The UK’s accountancy watchdog is telling audit firms to report approaches from private equity

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Britain’s accountancy regulator has ordered audit chiefs to tell the watchdog about any plans to sell shares in their businesses to private equity, as the industry prepares for a potential wave of investment.

Richard Moriarty, chief executive of the Financial Reporting Council, wrote to the heads of Britain’s top accountancy firms on Thursday, saying the regulator was not “in principle” against private equity investment in the sector but that there were “significant risks which will have to be carefully managed”.

The move signals the regulator’s concern that private equity investment could erode the rigor and independence of audit firms in auditing large companies’ accounts – key to maintaining investor confidence in the accuracy of companies’ accounts.

“A firm that is interested in or considering a change of ownership to bring in private capital should engage with the FRC at an early stage and in all sincerity, assured that all such discussions will be treated with the strictest trust,” wrote Moriarty, who was previously the UK’s aviation regulator.

His letter comes as private equity groups Permira and EQT are circling the UK businesses of mid-tier accountant Grant Thornton in a deal that could be worth up to £1.5 billion. This would be the largest private equity investment in the UK accountancy industry to date.

Private equity investment in the UK audit market has so far 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 lead 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 to stress to executives that the regulator will judge “control” by reference to “economic substance” and not just legal form, a person familiar with the matter said.

The FRC has pushed audit firms to invest heavily in improving the quality of their audits after a series of scandals, including the collapse of construction group Carillion in 2018 and failed retailer BHS in 2016.

In its annual assessment of the sector in July, the watchdog said there was a risk that private equity investors “lack a deep understanding of the objectives of audit practice and the public interest incentives to ensure audit quality”.

“The lack of clarity or long-term thinking on exit strategies from the EP also raises concerns about maintaining audit quality and public interest reasons in the years to come,” it added.

In Thursday’s letter, which was also sent to the heads of professional bodies including the Institute of Chartered Accountants in England and Wales, Moriarty said the FRC was open to talking to private equity or others considering investing in the audit market ” to help explain the regulatory framework. and expectations”.

“The FRC is not opposed in principle to greater participation of external private capital in the UK audit market. . . We recognize that access to external private capital could, in the right circumstances, have potential benefits for the UK audit market,” he said.

“It could generate additional investment that could be used to improve audit quality within firms that might not otherwise be able to fund such capabilities.”