Global Regulatory Agencies - the global policemen square up to the knowledge-based economy

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

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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

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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.

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The FSAs 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.

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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.

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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

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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.

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Analysis of the market in the US and UK before
the collapse of Andersons
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• UK OFT study on competition in professions
  in2000 concluded that the Big 5 had 79.2 of
  theUK accounting market.

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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.

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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.

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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.

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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).

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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.

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How to open the market?

• No easy options for the competition
• authorities
• Consider perceived barriers to entry for the
  second tier firms

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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?

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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.

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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.

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Conclusions?

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