Conflict of interest changes open doors for specialist consultancies

Advice about risk and regulation has been a big growth area for the largest consultants in recent years. Now the biggest firms — notably the Big Four accountancy and professional services groups — may need to take their own medicine.

Last year was, as the Financial Times put it, an “annus horribilis” for Deloitte, EY, KPMG and PwC, as the growing political, public and media clamour to curb their dominance of the audit sector turned into action.

The UK’s Competition and Markets Authority delivered an early — and for the firms not entirely welcome — Christmas present in December by proposing to improve audit quality and reduce the risk of conflict of interest by legally separating audit from non-audit services. It also proposed that the largest UK companies should be subject to audit by at least two firms, giving challengers to the biggest auditors a foothold among larger clients.

Seen from the boardroom of the UK firms, or from the point of view of their audit partners, these and other proposals represent a significant step up in regulatory scrutiny and activity. They are likely to occupy the diaries of firms’ leaders for months to come. But seen from the other end of the telescope, the consulting operations of the largest professional services groups would be largely unaffected.

The Big Four have attempted self-regulation in this area ahead of action from the watchdogs. KPMG informed its partners in November that it would stop offering consulting services to large audit clients, including advice on restructuring, mergers and acquisitions, and information technology, to “remove even the perception of a possible conflict”.

In truth, though, the quantity of non-audit services on offer to audit clients was already comparatively low. For instance, PwC generates just under a 10th of its annual UK revenue of £3.76bn from non-audit services for audit clients, and that business shrank 16 per cent between 2017 and 2018. It compares with the nearly 69 per cent of revenue that comes from consulting work for clients not audited by PwC.

Some of those non-audit services are essential adjuncts to audit work, the firm argues. For example, a thorough audit would now include scrutiny of a client’s cyber security, drawing on expertise from the consulting side of the business.

The proposals represent a significant step up in regulatory scrutiny and activity

For the consulting arms of the big professional service firms, then, the direct impact of the far-reaching regulatory changes coming to their parent companies is likely to be low. In fact, earlier regulatory moves, such as mandatory rotation of auditors, arguably created more opportunities for them to expand their consulting business.

That does not mean they can ignore the risk of conflict, but perhaps their greater concern is the same as that faced by large law firms or investment banks: the potential for conflict between different clients who might, for instance, be competitors.

The complexity has provided openings for smaller specialist consultants, and even for the non-audit arms of the mid-tier auditors. The 2019 list of the UK’s Leading Management Consultants again features the consulting arms of Grant Thornton and BDO. The real opportunity for specialist consultancies, though, is in picking off parts of wider multi-disciplinary transformation projects led by the bigger advisory groups.

Such projects require careful policing by the conflict and client committees of the bigger consultancies. Usually, a comprehensive database of client engagements flags potential conflicts before a detailed pitch has been made to a new client. The nature of long-running multi-disciplinary projects means that sometimes the scope of an engagement may change in the middle of a mandate — and such changes could introduce a new potential conflict of interest.

At PwC UK, for instance, risk managers and leaders of the lines of business would first discuss whether to proceed or whether to refer the question up to the group’s client committee, whose members include the chief risk officer and head of markets. The committee addresses not only whether a project can be done, but whether it should be done, taking into account reputational risks to the firm.

Margaret Cole, chief risk officer and general counsel of PwC UK, says she has seen an increase in the number of upward referrals. She attributes the rise to an internal campaign to increase awareness of potential conflicts, improvement in the system, and the increasing complexity and scrutiny of the group’s work.

“It recognises that the environment we live in means we have to make some of these decisions extremely carefully and difficult judgments have to be made,” she says. “We see it as a good thing that we get a good flow [of referrals].”