Chartered accountants dislike drama, so 2011 has been a year to forget.

The continuing backwash of the financial crisis of 2008, and the starring role of RBS and HBOS, saw the profession struggle as never before to maintain professional poise, further destabilising Scotland's 150,000-strong financial services industry.

Last week's 480-page FSA report into the failure of RBS, largely based on £7.7 million worth of investigations by Pricewaterhouse Coopers (PwC), hasn't helped much, and is destined to be remembered as much for what it omitted as for what it contained.

As has already been noted, not least by Parliament's Treasury Select Committee, the report failed to analyse in any depth the key relationship between the board of RBS and the bank's own auditors Deloitte. This was one of the headline points that escaped the self-serving attempts at news management by the FSA's chair Lord Turner, who initially attempted to suppress publication entirely "in the public interest".

But even the small amount it does say is damning enough, dragging up Deloitte's position on the eve of the crash that RBS's investment banking arm and ABN AMRO-derived collateral debt obligation expected losses, "individually and collectively, are not material to the results and financial position of the Group". In fact, these losses helped destroy Scotland's largest company, and the nest eggs of hundreds of thousands of shareholders.


Efforts to distract from the failures of audit – determining the validity and reliability of financial information and internal controls – in the banking crisis have been doomed since the May 2009 Treasury Select Committee report into the debacle that broke the UK economy.

This report condemned at some length the inter-connected world of elite auditors who failed to bark, let alone bite, where lucrative audit clients in the banking sector were concerned. Although no wrong-doing has been alleged, relationships like that between Sir Fred Goodwin and Deloitte's £5.2m-a-year boss John Connolly, mysteriously overlooked by the FSA last week, are now seen as part of a "cultural" problem (see panel).

Since the crisis, the dominance of the international accountancy elite, in particular the "Big Four" of PwC, Deloitte, Ernst & Young and KPMG, has come under examination, most significantly from Michel Barnier, the French centre-right politician now the European commissioner for the internal market. As he said last month, his ongoing consultation on changing the rules for audit is promising a permanent shake-up that has worried many and excited many others among Scotland's 10,000-plus army of CAs.

"Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary. We need to restore confidence in the financial statements of companies," Barnier said.

IN spring of this year a bruising investigation by the House of Lords economic affairs committee took a close look at the "oligopoly" of the Big Four after finding that "complacency" and "dereliction of duty" significantly contributed to financial crisis. A chain reaction involving the Lords, the European Commission and the Office of Fair Trading has led to a Competition Commission probe into the Big Four auditors' grip on the market, a process expected to take up to two years. After such recriminations, one outcome now in sight is greater access to listed companies whose affairs were previously seen as "too complex" even for long-established firms such as BDO, Grant Thornton, Baker Tilly, Johnston Carmichael and Mazars, all of whom have a strong presence in Scotland. Since the crisis, the share of the auditing pie earned by this "mid-tier" of firms has actually decreased, according to the Financial Reporting Council (FRC), a professional oversight board.

The FRC says that in the UK alone accountancy firms' fee income from audit in 2010 amounted to around £2.5 billion, which leveraged a further £13bn in non-audit work to the same clients. This is a sizeable chunk of the approximately £10bn in total fee income earned by the 30 or more biggest UK accountancy firms last year, around £7bn of which is currently earned by the Big Four.

No wonder that, while the entire process of business audit is being reassessed, a lobbying war is raging behind the surface of the accountancy profession. PwC is said to have 60 people working on the reform proposals in the UK and Brussels – "counter-productive", mutter their smaller rivals, hopefully.

The process of scrutiny has strong support among investors such as Guy Jubb, Edinburgh-based head of governance and stewardship at Standard Life Investments. "The concentration of the audit market in the Big Four global auditing networks is fundamentally unhealthy and presents a systemic risk which has the potential to undermine financial stability and the confidence of capital markets," he said in evidence to the House of Lords committee.

"Market measures have proved ineffective in changing the status quo; the time for constructive intervention by governmental and regulatory authorities is overdue. We should like to see the Big Four given a reasonable time to organise their affairs with the objective of enabling companies to have improved choice of audit supplier without prejudice to audit quality.

"It should be made clear to the networks that if they do not respond constructively then governmental and regulatory authorities are prepared to intervene with a view to achieving the objective."

