Supports Office of Fair Trading investigation but rejects House of Lords committee’s criticism of IFRS and call for legislation on dialogue between bank auditors and regulators
The Department of Business, Skills and Innovation (BIS) has responded (the Response) to the highly critical March 2011 report (the Report) by the House of Lords Economic Affairs Committee (the Committee) on the UK audit market. The BIS response was made on 19 May 2011 and has now been posted on the Committee’s website here.
The Committee’s Report drew some forthright conclusions about the large-firm audit market in the UK and made many recommendations to correct the perceived inadequacies and failures of that market. We discussed the Report’s conclusions in this post.
BIS’s Response to the Report
On the three principal recommendations made by the Committee, BIS has responded as follows:
- Office of Fair Trading inquiry. The Committee recommended that the OFT should investigate the large-firm audit market, with a view to an inquiry by the Competition Commission. The OFT announced on 17 May 2011 that it had provisionally decided that there are problems in the audit market that pass the statutory test for referral to the Competition Commission. We covered that OFT announcement in this post. In its Response, BIS welcomes that announcement by the OFT.
- IFRS. The Committee argued that the introduction of International Financial Reporting Standards has led to a downgrading of the key concept of “prudence” in the audit. BIS does not accept that IFRS has led to a loss of prudence, although in an apparent contradiction of its stance BIS does acknowledge that “prudence is no longer specifically referred to in the IASB Framework, or as a fundamental concept in UK GAAP”. Despite this, BIS argues “the concept of prudence continues to permeate accounting standards”.
- Banking regulation. BIS rejects the Committee’s suggestion that it may be necessary to legislate for increased dialogue between bank auditors and regulatory supervisors, and draws attention to the Financial Services Authority February 2011 consultation on its “Code of Practice for the relationship between the external auditor and the supervisor”, which can be read here.
BIS’s responses on other recommendations made by the Committee
- Mandatory audit tender. BIS agrees that major audit tenders should be put out to tender more frequently than is typically the case at the moment, but does not agree that FTSE 350 companies should carry out a mandatory tender every five years.
- Corporate governance code change. BIS would support amendment to the UK Corporate Governance Code to promote a dialogue between principal shareholders and the audit committee, and does not agree that this dialogue should be limited to once every five years.
- Restrictive bank covenants. BIS supports the Committee’s call for the OFT to conduct a market study of restrictive bank covenants – an issue we reported on in this post. This may be one of the remedies that the OFT considers in its work on deciding whether the audit market should be referred to the Competition Commission.
- Risk committee advice. BIS does not agree that the a bank’s auditor should be prohibiting from providing advice to a bank’s risk committee.
On what would happen should one of the Big Four audit firms fail, BIS states that the Government is working with the Financial Reporting Council, the Financial Services Authority and the Bank of England on potential responses to such a failure.
In various places in its Response, BIS draws attention to its forthcoming consultation (expressed to be in summer 2011) on reform of narrative reporting. BIS says that that consultation will set out proposals for disclosure of information about principal accounting and audit judgement.
The Committee’s view of BIS’s Response
The Chairman of the Committee, Lord MacGregor, was not overwhelmed by BIS’s Response:
“The House of Lords Economic Affairs Committee’s principal recommendation was that the Office of Fair Trading (OFT) should investigate the audit market in the UK, with a view to a possible referral to the Competition Commission. The Committee is pleased the OFT has responded favourably by its recent announcement of discussions with interested parties and that the Government has backed its initiative. The Government’s commitment to examine the introduction of living wills for large audit firms is also welcome.
However, the Government’s rejection of legislation to require regular dialogue between banks’ auditors and regulators is disappointing. Such legislation was a key demand of the Committee’s report which concluded such dialogue is ‘essential’ and ‘of the first importance’.
“In the run-up to the financial crisis the paucity of meetings between bank auditors and regulators was, the Committee said, ‘a dereliction of duty by both auditors and regulators’ that contributed to the financial crisis.
Legislation mandating regular meetings – for example, every quarter – is the only way to ensure this lamentable near-breakdown in communication between bank auditors and regulators is never repeated. The Government believes regular dialogue will follow the Financial Services Authority’s recently issued Code of Practice on the relationship between bank auditors and supervisors. But with no statutory backing this Code lacks the teeth to ensure this essential dialogue occurs regularly.
We were surprised by the Government’s denial that IFRS accounting standards had reduced prudence in audit. The Committee’s report concluded that IFRS has limited auditors’ scope to exercise prudent judgment. Auditors’ traditional, prudent scepticism must be promoted, whatever the accounting standards.”
Lord MacGregor’s statement is here.
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