The UK’s “Big Four” largest consultancy firms (KPMG, PwC, Deloitte and EY) have been told by industry regulators, the Financial Reporting Council (FRC), that they must submit plans to ring-fence their audit and consultancy units by this October in a historic shake-up of the sector.
A precarious market
Following the high-profile collapse of companies such as auditor-approved Carillion and BHS, the industry has come under mounting pressure to reform the oversight of corporate finances – specifically by weakening the “stranglehold” on the audit market, which has essentially been monopolised by the infamous Big Four.
Last year, a number of MPs called for the companies to “break-up” their audit and consultancy arms after it emerged from a government report that the Big Four had conducted audits on all but one of the UK’s 100 largest companies in 2019. Together, they audit 97% of FTSE 350 companies and collect 99% of audit fees.
Labour MP Rachel Reeves said at the time: “The big four’s dominance has fostered a precarious market which shuts out challengers and delivers audits which investors and the public cannot rely on”.
The FRC has set a deadline of this October for the Big Four to submit their separation plans, and expects the historic move to be fully completed by 2024. It said that the shake-up was ultimately “in the public interest” and would protect auditors “from influences from the rest of the firm that could divert their focus away from audit quality”.
Why did the FRC step in?
After construction giant Carillion collapsed in 2018, the Big Four faced heavy criticism for its handling of the company’s finances. Over 2,400 people lost their jobs and the taxpayer was forced to shoulder a £148 million bill – according to the National Audit Office (NAO) – after racking up debts totalling £1.5 billion.
A number of Big Four-backed companies have since followed in Carillion’s footsteps, including holidaymakers’ favourite Thomas Cook (audited by KPMG) and high street jeweller’s Links of London (overseen by Deloitte). In a shocking scandal just last month, German financial services firm Wirecard filed for insolvency after a £1.7 billion hole emerged in its coffers, paralysing the accounts of thousands of UK customers after it was subsequently banned by the Financial Conduct Authority (FCA). It was audited by EY.
The FCR’s intervention comes as part of a wider scheme to overhaul the UK’s “dysfunctional auditing industry”, following three government-led reviews and years of lobbying and unfulfilled promises. Previous reports in 2006 and 2013 failed to incite tangible change, but a December 2019 review calling for “urgent reform” appears to have finally wet the appetite for ameliorations.
New rules for the Big Four
The Big Four have agreed to a set of 22 operational principles outlined by the FRC, among them a new rule that audit practices should produce a separate profit and loss account from any overarching consultancy firm – designed to prevent consultancy work from unfairly subsidising audits.
FRC Chief Executive Sir Jon Thompson welcomed the news, stating: “Operational separation of audit practices is one element of the FRC’s strategy to improve the quality and effectiveness of corporate reporting and audit in the UK.
“Today the FRC has delivered a major step in the reform of the audit sector by setting principles for operational separation of audit practices from the rest of the firm. The FRC remains fully committed to the broad suite of reform measures on corporate reporting and audit reform and will introduce further aspects of the reform package over time”.