UK: OFT Publishes Consultation On Provisional Decision To Refer The Audit Market To The Competition Commission

Last Updated: 12 August 2011
Article by SJ Berwin's EU & Competition Team

On 29 July 2011 the OFT published its provisional decision to refer the audit market to the Competition Commission ('CC') and has invited comments.  The OFT has numerous concerns, due to the Big Four audit firms (Deloitte, Ernst & Young, KPMG and PwC), in relation to market concentration and barriers to entry.  This follows the OFT having taken the unusual step during June 2011 of exploring with various stakeholders, in a series of roundtables and bilateral meetings, whether potential remedies may be available to the CC and whether a reference would be appropriate (see Community Week Issue 521).

The consultation contains provisional conclusions on market definition.  The OFT contends that the starting point for the relevant product market is the provision of statutory audit by appropriately qualified auditors as is stated in the Companies Act 2006 ('CA 2006').  Within this the OFT also accepts that the market can be further segmented by size of company (i.e. FTSE 100 or 350) or by industry sector.  In terms of the geographic market the CA 2006 describes the statutory services as being provided purely within the EU, yet auditors themselves are rarely qualified to act in any country other than the one in which they are based.  Therefore the OFT is minded to follow the European Commission's view that audit markets are national in scope due to supply-side considerations.

The OFT has identified the following features of the market which prevent, restrict or distort competition:

  • Little incentive for companies to switch audit provider - fees are not the principal factor in auditor selection and technical audit quality is difficult to discern;
  • Low levels of switching - research provided by the OFT shows that average switching frequency amounts to 43 years for FTSE 100 companies and 24 for those in the FTSE 250, partially due to the cost of switching auditor, both in terms of tendering to select a new auditor and in the risk of any new auditor then making mistakes;
  • Low levels of tendering - lack of proper tendering means that a company cannot properly assess the audit services provided to it, and it also limits the ability of firms outside the Big Four to compete for audit contracts;
  • Barriers to entry - such as company's focusing on the existing size or reputation of their current provider; and the attributes of the Big Four, namely integrated international network, experience of auditing complex businesses, and relevant sector experience;
  • Smaller auditors struggling to raise capital for expansion - due to the requirements of a firm to be majority controlled by chartered accountants and by the partnership structure of audit firms;
  • High market concentration - in 2010 the Big Four had 99% and 98.5% of the market for audit fees levied for the FTSE 100 and 250 companies respectively, which has been largely stable since 2003; and
  • Limits on companies' choice of auditor - due to other factors such as: national regulators; rules on banking relationships; conflicts of interest; and internal policies.

The OFT acknowledges that at European level the Commission has concerns relating to audit quality and lessons from the financial crisis which it is looking into, whereas the OFT has specific competition concerns about the UK market which are separate.  The OFT also considers that the size of the market (of at least Ł600 million per year) is significant enough to warrant a reference to the CC. Following its discussions with stakeholders the OFT identified two broad categories of potential remedies:

  1. To reduce barriers to competition and increase rivalry - by for instance: splitting audit work between firms; limiting individual firms shares of the market; or the removal of covenants in bank loans specifying the auditor to use; and
  2. To increase transparency and empower purchasers - by for instance: increasing the frequency of audit tendering; making available greater public information and information for shareholders; and improving processes for handover between auditors.

The OFT, as usual, will also consider any proposal for undertakings in lieu of a reference made during the consultation period.

A final decision will be taken following a six-week consultation period and is likely to be before the end of 2011. Interested parties can send written representations to the OFT before 9 September 2011.

To view Community Week, Issue 532, 5th August 2011 in full, Click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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