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The Competition Commission (CC) has today published changes that will open up the UK audit market to greater competition and ensure that audits better serve the needs of shareholders in future.

In a summary of its final report on the supply of statutory audit services to large companies in the UK, the CC has confirmed that competition is restricted in the audit market due to factors which inhibit companies from switching auditors and by the incentives that auditors have to focus on satisfying management rather than shareholder needs. The final report follows the provisional findings report which was published in February, as well as the provisional decision on remedies in July.

The full final report will be published shortly. All information relating to the investigation can be found on the audit market home page.

The CC has set out a package of remedies in response to these findings which includes measures to improve the bargaining power of companies and encourage rivalry between audit firms; measures to enhance the influence of the Audit Committee; and measures to promote audit quality and shareholder engagement in the audit process.

The main measures the CC has proposed are as follows:

• FTSE 350 companies must put their statutory audit engagement out to tender at least every ten years. This differs from guidance introduced by the Financial Reporting Council (FRC) in 2012, which encouraged companies to go to tender on a ‘comply or explain’ basis. No company will be able to delay beyond ten years, and the CC believes that many companies would benefit from going out to tender more frequently at every five years. If companies choose not to go out to tender this frequently, the Audit Committee will be required to report in which financial year it plans to put the audit engagement out to tender and why this is in the best interests of shareholders.
• The FRC’s Audit Quality Review (AQR) team should review every audit engagement in the FTSE 350 on average every five years. The Audit Committee should report to shareholders on the findings of any AQR report concluded on the company’s audit engagement during the reporting period.
• A prohibition of ‘Big-4-only’ clauses in loan agreements (ie clauses that limit a company’s choice of auditor to a preselected list or category), although it will be possible to specify that any auditor should satisfy objective criteria.
• There must be a shareholders’ vote at the AGM on whether Audit Committee Reports in company annual reports are satisfactory.
• Measures to strengthen the accountability of the external auditor to the Audit Committee and reduce the influence of management, including a stipulation that only the Audit Committee is permitted to negotiate audit fees and influence the scope of audit work, initiate tender processes, make recommendations for appointment of auditors and authorize the external audit firm to carry out non-audit services.
• The FRC should amend its articles of association to include an object to have due regard to competition.

Laura Carstensen, Chairman of the Audit Market Investigation Group, said:

‘Our measures will deliver lasting change in a market where currently a major company putting its audit out to tender remains unusual enough to be a news story. Instead, all this business will be open to competition on a regular basis. The introduction of regular and predictable tenders will benefit shareholders, who will also have a much greater say and knowledge of whether their needs as customers are being met.

‘Instead of long unchallenged tenures which can reduce the appearance of objectivity and scepticism essential to an effective audit, there will now be far greater transparency and scrutiny.

‘It will also open the door to other auditors who now have the chance to compete regularly for business and show they’re up to the mark. This will help them prepare for and counter any perceived lack of experience, resources and reputation which may have hindered them from winning FTSE 350 audit engagements in the past. In effect they will more frequently be able to compete on a level playing field.

‘After listening carefully, in particular to shareholders whose interests have been our main focus, and the FRC, we have decided that ten years is the appropriate backstop period for mandating that the audit engagement be put out to tender. Whilst we think many companies would benefit from a greater frequency of five years (and that an increasing proportion would benefit from going to tender as the period since the last tender process lengthens), we have accepted that requiring this in all cases could dilute the benefits we all want to see. However, in keeping with the greater responsiveness to shareholders we are promoting, companies will be required to spell out when they next intend to hold a tender process if five or more years has elapsed since the last one.

‘This remedy will be supported with other measures that will empower shareholders and also shift influence to Audit Committees, so that they can perform their role more effectively in ensuring external audit works well.

‘The FRC has done valuable work in recent years in assessing audit quality and we feel that extending this and making it more transparent will further serve the cause of shareholders.

‘If audits and auditors are regularly being called to account, by being answerable to shareholders and assessed on quality and can be contested by other companies, that will address the concerns we’ve expressed. We do not think that mandatory switching would add to that, when an auditor will already have to prove its worth in a competitive tender process run by the Audit Committee in order to retain the business. Mandatory switching would also reduce choice at such tender processes.’

The CC will now work towards drawing up an Order for those elements of the remedy package it can require and make recommendations for the others. It is expected that these will come into force from the last quarter of 2014.

The CC is aware that its proposed package of remedies may be affected by measures currently being considered by the EU. However, there are as yet no definitive EU proposals, and we have therefore proceeded on the basis of the evidence produced by our investigation. The CC will be able to amend its remedies, if necessary, in the light of agreed EU measures.

The full final report will be published shortly. All information relating to the investigation can be found on the audit market home page.

Notes for editors

1. The CC is an independent public body, which carries out investigations into mergers, markets and the regulated industries.

2. The members of the Audit Market Investigation Group are: Laura Carstensen (Group Chairman and CC Deputy Chairman), Carolan Dobson, Barbara Donoghue, Richard Farrant and Robin Mason.

3. Under the Enterprise Act 2002, the Office of Fair Trading (OFT) can make a market investigation reference to the CC if it has reasonable grounds for suspecting that competition for the supply or acquisition of certain goods or services is not working effectively.

4. The OFT referred the market to the CC for investigation in October 2011.

5. In its investigation, the CC is required to decide whether ‘any feature, or combination of features, of each relevant market prevents, restricts or distorts competition in connection with the supply or acquisition of any goods or services in the United Kingdom or a part of the United Kingdom’. If so, then there is an adverse effect on competition and the CC will also consider whether this is resulting in a detrimental effect on customers such as higher prices, lower quality or less choice of goods or services. The CC will then decide whether the CC should introduce remedies to tackle the adverse effects on competition or detrimental effects on customers or whether the CC should recommend action be taken by other bodies to remedy the adverse effects on competition, and if so, what actions or remedies should be taken. If the CC finds that there is no adverse effect on competition, the question of remedies will not arise.

6. Enquiries should be directed to Rory Taylor or Siobhan Allen or by ringing 020 7271 0242.