear that its reform proposals fully address the concerns that have been raised.

Managed Shared Audit

The CMA’s preferred approach in this area was mandatory joint audits for FTSE 350 companies with the (typically) Big 4 firm being required to conduct the audit with a smaller firm; both being jointly responsible for the audit report. While this is a form of audit that appears to have worked well in France it presents some challenges which the Government considered were too difficult to overcome - not least the issue of joint and several liability on both firms.

Instead, the Government is proposing mandatory managed shared audits for UK registered FTSE 350 companies with companies required to appoint a Challenger Firm (being a firm with less than 15% of the FTSE 350 statutory audit market) to conduct a meaningful proportion of the statutory audits of entities within the corporate group. However, one firm, typically a Big 4 audit firm, would be appointed to lead the group audit (“Lead Auditor”) for which it would bear overall liability with the Challenger Firm only being liable for the components that it audited.

It is envisaged that companies could seek exemption from the shared audit requirements in exceptional circumstances, for example where no bids from Challenger Firms were received or no bids of sufficient quality. Issues with the Government’s shared audit proposal which will need to be addressed are:

  • containing the costs of audit - despite the lack of joint liability the Lead Auditor, who retains overall responsibility, may feel obliged to redo the work of the Challenger Firm;
  • access to the Audit Committee - while the BEIS Paper envisages that the Challenger Firm will have direct access, further detail will need to be provided about how it is intended that this will be achieved in practice;
  • liability issues – Challenger Firms may still be exposed to substantial liability risk if auditing a major component;
  • ensuring sufficient engagement from audit firms – for the Government to achieve its objectives there needs to be sufficient appetite from accountancy firms with the requisite skill-sets and resources to participate in tenders for FTSE 350 audits. Given the restrictions around providing non-audit services, and the other risks and regulatory burdens associated with statutory audit work, this may present a challenge; and
  • the role of management and Audit Committees – both clearly have a key role to play in managing this new framework which will inevitably mean audits take up more management time and resource. They will need clear guidance on their roles and responsibilities in respect of managed shared audit.

Managed shared audit bears some similarities to group audit engagements and ISA 600 provides guidance on respective roles and responsibilities of group and component auditors. However, in recent years the challenges of group audits have been reduced to some extent by group and component auditor services being provided by firms within the same audit firm network. This provides some assurance to the group auditor in circumstances where group and component auditors apply the same audit methodology and are subject to at least some of the same standards and requirements imposed on them by virtue of being part of the same network. Further guidance will need to be provided for the purposes of managed shared audit, which will bring additional challenges for the Lead Auditor and Challenger Firm to navigate. Careful consideration will also need to be given to the scope of engagement letters and liability attaching to the work performed under them.

Under the Government’s proposals the new regulator, the Audit, Reporting and Governance Authority (“ARGA”) will be given information gathering and sanctioning powers to ensure mandatory shared audit requirements are complied with and to enable it to monitor whether Challenger Firms are increasing their share of the FTSE 350 audit market. A market share cap (another CMA recommendation) for the largest audit firms would only be introduced if mandatory shared audit does not bring about a change in the FTSE 350 audit market within a reasonable time.

Operational Separation

Another of the CMA’s proposals was to separate the audit and non-audit sides of audit firms on the basis that this would improve audit quality. The Government has largely adopted the CMA’s recommendations in this regard with operational separation at the Big 4 already well underway through a consensual arrangement with the current regulator, the Financial Reporting Council (“FRC”). The FRC has published its Principles of Operational Separation with implementation to take place by 30 June 2024.

The Government has not adopted the CMA’s recommendation to prohibit the sharing of profits between the audit and non-audit practices. Instead it opted for regulatory oversight of remuneration of audit partners to ensure partner incentives are aligned to audit quality. This was due to concern that the CMA proposal would lead to separation of the larger firms and further undermine market stability.

The concerns that underpin the proposed operational separation reforms include that multidisciplinary structures can result in behavioural and financial incentives that undermine independence and professional scepticism. Therefore, it seems likely that Challenger Firms will want, and ultimately be required to, adopt at least some of the Principles of Operational Separation where they are looking to audit a meaningful portion of FTSE 350 companies.

If the proposed reforms don’t increase Challenger Firm participation in FTSE 350 audits, the Government has made clear it will look at the more drastic measures put forward in the CMA Report, such as a full structural split of audit from the accountancy firms.

Competition Objective and Powers

The Government agrees that ARGA should be given a specific competition objective to promote effective competition in the market for statutory audit work when exercising its policy-making functions. However, the Government does not consider that ARGA should prioritise its competition objective over its quality objective (to promote high quality audit, corporate reporting, corporate governance, accounting and actuarial work). Instead, the Government considers that ARGA should have a duty to advance either or both its competition objective and quality objective when carrying out its policy-making functions. This is in contrast with the FCA, which has a core strategic objective to ensure that relevant markets function well.

Like other UK regulators, such as the FCA and the Payment Systems Regulator (“PSR”), ARGA will be given certain competition law powers which it will exercise concurrently with the CMA. ARGA will be able to carry out market studies, make a referral to the CMA to conduct a full market investigation, and take enforcement action to address anti-competitive practices and abuse of dominant market position specifically within the statutory audit market. Similar to the FCA, ARGA will be able to use its sector-specific expertise and access to a wide range of information to assess market-wide competition issues in the statutory audit market.

The Government reform agenda in relation to competition, choice and resilience in the audit market is perhaps the most difficult area of the BEIS paper and there needs to be a careful balancing between the Government’s proposals to improve confidence in audit and those designed to encourage more accountancy firms to participate in FTSE 350 audits. Consultation on the Government proposals closes on 8 July 2021 and the responses to these aspects of the BEIS Paper may prove to be the most interesting.

For more information, please contact: