The FRC’s market study into sustainability assurance

The highlights from our response include:

Concentration in the assurance market

The sustainability assurance market is immature, consisting mainly of voluntary assurance over a restricted set of sustainability-related indicators. However, early indications are that sustainability assurance is reinforcing the already high concentration in the audit market. This raises concerns such as the risk sustainability and other forms of assurance may further reinforce this concentration, impacting competition and choice, as well as market resilience. 

In a recent paper published by the European Capital Markets Institute, Forvis Mazars’ Global Head of Capital Markets, Fabrice Demarigny, highlights the risks of further market concentration as the demand for assurance over sustainability and other matters grows.

He discusses a potential ‘butterfly effect’ on audit and assurance market resilience, whereby the “growth of the demand for [assurance services] enhances the risks attached to the already excessive level of concentration in the audit market. If a high proportion of the various types of [assurance engagements] in very different areas are provided by the same limited number of audit firms, the consequence of an audit failure in one area might have a significant negative impact on other (unrelated) areas and generate a ‘butterfly effect’. For example, a financial audit failure by a dominant audit firm might put […] the accuracy of carbon footprint disclosure by key companies at risk, if the latter are performed by the same dominant audit firm”.

The paper goes on to argue a new structure for the audit market in Europe is needed, we believe this need is replicated in the UK and other markets.

Drivers of competition

There will be two drivers of the need for sustainability assurance in the UK market:

• The introduction of mandatory reporting requirements (likely impacting listed companies in the first instance).
• The knock-on impact for entities in the value chains of listed companies may be required to obtain assurance on some information (e.g. greenhouse gas emissions) that is provided to larger companies for the purposes of their reporting.

When UK standards are implemented, we anticipate that audit firms will be largely appointed to provide this assurance. It is likely unless regulation prevents it, most companies will appoint their auditor to provide the necessary assurance. As a result, absent any regulatory or competition measures are being put in place. We anticipate a similar level of concentration in the assurance market, dominated by the largest four audit firms, as we see in the audit market. This would be a significant missed opportunity to address competition and choice, as well as market resilience in the wider audit and assurance market.

Barriers to entry

In addition to market concentration and competition issues, regulatory burdens will present a barrier to entry to the sustainability assurance market for firms, especially those with a lower risk appetite. For example, the well-known challenges around regulation that present barriers to entry to the PIE audit market, for which there is plenty of real and anecdotal evidence, will equally apply to the sustainability assurance market.

These challenges could be exacerbated in sustainability assurance given the rapid pace of development. It is widely acknowledged sustainability reporting and assurance is a “journey” and it will take many years until reporting systems and data quality are sufficiently mature. Add to that the rapidly developing standards regime around reporting, assurance and ethical requirements. It is highly likely issues may come to light down the line and the risk of “regulatory hindsight” is significant. It will be important for the FRC, as the regulator, to ensure it does not apply hindsight to any future inspection and enforcement activities when investigating matters that may arise in the early stages of the adoption of sustainability reporting.

Regulatory framework - what would we want to see?

• International regulatory alignment - To the extent possible, alignment of international and European reporting standards to enable consistency and equivalence.
• Implementation of UK Sustainability Reporting Standards – IFRS standards should be endorsed with minimal amendment and clarity provided over which companies will be required to report under the UK standards and when reporting will be required.
• Assurance requirements - There is no mention yet of whether and when assurance will be required over sustainability reporting. Without certainty as to when a requirement for assurance will be introduced and what level of assurance will be required (limited or reasonable), it is difficult for firms to make the required investment.
• Assurance and ethical standards – The international standard setters (IAASB and IESBA) are finalising assurance and ethical standards later in 2024 which will be effective from 2026. We urge the FRC to consult on the adoption of these standards as a matter of priority, and with minimal if any amendment, to enable firms to adopt the standards early where possible.
• Competition and managed shared audit – The FRC should consider whether a Managed Shared Audit approach may be appropriate for sustainability assurance to address some of the challenges and barriers to entry that are mentioned in our responses to the earlier questions.
• Accreditation and qualifications – Clarity is on whether there will be an accreditation process for sustainability assurance providers, and who will be responsible for accreditation, monitoring and enforcement of providers. 
• Level playing field for all providers – It is imperative the sustainability assurance market is a level playing field for all assurance providers. E.g. all providers should be subject to the same assurance, quality management and ethical standards, as well as being subject to the same rigorous quality inspection and enforcement regime that audit firms are used to.
• Role of the FRC – Clarity on the role of the FRC in relation to matters such as sustainability reporting (similar to the Corporate Reporting Review), quality inspection and enforcement would be helpful for all parties, including the FRC itself undoubtedly.
• Ex-ante regulation - We believe regulation should not just be a process for identifying where things have gone wrong. A focus on improvement is also critical for a strong and effective regulator to enable a “right first time” outcome. We encourage the FRC to take more of an “ex-ante” and participative approach to its regulatory activities around sustainability reporting and assurance, rather than merely acting as a judge after the event.