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Regulation

U.K. regulator recommends largest audit firms separate audit, consulting businesses

The U.K.’s CMA recommended that the largest audit firms split their audit businesses from their consulting services.

The U.K.'s Competition and Markets Authority recommended Thursday that the largest audit firms split their audit businesses from their consulting services.

Following an earlier consultation, the CMA also said Thursday it is proposing a mandatory "joint audit" to enable firms outside the four largest consulting firms to develop the capacity to enter the market and review the U.K.'s biggest public companies.

The CMA proposed the "operational split" to compel auditors to focus "exclusively" on conducting productive audits, rather than being influenced by their much larger consultancy businesses. Auditors will be required to appoint separate management — a CEO and board for the audit arm — and end profit-sharing between the audit and consultancy businesses.

However, the CMA said the recommendations are going to be applicable to U.K. market only.

"Given the difficulties with an immediate global structural split, the CMA is — at this stage — recommending an operational split of U.K. only audit," the U.K.'s competition regulator said.

U.K. money managers supported the CMA's proposals in their responses to the consultation.

In its response, Legal & General Investment Management said: "We see numerous positive benefits from implementing a 'ring-fencing' structure which aims to improve audit quality and provide a better balance between audit and non-audit work."

The firm added: "Within the ring-fence structure, partners and senior employees are protected from the commercial interests of advisory services and therefore can operate without dealing with conflicts arising from such services."

In efforts to boost audit quality, the CMA also recommended Thursday a mandatory joint audit. Under the proposal, firms from outside of the Big Four — Ernst & Young, Deloitte , KPMG and PricewaterhouseCoopers — will work alongside the largest auditors and will be jointly liable for the results.

Money managers and pension funds welcomed the joint audit proposal in their consultation responses, but some questioned the impact of such joint audits.

The 64 billion ($84 billion) Universities Superannuation Scheme, London said in its response: "If midtier firms were encouraged to participate, this solution could leverage the skills and capabilities of each firm, allowing midtier firms to be exposed to the technologies used by the Big Four. In addition if the allocation of (audit) sections is changed every two or three years, it would ensure the audit work is reviewed on a more regular basis. We would assume that peer reviewing improves quality if there is accountability at the end."

However, Schroders its response said: "The implementation of a joint audit requirement is likely to increase audit costs, may introduce additional inefficiencies and there is a risk that it actually reduces the quality of the audit overall. We believe that joint audits do not necessarily enhance the quality of the audit, they are not a control mechanism over each firm. Instead, we believe that there is an enhanced risk of lower quality through neither firm being accountable for the overall assessment of the true and fair presentation of the results."

Andrew Tyrie, CMA chairman said in a news release Thursday: "People's livelihoods, savings and pensions all depend on the auditors' job being done to a high standard. But too many fall short — more than a quarter of big company audits are considered substandard by the regulator. This cannot be allowed to continue."

Mr. Tyrie added: "Conflicts of interest cannot be allowed to persist; nor can the U.K. afford to rely on only four firms to audit Britain's biggest companies any longer. Early action will require legislation — hence the CMA's proposals."

Commenting on the CMA's report, Chris Cummings, CEO of the Investment Association, said: "There is no silver bullet, but the CMA have presented a range of options that seek to strengthen and enhance the audit market. We particularly welcome the focus on improving the accountability of audit committees and the proposed operational split of audit and non-audit services. We remain unconvinced of the value of joint audits, as there is little evidence that they actually lead to the better quality audits that investors want to see."

"These options will need careful implementation, and we look forward to working with the CMA and the government to take these proposals forward and deliver a robust audit market that meets the needs of investors," Mr. Cummings said.