Towards a Revised Regulatory Regime : A UK Perspective Richard THORPE Manager, Accounting Auditing Transparency & Valuation, UK Financial Services Authority United Kingdom

Global Regulatory Agencies - the global policemen square up to the knowledge- based economy Issues for regulators arising from consolidation in the auditing/accounting industry Richard Thorpe UK Financial Services Authority

What is the FSA UK Financial services regulator responsible for around 10,000 institutions including: –Over 7500 Investment Firms –Over 660 Banks –Around 70 Building Societies –Nearly 1000 Insurance and Friendly Societies –Plus the UK Markets, and around 2500 listed companies

Four main statutory aims Maintaining Confidence in the UK Financial System Promoting public understanding of the Financial System Securing the right degree of protection for consumers Helping to reduce financial crime

For 2002/3 these are underpinned by the following strategic aims: Consumers: consumers are better able to make informed choices and achieve fair deals in their financial dealings Firms: Regulated firms and their senior management understand and meet their regulatory obligations Markets: Consumers and other participants have confidence that markets are efficient, orderly and clean. Regulatory regime: An appropriate, proportionate and effective regulatory regime is established in which consumers, firms and other FSA stakeholders have confidence.

The FSA’s interest in accounting Objective of a single set of global accounting standards that are capable of consistent application, interpretation and enforcement and that balance the (potentially conflicting) needs of investors, depositors and policyholders and other users.

Why do we care? As a prudential supervisor, we need reliable and transparent financial information on which we can base assessments of capital adequacy. As a major host market we need to be confident about the quality of the accounts prepared by the overseas parents of companies we regulate. In pursuit of our market confidence objective, we need high quality financial accounts for listed companies.

The role of auditors Principles based accounting standards are needed for global application Principles will only work if they are overseen by high quality independent auditors

Concentration in the profession There are now four global accounting firms that have the resources and expertise to undertake audits of internationally active companies. In some sectors, concentration of resources and expertise mean that there are fewer than four firms that can actually do the work.

Analysis of the market in the US and UK before the collapse of Andersons

UK OFT study on competition in professions in 2000 concluded that the Big 5 had 79.2% of the UK accounting market.

Reasons offered by the OFT: Multi-nationational clients often want their audit or other accountancy work to be done consistently round the world by a firm with global reach. Although the second-tier firms have tried to set up their own international networks, their coverage is only partial. Even large national companies often prefer to use a Big 5 firm because they believe their investors feel more comfortable if their accounts are signed by a firm with a strong reputation.

Concerns expressed by IOSCO and the OFT include: Companies changing auditors have very limited choice. Even more of a problem when major corporate rivals in the same industry want to avoid having the same auditor. Can be very difficult to find an independent auditor/reporting accountant for complicated capital transactions, mergers etc The big firms can operate as a cartel, obstructing entry to the market, and so stifling innovation.

Other factors Some audit assignments require specific expertise that is not widely available. The choice available is often less than four firms. In the banking sector, the choice is more restricted because auditor independence rules do not allow an audit firm to audit its own banker. Often similar problems for prudential regulators in undertaking major investigations. It can be difficult to find a firm with sufficient expertise that is not already conflicted out through an involvement in the issue that gave rise to the investigation.

Other factors (continued….) Some jurisdictions require companies to change their auditors every five or seven years. Choices are now potentially very limited for that change - particularly in regimes where the company cannot simply reappoint the previous auditors (i.e. they need at least three firms to choose from).

How many firms do we need? The European Commission, at the time of the PriceWaterhouse/Coopers merger, concluded that most clients ask three or four firms to submit bids when audits go to tender. We now have just four firms. What would happen if one firm failed? –Independence would be damaged, as companies would find it almost impossible to change their auditors.

How to open the market? No easy options for the competition authorities Consider perceived barriers to entry for the second tier firms

How to open the market? (continued….) The second tier firms do not have the resources or infrastructure to undertake major cross border audits Smaller firms could merge and so form a fifth major firm, but that has not happened because there is no demand Would compulsory rotation help?

How to open the market? (continued….) Lack of Specialist expertise A more practical variant might be to provide incentives for second tier firms to consider moving into specialist markets. For example, mergers and acquisitions, where the big firms are conflicted out.

Market expectations are that major companies are always audited by Big 4 firms Many large listed companies are not active in such a wide range of markets that they can only be adequately serviced by a Big 4 firm. If there were less pressure from stakeholders for such companies to use Big 4 auditors they might be prepared to use a smaller firm, and so avoid the problems outlined above of having the same auditors as competitors. The forum of firms might help overcome the perception issues.

Conclusions? No easy answers Views from IFAC and the profession at large very welcome.