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The Competition Commission (CC) has yesterday published a provisional decision regarding the remedies it is considering introducing when it publishes its final report on the supply of statutory audit services to large companies in the UK this autumn.

In a summary of its provisional decision on remedies, the CC has put forward a package of measures to promote competition and to ensure that competition is directed towards satisfying the demands of shareholders. The remedy package 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 shareholder engagement in the audit process.

In its provisional findings report published in February, the CC said that competition was 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 main measures the CC has proposed are as follows:

• FTSE 350 companies should put their statutory audit engagement out to tender at least every five years. Companies may defer this obligation to go out to tender by up to two years in exceptional circumstances. There will be a transitional period of five years before the measure comes into full effect.
• The Financial Reporting Council’s (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 documentation (ie clauses that limit a company’s choice of auditor to a preselected list).
• A shareholders’ vote on whether Audit Committee Reports in company annual reports contain sufficient information.
• 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 and agree audit fees and 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 a secondary objective to have due regard to competition.

The CC has decided against bringing in measures requiring mandatory switching of auditors, further constraints on audit firms providing non-audit services; joint audits; shareholder or FRC responsibility for auditor reappointment or independently resourced risk and Audit Committees.

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

‘This is a comprehensive set of measures that will ensure that shareholders are better served by a more competitive market for statutory audit which is more responsive to their requirements. More frequent tendering will ensure that companies make regular and well informed assessments of whether their incumbent auditor is competitive and will open up more opportunities for other firms to compete. A more dynamic, contestable market will reduce the dangers that come with overfamiliarity and long, unchallenged tenures.

We have found that tender processes are thorough, fair and transparent processes which produced effective competition—but we need to see more of them. We think that a five-year period is an appropriate period to subject the engagement to scrutiny and challenge—and it is also aligned with existing FRC guidelines on rotating the Audit Engagement Partner, making it an appropriate time to put the service out to tender.

The audit function is too important to be left undisturbed for longer than five years. Audit provides a vital role in providing assurance to shareholders on the reliability and accuracy of corporate reporting and an audit market in which shareholders can have increased confidence will have benefits for the economy more widely. Whilst there are costs involved in going out to tender, we think that they are outweighed by the benefits of a more competitive market in which shareholders can have increased trust.

Audit Committees have a vital role in ensuring that the external audit is effective. We found that finance directors often have considerable influence over the audit relationship in practice despite the formal authority of Audit Committees. We are therefore proposing measures that increase the influence and responsibilities of the Audit Committee.

We would also like to see the FRC build on the valuable work it has carried out in recent years in reporting on and promoting audit quality. Public reporting of AQR grades, alongside recent FRC initiatives to improve information on the audit process, will help shareholders assess the performance of auditors and the key judgements underpinning the audit process, and will promote engagement with companies.

We gave careful consideration to other measures, including mandatory switching, but we think that the measures that we have provisionally chosen will be the most effective and proportionate way to address the problems we have found. We do not see a competition problem with audit firms retaining business if they do a good job—but they will have to demonstrate this on a regular basis.’

The CC is aware that its proposed package of remedies may be affected by measures currently being discussed 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 inquiry.

The CC will publish the full provisional decision on remedies shortly and consider all responses before publishing its final report. It is required to publish its final report by 20 October 2013.

Any interested party is invited to respond to the provisional decision on remedies in writing by 13 August 2013.

To submit evidence, please email auditors@cc.gsi.gov.uk or write to:

Inquiry Manager
Audit Market Investigation
Competition Commission
Victoria House
Southampton Row
LONDON
WC1B 4AD

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. Full details on the CC’s guidelines for market investigation references are available on the CC website: www.competition-commission.org.uk/assets/competitioncommission/docs/2013/publications/cc3_revised_.pdf.

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