Big Four accounting firms brace for competition probe from CMA

As pressure continues to mount on the top figures of the auditing and advisory industry, the dominance of the Big Four in the accounting arena will now be the subject of a landmark competition probe. Deloitte, EY, KPMG and PwC are set to be scrutinised by the Competition & Markets Authority, following a litany of auditing scandals in recent months.

Over the past five years, the Big Four’s share of FTSE 350 auditing expanded from 95% to 98%, in spite of a series of supposedly stringent reforms from the EU and UK aimed at tackling a lack of competition in the sector, since the 2008 financial crisis. Fears of both monopolisation and conflicting interests have both grown through 2018, meanwhile, as all of the Big Four were implicated in the collapse of Carillion. These fears are precisely why ‘breaking up’ the Big Four in the UK has suddenly become a major talking point among Britain’s politicians.

The alleged stranglehold of the Big Four on the UK’s auditing scene is so drastic that earlier in 2018, professional services firm Grant Thornton announced that it would no longer bid for audit contracts from Britain’s largest listed companies. Grant Thornton is the fifth largest auditing and advisory firm in the UK, and is seen as the gang of four’s nearest major rival. Tender processes for contracts among the FTSE 350 average out at a costly £300,000 per courtship, though, and routinely resulted in “a glorious second place”, according to Sacha Romanovitch, Grant Thornton’s Chief Executive.

Remarking on the change of emphasis, Romanovitch said, “Structures in the [FTSE 350] market make it impossible for us to continue to succeed in it. If this space is dominated by four players and there does not seem to be market appetite to change, let’s focus on areas where we can [succeed]. You have to have that strategic clarity.”

The withdrawal of Grant Thornton from FTSE 350 auditing only served to add to a growing collective call for some form of intervention in the UK accounting scene. Elsewhere, a paper commissioned by Members of European Parliament has called for regulators to step up their bid to clamp down on the facilitation of global tax avoidance by the accountancy practices of the Big Four consultancy firms in the wake of the “Panama papers” scandal. The Big Four are seen as key pieces of the business world’s apparatus for corporate tax avoidance, playing a large role in the movement of capital to tax havens by some of the world’s richest companies. 

Accountants under pressure

Elsewhere, a Parliamentary report by two select committees produced a scathing assessment of the work of KPMG for Carillion; with the firm facing an Financial Reporting Council (FRC) investigation for its role as auditor as well. Members of the Work & Pensions and Business committees also pilloried PwC, Deloitte, and EY in the process, accusing them of “feasting on the corpse” of a collapsing outsourcer.

A succession of further accounting scandals has seen state intervention and the forcible breakup of the quartet’s British wings increasingly talked about. While it is still UK Government policy to apply light-touch regulation so as to not impede a booming source of GDP growth, opposition figures have been quick to seize on the turning public sentiment. During party conference season, this saw the Labour Party become the latest group to publically consider breaking up the UK’s largest professional services entities, on the grounds of a conflict of interest.

Now, with no end to the mounting body of criticism in sight, the Competition and Markets Authority (CMA) has announced it will probe into the sector. The study will look to find whether the UK’s auditing industry is "competitive and resilient enough to maintain high quality standards," following fears the sector "is not working well for the economy or investors," according to a statement from the body’s Chairman.

Andrew Tyrie added, "If the many critics of the audit process are right, it is not just the companies which buy audits that lose out; it is the millions of people dependent on savings, pension funds and other investments in those companies whose audits may be defective.”

The CMA's decision comes after the FRC, the auditing industry watchdog in Britain, censured the Big Four firms for an “unacceptable deterioration” in standards. The FRC again earmarked KMPG's audits for special scrutiny, taking the unprecedented step of monitoring a quarter of all KPMG’s auditing work in the 2018-19 financial year.

The CMA’s investigation will examine three main areas. These are: how firms choose auditors and the frequency of switching, the resilience of the industry if the Big Four have become "too big to fail", and finally if there are a lack of incentives for auditors to produce "challenging performance reviews" given that companies, not investors, pick their own auditor. The provisional results of the probe are expected to be released before Christmas 2018.

Commenting on the news, Michael Izza, the Chief Executive of the Institute of Chartered Accountants in England and Wales, said, "It is vital that we rebuild public trust in audit - the success of UK business depends on it.”

“Paper tiger”

While some critics of the Big Four’s dominance of the auditing sector will undoubtedly be pleased to see the CMA take action, others will point to another probe which was labelled a “paper tiger” by sources close to the investment consulting industry. The CMA was recently involved in a similar industrial examination of that sector, and its provisional decisions report suggested that the market was not heavily concentrated, despite the largest investment consultancies in the UK. Aon Hewitt, Willis Towers Watson and Mercer, known in the segment as the Big Three, were referred to the CMA by the Financial Conduct Authority (FCA), which estimated the trio collectively controlled up to 71% of investment consultancy revenues in the nation.

After a two year saga during which the industry’s leading firms repeatedly attempted to assuage the concerns of regulators, the CMA delivered a provisional verdict that an industry-wide overhaul was not necessary. The CMA estimated itself that the three largest investment consultancy firms in fact made up less than a 50% share of the market, but this conclusion left a large portion of the leading firms’ competitors dis-satisfied. In the fallout, a number of criticisms and suggestions were subesequently leveled at the body’s methodology. Consultancy bfinance UK complained that the CMA "appears not to have addressed broader conflicts of interest that arise when investment consulting firms provide asset management services,” while a number of other firms objected to the basic definitions used in the report, claiming this could lead to regulatory gaps, among other issues.

Speaking at the time, one competition lawyer said there was a “mismatch between what [the CMA] finds to be problematic and the remedies they propose”, before dismissing the CMA’s defence of its decision not to force a break-up, arguing that its economies of scale argument did not make sense.

The source went on to brand the watchdog’s ideas as toothless, stating, “The CMA has just subjected a whole industry to huge costs and a massive burden in complying with all the information requests – and come up with a paper tiger.”

As the CMA prepares to undertake its latest investigation into the professional services world, then, it is likely to be under intense scrutiny itself. Whether that may push it toward a more drastic finding of a statistically more concentrated market remains to be seen.