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FRC Publishes Recommendations On Increasing Audit Choice In The UK

by Jason Gorringe, for, London

27 April 2007

The UK's Financial Reporting Council has this week published the interim report of the Market Participants Group that is advising the FRC on its 'Choice in the UK Audit Market' project.

The Market Participants Group was established in October 2006 to provide advice to the Financial Reporting Council on possible actions that companies, investors and audit firms could take to mitigate the risks arising from the characteristics of the market for audit services to public interest entities in the United Kingdom, namely the stranglehold that 'Big Four' accounting firms (KMPG, PricewaterhouseCoopers, Deloitte, and Ernst & Young) have on the market.

According to the FRC:

"The Group noted that due to the level of concentration in the audit market there is a high degree of concern amongst market participants over the uncertainty and costs that could arise in the event of one or more of the Big Four audit firms leaving the market. This risk could be mitigated through increased choice of auditors."

"However a number of current market characteristics, when taken together, reduce the propensity of non-Big Four firms to offer to audit public interest entities and also reduce the propensity of public interest entities to select non-Big Four firms as auditors."

It continued:

"The Group believes that its 15 provisional recommendations could, when taken together, enhance the efficiency of the market and in so doing mitigate the risks associated with a firm leaving the market."

The provisional recommendations made in the interim report set out actions that could be taken by companies, investors and audit firms working collectively, some of which require support from regulators, to allow the market to work more efficiently.

The recommendations made by the Market Participants Group are as follows:

  1. The FRC should promote wider understanding of the possible effects on audit choice of changes to audit firm ownership rules, subject to there being sufficient safeguards to protect auditor independence and audit quality.
  2. Audit firms should disclose the financial results of their work on statutory audits and directly related services on a comparable basis.
  3. In developing and implementing policy on auditor liability arrangements, regulators and legislators should seek to promote audit choice, subject to the overriding need to protect audit quality.
  4. Regulatory organisations should encourage appropriate participation on standard setting bodies and committees by individuals from different sizes of audit firms.
  5. The FRC should continue its efforts to promote understanding of audit quality and should promote greater transparency of the capabilities of individual audit firms.
  6. The accounting profession should establish mechanisms to improve access by the incoming auditor to information relevant to the audit held by the outgoing auditor.
  7. The FRC should provide independent guidance for audit committees and other market participants on considerations relevant to the use of firms from more than one audit network.
  8. The FRC should amend the section of the Smith Guidance dealing with communications with shareholders to include a requirement for the provision of information relevant to the auditor re-selection decision.
  9. When explaining auditor selection decisions, Boards should disclose any contractual obligations to appoint certain types of audit firms.
  10. Investor groups, corporate representatives and the FRC should develop good practices for shareholder engagement on auditor appointment and re-appointments and should consider the option of having a shareholder vote on audit committee reports.
  11. Authorities with responsibility for ethical standards for auditors should consider whether any rules could have a disproportionately adverse impact on auditor choice when compared to the benefits to auditor objectivity and independence.
  12. The FRC should review the Independence section of the Smith Guidance to ensure that it is consistent with the relevant ethical standards for auditors.
  13. Regulators should develop protocols for a more consistent response to audit firm issues based on their seriousness.
  14. Every firm that audits public interest entities should comply with the provisions of the Combined Code on Corporate Governance with appropriate adaptations or give a considered explanation if it departs from the Code provisions.
  15. Major public interest entities should consider the need to include the risk of the withdrawal of their auditor from the market in their risk evaluation and planning.

FRC Chief Executive, and Convenor of the MPG, Paul Boyle stated that:

“The Market Participants Group has brought together senior representatives of the corporate community, audit firms and investors. It is important now that a wide range of organisations read the report and respond to the consultation.”

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