The proposals in Barnier's green paper apply mainly to audits of large, publicly traded firms – "public interest entities" in the jargon – where, in the UK, the Big Four have around 99% of the market.

Most of the fuss surrounds Barnier's main proposals: that audit firms are prohibited from providing non-audits services such as tax and management consultancy; that auditors are required to report potential breaches of financial health and safety more assiduously; and that the maximum duration of an audit engagement be limited to between six and eight years.

According to a Big Four internal response paper seen by the Sunday Herald the last of these will have a "massive disruptive effect" on companies required to manage the regular re-appointment of auditors, and the market leaders' main fear is Barnier's proposal that accountants which derive income significantly from PLCs (ie the Big Four), establish separate "pure audit firms" as separate legal entities.

To the giants, this is nothing short of a requirement to "break up, within the EU, the Big Four" and "presumably a disincentive to other firms to get too large and dependent on [FTSE 350] audits".

The proposals could have "negative unintended consequences," warns David Sproul, senior partner at Deloitte.

"The detrimental effect of such measures on audit quality would affect all sectors but would be most severe for financial institutions," Sproul says.

SMALLER firms are more sanguine. Edward Nusbaum, chief executive of Grant Thornton, said he is "encouraged by the banning of restrictive covenants that artificially limit the choice of auditor, and that proposals for shared audits have been retained in the proposed legislation".

James Barbour, director of accounting and auditing for the Institute of Chartered Accountants in Scotland (ICAS), which balances the interest of Big Four and mid-tier firms, is also supportive of "increased choice" in the auditing market for blue-chip companies, though he insists that there is already competition on the "infrequent" occasions when audits of listed firms come out to tender. He subscribes to the self-reinforcing orthodoxy that "the complexity of big listed firms requires big accountancy firms to audit them".

ICAS is opposed to the EU's "mandatory rotation" proposal (changing auditors every few years) on the grounds that it implies onerous upheavals on audited business, and will not necessarily weaken the grip of the Big Four.

According to Barbour, the body is also firmly against Barnier's intended attack on conflicts of interest between running the rule over a company while being compromised by existing or hoped-for future consultancy services

In fact, the mid-tier companies are no more enthusiastic for a rigid separation between audit and non-audit, as a large part of their business is providing advice services to growing companies, which would pay the price for this piece of euro red tape.

So says Tom McMorrow, Edinburgh-based director of policy at Baker Tilly, whose comments reflect concern that Barnier could end up making things worse for the smaller players.

"All of the business models are predicated on non-audit services to audit clients. These clients are generally owner-managed companies, so you don't get the systemic problems that you get in the top companies. The services we provide are complimentary to providing an audit, because you get to know the company."

"For companies with turnover of between £25m-£50m to grow, they need to take good quality professional advice and they want to take it from their auditors. From the mid-tier perspective, we need the right to continue to provide non-audit services and there are [already stringent] ethical rules and oversight procedures,"

For David Harbinet, head of Mazars' corporate and public interest team in the UK, the concentration of the dominant players is made worse by the danger that "one or more of them might leave the market unexpectedly" as Arthur Andersen did after the Enron debacle. He deplores the low frequency of tendering for audits, which gives smaller firms no chance to "present their capability and credentials and initiate a process of changing perceptions."

HE dismisses the assumptions that only a company of similar size to FTSE 350 companies should be allowed to audit them, not least because the big auditors are seldom the most innovative in approach.

Herbinet pulls no punches about the "oligopoly premium" that means businesses must pay for the privilege of a Big Four audit. He also points to an "institutional bias" – a hard thing to pin down admittedly – hinting at an old boys network (and accountancy is far more male-dominated than law) and some unpleasant bullying tactics.

"We have heard [of] unhelpful messages from some advisers and dominant players, to the effect that a signature from a non-dominant player has a negative effect on share price. We do not believe this position is supported by academic research."

Market research, and competing submissions throughout 2012 should resolve at least some of these bugbears, and the EU, and the Competition Commission is braced for a blizzard of lobbying by the well-resourced audit "oligarchs" who stand to lose the most from any shake-up "We're used to it, we don't pay too much attention" confides one CC staffer.

For much of the market in Scotland as elsewhere, the Barnier process may prove to be a rare piece of Brussels "interference" that is actually welcome. That is, as long as that notorious "red tape" ties the big hands, not the smaller ones.