PwC, Deloitte, EY and KPMG dominate the auditing sector, but they are failing at their task
It was not only bankers, and central bankers, who got off lightly in the crisis of a decade ago. The group that most successfully stayed out of the spotlight was the auditing profession. Vast financial institutions fell over in a heap, sometimes only months after their books had been signed off as healthy, yet the auditing industry was never seriously held to account. Even when inquiries happened, their findings were mostly banal, and they took years to arrive.
The mood now seems to be turning. Sir John Kingman, a former Treasury official who is now chairman of Legal & General, is already conducting a review for government to determine whether the audit watchdog, the Financial Reporting Council, is fit for the future. A heavier battalion arrived this week in the form of the Competition and Markets Authority, which launched a inquiry into concerns that the audit market is not working well for the economy or investors. Encouragingly, the CMA says it will move quickly: provisional findings are promised by Christmas.
One trigger was the collapse of Carillion in January this year, which touched a nerve in the way bank failures never did. And a succession of scandals with auditing failures at their heart have played a role. BHS, over which PwC copped a £6.5m fine from the FRC, was a prime example. Further questions will be raised after the crisis that has engulfed Patisserie Valerie – audited by Grant Thornton – last week.
The CMA is a competition watchdog, and competition is definitely the place to start. Four firms – PwC, Deloitte, EY and KPMG – enjoy a dominance that would be tolerated in few other sectors. They audit 99 of the 100 biggest quoted companies and have a combined market share of 98% of FTSE 350 firms – a reasonable definition of a oligopoly.
This concentration isn’t new, which is why in 2013 the CMA’s predecessor, the Competition Commission, ordered companies to put their audit engagements out to tender every 10 years. But the reform has proved useless in generating competition from new quarters. The auditing merry-go-round turns at greater speed but the big four are still the only players aboard. Grant Thornton, the fifth-biggest firm, has now given up pitching for audit contracts from FTSE 350 companies because of the expense of coming second.
There is no painless way to smash this dominance, but caps on market share would be an obvious solution. The drawback could be higher prices for audit contracts, but responsible shareholders might be happy to pay more, since the deep suspicion is that dominance has bred complacency among the big four. Life just seems too comfortable for them.
That the quality of audit work has fallen is almost beyond dispute. In June, the FRC said standards had slipped at all four of the major outfits. It highlighted “a failure to challenge management and show appropriate scepticism”. Carillion’s auditor, KPMG, was put in the regulatory equivalent of special measures after being singled out as showing “an unacceptable deterioration” in the quality of its work.
Against such a backdrop, the CMA must be prepared to be bold. It should ignore the squeals from the big four that separating auditing from non-auditing work would be too complex. If the watchdog judges that separation would raise standards, it should make it happen: difficult tasks can be worthwhile.
And the CMA should definitely pursue the idea that incentives are misaligned because it’s the boards of companies, rather than their investors, that pick the auditor. Handing powers of appointment to owners, to the people who most want to see sceptical auditors, would be an interesting innovation.
Andrew Tyrie, the CMA’s new chairman, picked over the bones of the banking catastrophe when he was an MP and chair of the Treasury select committee. He was commendably withering about some of the failures he uncovered and unafraid to challenge vested interests. More of that, please.
EU should not push Salvini to the limit
Enter the Forum in Rome and you step back in time. And, like so many politicians, Matteo Salvini wants to time-travel back to an age when European economies grew quickly and the people got richer every year.
This week Salvini, the far-right deputy leader of Italy’s ruling coalition, will preside over a rule-busting budget that seems innocuous at first glance – it only proposes a 2% deficit in the coming year – but nonetheless breaks the European Union’s deficit rules.
Brussels will examine the details of the budget over the following two weeks and probably ask for revisions. At this point, unless someone has succeeded in bringing down the political temperature, Salvini and prime minister Giuseppe Conte will probably declare war on Brussels and dare Eurocrats to stop them.
Salvini’s economic problem is that the budget is a cobbled-together wish list masquerading as a coherent boost to productivity, GDP growth and household incomes.
It is a long time since Italy’s economy grew at a pace that brought down its debt-to-GDP level; at 131%, it ranks as the worst EU nation bar Greece. Extra spending has the potential to kickstart the economy, as Salvini expects, but Italians have a habit of mistrusting politicians and their promises. When extra cash comes their way, they save it rather than spend.
More immediately, the ratings agencies are waiting in the wings to downgrade Rome’s debt mountain and make it more costly to service. A downgrade could come only weeks after the EU says no.
Still there is pressure on both sides. Brussels has taken a hard line so far. That looks like inflaming the situation just when tense Brexit negotiations are at their zenith, which seems unwise. Yes, Salvini’s government is distasteful: but it is a duly elected administration and should be listened to.
Cost-cutting could spell disaster for energy firms
The millions of people who have seen their energy bills raised repeatedly in the past two years will take some comfort in the news that profits at the big six energy firms dropped by 10% over the last year.
But while that is a big fall for a single year, these companies still made £900m profit from supplying people with the essentials of electricity and gas.
And though the average profit margin, of 4.2%, is down slightly, the reality is that the profitability of the big six has stayed broadly stable over the past seven years, ranging between 2.8% and 4.5%.
To focus on the average would also be to miss the fact that some companies, such as British Gas, are making a stonking margin of 8%.
It’s worth remembering that these profits flow from a business model which relies on exploiting the inertia of people who fail to shop around, who are usually society’s poorest, oldest and least-educated.
While switching figures are at record highs, there is still a huge rump of people who do not move. A third of customers cannot recall ever switching, Ofgem found last week.
While the government’s price cap will not fix the energy market, and is far from perfect, there is little doubt that it will cut the big six’s profits. All of the large players’ default tariffs come in above the £1,136 cap, based on an annual dual-fuel bill with typical consumption.
With few options available, most of the companies will probably try to cut their costs to preserve profit margins, which could potentially knock their customer service.
But that approach could spell disaster in the longer run. With customer service a priority for consumers, and the firms already losing thousands of customers, the big six can ill afford an exodus sparked by threadbare call centres.