June 7, 2022 How Big 4 audit reform could impact Big Law
The government has released an update on plans to strengthen the UK’s framework for major companies and the way they are audited, and it may spell a further threat to law firms.
Last year the government published its initial plans for how it was going to increase transparency and accountability in UK business.
Following industry consultation, the government has published its latest plans and now proposes a new regulator, the Audit, Reporting and Governance Authority (ARGA) to replace the Financial Reporting Council (FRC).
The new regulator will be charged with protecting the interests of broader stakeholder groups and will have tougher enforcement powers.
Specifically, ARGA will be given the following powers to challenge the dominance of the big 4 auditors (EY, Deloitte, PwC and KPMG):
- A phased introduction of a ‘managed shared audit’ regime. This will give challenger audit firms the opportunity to audit a meaningful proportion of FTSE 350 companies.
- Operation of a ‘market share cap’, in the event of an existing auditor collapsing and to prevent further concentration of the market.
- Requiring ‘operational separation’ of the largest firms, improving governance of the audit practice with a view to promoting greater professional scepticism within multidisciplinary firms.
- Monitoring the health of audit firms and addressing any concerns around an audit firm’s resilience.
Other notable announcements included:
- fines for directors of the biggest companies for reporting and audit failures.
- large private companies (750+ employees AND £750m revenue) being required to meet the same higher standards of reporting and accountability as large-listed companies
- large companies’ reporting to contain better information about risks, fraud prevention and what information has been assured.
Industry commentators have been united in their acceptance for calls for reforms. However, the general feeling is that this latest update from the government doesn’t go far enough. The CEO of the Institute of Chartered Accountants of England & Wales (ICAEW) described the approach as having “a half-hearted and lopsided feel to it”. Both the ICAEW and the Associate of Chartered Certified Accountants (ACCA) pointed to a lack of emphasis and legislation on internal controls. The CEO of KPMG pointed out the operational challenges of shared audits: “There is work to do to make shared audits function well in practice, and we will play our part to find solutions to these challenges, including by offering to pilot managed shared audits.”
Our view – What it means for Clients and Big Law
These reforms pick up from where the Competition and Markets Authority’s 2019 consultation on Statutory audit services left off. Much of this new consultation looks at ways to loosen the big 4’s grip on the UK audit market and as a result, build the resilience of the wider market.
Since the publication, the FT (£) reported that EY is considering splitting its audit and advisory function. If given the go-ahead the other three may follow suit. This might just be the key to unlocking the legal market for the big 4, no longer tied down by the requirement for audit independence. It was only a month ago that KPMG announced plans to double the size of is UK legal department with 220 new hires by the end of 2024. With their one-stop shop offering the threat to Big Law is real. Or as Professor Richard Susskind puts it:
“Unfettered by audit independence, they will be able to act on many more deals and disputes. Their massive consulting, tax, risk and advisory practices will be free to acquire large law firms, creating a new kind of multidisciplinary beast.”
We are supportive of the audit reforms. We work with a number of subsidiaries for large international clients in the UK. In these cases, we partner with challenger firms to meet audit requirements. The introduction of ‘managed share audits’ will expose even more large firms to the service of challenger audit firms. We believe this can only be a good thing and that many of these clients will like what they see.