The Sunday Telegraph - Business & Money

Can challenger audit firms break the Big Four?

Plans for mid-tier accountant­s to take on the oligopoly come at an awkward time for the scandalhit sector, writes

- Simon Foy

Kwasi Kwarteng might be fighting to keep the lights on this winter, but when the energy crisis subsides he will find a perennial issue remaining in his in-tray: audit reform.

Overhaulin­g the scandal-hit sector has probably become even more complicate­d since he last checked in. The Business Secretary needs smaller auditors to challenge the oligopoly of the so-called “Big Four”, but the accounting watchdog has been turning its ire on several of these supposed challenger­s.

When the Financial Reporting Council (FRC) slapped a £2.3m fine on Grant Thornton last month for botched audits at cake chain Patisserie Valerie, it hit out at the UK’S sixthlarge­st accounting firm for displaying a “serious lack of competence”.

A senior accountant at a rival firm is less generous in his assessment. “The mistakes by Grant Thornton were among the worst I’ve ever seen.”

The blunders included an inability to identify dodgy bank statements that were effectivel­y pasted on to spreadshee­ts, and a difficulty in obtaining basic informatio­n from documents, such as how much cash was in a bank account.

Since the extent of its failings were laid bare, the regulator has launched two investigat­ions into other mid-tier challenger firms: Mazars over its audit at fashion retailer French Connection; and Crowe over its audits at music streaming business Akazoo. Grant Thornton is also subject to two further ongoing FRC probes.

The timing of the crackdown is problemati­c. It comes as Kwarteng is mulling a set of sweeping reforms that will seek to boost competitio­n by giving accountant­s outside the Big Four of KPMG, EY, Deloitte and PWC a greater role in the audit market. It therefore begs the question: are the challenger­s up to the task?

Ed Warner, a former chairman of Grant Thornton, points out that you don’t have to be a challenger firm to be vulnerable to audit breaches – the Big Four are equally, if not more, accustomed to falling foul of the regulator. However, he acknowledg­es that recent controvers­ies for mid-tier firms have come at an inopportun­e time. “The challenger­s are attempting to break into the bigger audit market and any reputation­al issues just give incumbent audit committee chairs an excuse to stay with the Big Four,” Warner says.

He adds: “I don’t believe that audit chairs collective­ly are wedded to the Big Four but I do think collective­ly they are risk averse – that goes with the nature of the role.”

The FRC’S latest annual audit quality report published in July criticised BDO and Mazars, saying the former needed to urgently improve the quality of its audit of revenue, as well as its team’s understand­ing of significan­t fraud risks. Grant Thornton, on the other hand, was one of only four firms to receive a positive review, highlighti­ng that improvemen­t is possible.

However, the main takeaway was the continued poor performanc­e of KPMG’S banking audits, which the watchdog said were “unacceptab­le” for a third consecutiv­e year.

But a senior accountant at one challenger firm says people in the market will accept that KPMG has issues, meaning its blunders don’t taint its brand as much as Grant Thornton’s mistakes at Patisserie Valerie, for example. “It’s partly the strength of those brands. They can withstand the hammering and are a bit weather beaten already,” he says. “The challenger firms have got to be on the front foot around audit quality.”

One proposal Kwarteng is weighing up to boost competitio­n – that is almost universall­y disliked by firms both big and small – is a shared audit regime. By allowing smaller firms to share a proportion of a major company audit, alongside a Big Four firm, ministers hope it will give mid-tier players more experience so that in time they can rival the incumbent.

Yet critics argue that such a scheme would be riddled with issues such as higher costs and potential legal risks.

On Monday, Sir Jon Thompson, head of the FRC, said he had asked ministers to give him the power to cap the number of large listed companies that can be audited by a single firm – a proposal supported by firms such as BDO and the clearest sign yet that managed shared audits could be kicked into the long grass.

Ben Johnson, managing partner at Berkeley Research Group, a forensic accounting firm, says that before challenger firms audit bigger, more complex companies, it is important that they get their own houses in order.

But there remains a question about whether these challenger firms even want to take on a significan­t number of FTSE 100 companies.

Warner estimates that the three leading mid-tier firms – Grant Thornton, BDO and Mazars – would require hundreds of millions of pounds of investment over a long time to build the scale and internatio­nal breadth necessary to be a lead auditor for many blue-chip companies.

“There is a scale, and even sector expertise, that’s required that the main three challenger firms simply don’t have right now,” he says. “There’s possibly a naivety on the part of

government that needs to be

‘I don’t believe that audit chairs are wedded to the Big Four but I do think they are risk averse’

‘Auditors used to have a sense of public interest but the whole industry has become highly corporatis­ed’

disabused. It’s not as easy as waving a wand and saying we’re going to lean on the biggest company audit chairs to open up to the challenger­s or even legislate for it without some way of promoting significan­t investment in their audit capabiliti­es.”

Johnson agrees that there would be significan­t cost implicatio­ns for these firms in terms of building skills and resources to challenge the Big Four.

So what next? Atul Shah, a professor of accounting and finance at City, University of London, says reform is long overdue, and this was further demonstrat­ed this week by the tribunal finding that KPMG gave a “fundamenta­lly untruthful” defence during a hearing over its role in the sale of mattress company Silentnigh­t to a US private equity firm.

“The conflicts are deep and profound,” he says. “Auditors used to have a sense of public interest but the whole industry has now become highly corporatis­ed. Audit quality depends on being suspicious.”

But rather than winning a raft of new FTSE 100 mandates, like Kwarteng wants to see, Warner thinks the challenger firms will instead build a FTSE 250 roster of clients over time that plays to their sector and geographic strengths.

“I don’t see the Big Four becoming a Big Five in the foreseeabl­e future, that’s for sure,” he says.

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