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Audit watchdog in secret talks to bolster ‘challengers’

Major British companies will be forced to ring-fence a substantial proportion of their audit work for challenger firms outside the “big four” under secret proposals drawn up by the accounting regulator.

Sky News has learnt from sources in Whitehall that the Financial Reporting Council (FRC) has told the government that it wants to oversee a regime it is describing as “managed shared audits”.

Under the system, all but the very biggest FTSE-350 companies would be required to include at least one challenger firm in their audit tender process.

If a big four firm – one of Deloitte, EY, KPMG or PricewaterhouseCoopers – is appointed, work equating to a substantial minority of the audit fee would then have to be undertaken by a smaller rival.

One City figure said that substantial minority could be around a third of the audit work.


The principal auditor would, however, retain responsibility for signing off the group accounts.

Sources said the FRC’s plans would also give it – or its successor, the Audit, Reporting and Governance Authority (ARGA) – the power to intervene in any audit tender process and to ensure that the challenger firm was subsequently being allocated a sufficient degree of a company’s audit work.

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The FRC hopes the template will enable challenger firms – the likes of BDO, Mazars and Grant Thornton – to accelerate their transformation into credible contenders for the largest audit mandates.

City sources said the regulator’s latest proposals constituted its formal response to the Competition and Markets Authority’s recommendations last year, with the centrepiece being a more draconian “mandatory joint audit” requirement.

That idea, devised with the endorsement of Lord Tyrie, the CMA chairman, is now widely regarded as having been discarded by ministers.

It was rejected outright by the accounting profession and blue-chip companies alike as being unworkable, since it would have handed collective oversight of their books to different auditors and necessitated the sign-off of both.

One senior corporate figure described the FRC’s new idea as “a sensible compromise that included the right degree of reform without causing chaos in boardrooms”.

The fact that the latest proposal originated directly from the watchdog made it likely that it would be adopted by the government, according to one FTSE-100 finance chief.

The FRC is considering whether to grant an exemption to the new rules to the very largest multinationals in the FTSE-100 because of their size and complexity – in line with the CMA’s proposal last year.

Sky News revealed in November that the Department for Business, Energy and Industrial Strategy (BEIS) was exploring some form of shared – rather than joint – audit arrangements.

The drive for reform of the audit sector has been the focus of fierce debate since the collapses of BHS in 2016 and Carillion two years later, both of which were partly blamed on defective audit work.

Last autumn’s insolvency of Thomas Cook Group, which triggered thousands of redundancies and left creditors with billions of pounds of losses, has fuelled the desire for urgent reform.

The FRC’s new top team of chairman Simon Dingemans, GlaxoSmithKline’s former finance chief, and chief executive Sir Jon Thompson, who ran HM Revenue & Customs, have held talks about their new blueprint with Whitehall officials and big companies since the turn of the year.

Among the major companies expected to tender their audit work in the next couple of years are International Airlines Group, British Airways’ parent, and Prudential and Pearson, the education group.

FTSE-350 companies are in the process of negotiating substantial increases to the audit fees they pay, as reform of the big four and increased scrutiny of audit work leads to higher costs for the profession.

An overhaul of the way major quoted businesses are audited is far from the only significant item on the FRC’s agenda.

The regulator is discussing an 18-point plan for “operational separation” with the big four which would avoid a full legal break-up of the firms.

That plan would entail separate boards, remuneration and governance arrangements for the quartet’s audit and consulting arms.

A wider package of measures was recommended in separate reports by Sir John Kingman, the former Treasury mandarin, and the City grandee Sir Donald Brydon last year.

Sir John has been critical of the government’s hitherto vague commitment to introducing the legislation necessary to abolish the FRC and replace it with the more robust ARGA.

The existing watchdog has tried to show its teeth under pressure by levying a stream of multimillion-pound fines in the last two years – many of them against KPMG for its audit work on companies including Ted Baker and the Co-operative Bank.

In an interview with the Financial Times this week, Mr Dingemans said there was a debate under way about whether to bring large privately owned companies within the scope of its regulatory regime.

The FRC declined to comment on Saturday.


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