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The UK accounting regulator has ordered audit bosses to tell the watchdog about any plans to sell stakes in their businesses to private equity as the industry gears up for a potential wave of investment.
Richard Moriarty, chief executive of the Financial Reporting Council, wrote on Thursday to the bosses of the UK’s top accounting firms, saying the regulator was not “in principle” against private equity investment in the sector but there were “important risks that will need to be carefully managed”.
The intervention signals the regulator’s concerns that private equity investment could erode audit firms’ rigour and independence in auditing the accounts of large companies — key to maintaining investor confidence in the accuracy of companies’ accounts.
“A firm that is interested in, or considering, a change of ownership to introduce private capital should engage with the FRC at an early stage and with full candour, assured that all such discussions will be treated in strictest confidence,” wrote Moriarty, who was previously the UK’s aviation regulator.
His letter comes as private equity groups Permira and EQT circle the UK business of mid-tier accountant Grant Thornton in a deal that could be worth up to £1.5bn. This would be the most significant private equity investment to date in the UK’s accounting industry.
Private equity investment in the UK audit market has until now been limited to a handful of smaller firms but has been much more extensive in the US.
Accounting firms have traditionally been structured as partnerships owned by the practitioners who run them, limiting their ability to raise equity capital to expand or invest in new technology.
UK rules require audit firms to be majority controlled by qualified accountants. Moriarty is set to emphasise to executives that the regulator would judge “control” by reference to “economic substance” and not just legal form, said a person familiar with the matter.
The FRC has pushed audit firms to invest heavily in improving the quality of their audits after a series of scandals, including at collapsed construction group Carillion in 2018 and failed retailer BHS in 2016.
The watchdog said in its annual review of the sector in July that there was a risk that private equity investors “may lack a deep understanding of audit practice objectives, and the public interest incentive to deliver audit quality”.
“A lack of clarity or long-term thinking regarding PE exit strategies also raises concerns about maintaining audit quality and public interest motives over future years,” it added.
In Thursday’s letter, which was also sent to heads of professional bodies including the Institute of Chartered Accountants in England and Wales, Moriarty said the FRC was open to speaking to private equity or others considering investing in the audit market “to help explain the regulatory framework and expectations”.
“The FRC is not in principle against a greater participation of external private capital in the UK audit market . . . We recognise that access to external private capital could, in the right circumstances, have potential benefits for the UK audit market,” he said.
“It may generate additional investment that could be used to enhance audit quality within firms that might not otherwise be able to fund such capabilities.”