Utility Week

UTILITY WEEK | 3RD - 9TH MAY 2019 | 19 Finance & Investment Analysis T he UK's "big four" accountants – KPMG, EY, PwC, and Deloitte – are under fire; currently, they audit 97 per cent of the UK's 350 largest companies. Apart from this clear oligopoly, there are real con- cerns about the dual role that they perform in many cases. On one hand, they undertake the role of independent auditor – nothing wrong with that. OŠen, though, they also provide profit- able consultancy services to the very compa- nies that they audit. Recently, there have been some high-pro- file issues relating to collapsed companies such as the hapless Carillion, a one-time support services provider, and the Patisserie Valerie café chain. Underlying concerns Of course, accounting issues relating to the support services sector is nothing new. For many years there have been underlying con- cerns about the accuracy of the accounts of some sector companies. Similar issues have dogged several collapsed telecoms and IT companies. In many cases, recognising revenues, especially those under long-term contracts, and aligning them with the accompanying costs has been a thorny issue – something that a professional auditor should pick up. To be fair, audits of many companies – think Shell and RBS, for example – are immensely complex. Nonetheless, the House of Commons Business, Energy and Industrial Strategy Select Committee has put forward some radical policy proposals. While the Competition and Markets Authority (CMA) had advocated an opera- tional break-up by a legal separation of the audit business from other activities, the select committee has gone further. It has endorsed a full break-up strategy. Labour's Rachel Reeves, the committee chairman, argues that "splitting audit from non-audit business would be a big step towards boost- ing the culture of challenge needed to deliver high-quality audits". The committee also suggested both lim- iting the number of listed companies in a sector that any accountancy business can audit and requiring a company's auditors to change more frequently. Sensible though some of the policy pro- posals may be, the chances of major reform are unlikely. Not surprisingly, the big four are quite happy with the status quo. Moreover, with the government effectively paralysed by Brexit, and with the lack of qualified com- panies to undertake highly complex audits, it seems improbable that underlying reform will be pursued. The scenario is similar to the shambolic railway franchise system, with the Depart- ment for Transport terrified of scaring off the few remaining UK railway franchisees. Utilities and audits As expected, the big four are very active in the utilities sector, notably Deloitte. Fresh from winning the complex National Grid audit, it is also the auditor of Centrica – which given its many gas contracts, is not a straightforward task – and of Severn Trent. Outside the UK, there have been massive utility accounting scandals. In the US, the infamous names of Enron – once the subject of a West End play – and the failed WorldCom telecoms business – run by Bernie Ebbers, a former Mid-West milkman who is now behind bars – are still bitterly recalled. In contrast, the UK utilities sector, apart from BT's global business division and espe- cially its Italian operations, has faced few serious accountancy issues. Indeed, the UK water sector is probably better policed than any other sector, with its quinquennial pricing reviews seeing Ofwat drilling down – in excruciating detail – into every material cost. The degree of detail is illustrated by the Test Area Assessments for each water company recently published by Ofwat. No auditor would be expected to carry out such detailed work. And if they were to do so, the annual accounts of such behemoths as Shell and HSBC would never be published on time. The price-regulated electricity distribu- tion companies are theoretically in a similar position, with the undertaking of periodic reviews requiring detailed financial analysis. However, their ownership has become increasingly disparate, with most being sub- sumed into far larger companies. Within the utilities sector, it is probably National Grid and Centrica that present the greatest challenges for auditors. Gas contracts are generally complex; adjustments oŠen need to be made for the fluctuating price of gas, especially for Cen- trica with its pivotal "weighted average cost of gas" benchmark. Within the electricity sector, the persis- tent failure of smaller energy supply com- panies might suggest audit shortcomings. However, the business model of many such companies is flawed – it is a very crowded marketplace – and it is hardly surprising that some have failed. It is more the responsibility of Ofgem to ensure that licences are awarded to new entrants only if their business case is clear and compelling. While the utilities sector faces many challenges – pricing reviews and Labour's planned renationalisation to name but two – auditing shortcomings are not uppermost in utility executives' minds. But if you are seeking new funds in the support services sector – as Capita did last year with its heavily discounted £700 mil- lion rights issue – a "clean" set of accounts is paramount. Nigel Hawkins, utilities sector analyst, Hardman & Co Parliament takes on the number-crunchers A select committee has proposed breaking up the big four accountancy firms, who together audit 97 per cent of the FTSE-350. Nigel Hawkins asks, should utilities be worried if they do?

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