Position Available: Pay – $130m-a-year

By Richard Bicknell

The Financial Times this week reported that HSBC has struggled to solicit tenders from the other ‘Big Four’ (KPMG, PwC, Deloitte and EY) to replace its current auditor EY. In the last year EY was paid a princely $130m in fees to cast its eye over the books of the UK’s largest lender.

The industry runs an argument that the cost of bidding for such a large (and complex) audit, means the fees actually present a low return on investment, which for any incumbent are only further diluted in unwinding conflicts of interest. Despite this protestation, the reality is that one of the Big Four will eventually take up the contract and be paid handsomely for it. 

The reluctance of the Big Four is likely simpler; not only have risks increased and margins decreased, many now find themselves having  to actually do their job. This new awakening comes on the back on the Competition and Market Authority’s (CMA)’ 2019 Independent Review into the Quality and Effectiveness of Audit. Sir Donald Brydon’s Report articulate surmised: “Audit is not broken but it has lost its way”.

The effect is clear. A cursory glance over the London Stock Exchange’s Regulatory News Service is littered with plc’s announcing delays to their reporting due to their auditors requiring further time. While on earnings calls listed Chief Financial Officers and Finance Directors are increasingly reporting that auditors have suddenly become sticklers for rules, and recalculating models to an extent not previously seen.  

This vigour comes on the back of an all-time low in investor and public confidence in how businesses are audited. The role of auditors had become somewhat of an open joke following their public failures to properly run the ruler over Carillion, Thomas Cook, Wirecard and BHS. A joke which has elicited a somewhat sinister smirk from ever power hungry politicians and regulators alike keen to continue the CMA’s earlier work. 

The industry’s regulator, the Financial Reporting Council (FRC), has jumped on the erosion in confidence to extend its mandate and will morph to become the Audit, Reporting and Governance Authority. It also found its teeth with a newfound fondness to handing out fines when audits go pear shaped, as KPMG recently found for its audit of Barclays. In a double blow to profit lines, the fines come as the FRC announced significant reforms last year to the way the Big Four do business.

Introducing new ring-fencing rules, the FRC will make the audit practices of advisory firms stand apart from the rest of the business. The new rules require audit divisions of advisory firms to have a separate profit and loss accounts along with independent boards to oversee the practice. It also means that auditors can no longer be cross subsidised from elsewhere in the business– such as the more lucrative advisory practices.

Despite the new attention to detail, internal changes and fines, a larger problem still exists – the number of FTSE100 companies not audited by the Big Four: one. The number of FTSE250 companies: twenty.  For it would seem that audit is one of an elite group of industries in which the quality of your work does not impact your ability to win it. When you’re one of only four companies big enough to do the job, the job itself becomes secondary because while the margins are slim – they’re still profitable.

Until this changes – investors, and the public, will continue to be left in the cold when auditors fail to do their job, while the auditors themselves will move on to their next $130m-a-year job .