AQIs Must go Beyond ‘Big Four’ Auditors – Railpen   

Pension fund calls for new audit quality metrics to cover “as many firms as possible”, including challengers to market leaders.

Proposed audit quality indicators (AQIs) will have to be applied widely in order to improve audit standards in the UK, according to Railpen, one of the UK’s largest pension funds with £37 billion in assets under management.  

AQIs, which were under consultation by the Financial Reporting Council (FRC) until last week, are intended to measure and compare the ability of audit firms to accurately audit the financial statements of large corporates, which can be a critical factor in institutional investors deciding whether or not to purchase or hold their shares.  

In its response, Railpen said AQIs should apply to more audit firms than just the big four, and that it is important for AQIs to have narrative metrics supporting data metrics to provide “vital context” and prevent misinterpretation. 

The FRC has proposed 11 AQIs for the “largest” UK audit firms, which aim to provide investors with a range of comparable indicators covering the perceived culture within an audit firm, audit quality inspection results, staff workloads, and the level of partners’ involvement in individual audits.  

The initiative looks to address the limited information currently available to compare audit quality between firms and enable discussions between audit committee chairs and audit firms on the drivers of audit quality helping them to make more informed comparisons between firms when appointing external auditors.  

The ‘big four’ audit firms – Deloitte, EY, KPMG and PwC – are “largest” UK audit firms referred to in the FRC’s consultation. Railpen recommended that AQIs apply to as many audit firms “as possible”, which would help to increase competitive pressure on the big four firms.   

These have recently come under fire for mistakes in signing of financial statements which have often led to significant fines. Audit quality and cost is seen in some quarters to be detrimentally affected by large corporates tending to only use big four firms for audits, despite increased scrutiny from regulators.  

This year, PwC has received fines of £5 million and £1.8 million, KPMG was fined £14.4 million, Deloitte £1.45 million and EY’s admission its employees had cheated on ethics exams led to a fine of US$100 million. These sanctions follow on from the highly publicised cases of Carillion and Patisserie Valerie in recent years.  

While Railpen acknowledges not all audit firms will be able to report on the full range of AQIs, it recommended the FRC should encourage “challenger” audit firms to report and even consider a tiered approach to AQI reporting for smaller firms.  

Even if challenger firms – firms with a market share below that of the market leader, but a sufficient presence to exert upward pressure – do not currently meet the threshold for reporting being able to demonstrate consistent, Railpen said provision of AQIs can provide an additional criterion for audit committees considering whether to award an audit to such a firm.  

The second key recommendation of the pension provider was to supplement AQIs with narrative or contextual information to provide investors with a “full picture of an issue”. Railpen said supporting narratives alongside metrics can provide important context and “partly mitigate any misinterpretation” from solely using metrics. Through this, the risk of an issue being “buried” in the data can be lessened.   

Useful metrics suggested by Railpen to ensure an audit firm has the “right kind of culture in place” included whether the culture supports an ethical, principled approach to audit and avoids groupthink, whether auditors have enough time to do a good job, the level of experience of audit teams and the team structure and how auditors are incentivised on audit quality.   

Once AQIs have been adopted, Railpen said it would be “supportive” of any steps the FRC could take to encourage audit firms to break down metrics by not just sector or size of the entity, but also by the ‘risk-level’ of an audit.   

Caroline Escott, Railpen’s Sustainable Investment Senior Investment Manager, said: “We recognise that much of the investor community has not historically been engaged on audit issues and we do not think that lack of current wider investor interest should delay the FRC’s current work on AQIs.”  

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