After EY announced its decision to split the audit and advisory businesses globally, headlines are buzzing about other firms’ plan to split their audit and advisory businesses.

They have all presently denied such plans but clearly are watching EY and evaluating their strategy. We recollect the creation of Accenture after the demise of Arthur Anderson, sale of consulting business by PwC to IBM, EY to Capgemini and KPMG’s spin off Bearing Point about two decades ago. Today all firms have rebuilt/grown their consulting businesses to levels where the non-audit revenue is about twice the audit revenue and usually more profitable. The reasons behind such plans to split,including the lack of synergies between audit and advisory, impact on both businesses and long-term implications, need to be explored.

Regulators pushing hard on audit firms with fines and penalties have been hogging the headlines off late.

Regulators have also defined complex rules for independence and to avoid conflict of interest. Firms get penalised for failing to follow these rules. Partners in the firms get frustrated at having to regret/reject work due to independence rules.

Advisory partners complain about the fines paid by audit and high cost of insurance owing to these fines.

Firms such as EY seem to have decided to take the issues head-on and split audit and advisory. Being a pioneer, it expects to grab audit clients freed of independence and conflicts. The consulting business, unhinged from audit is expected to grow faster, giving them the best of both worlds.

The rationale for audit and consulting to be together was driven by the need for advisory services by audit clients. Audit partners believed that they could do well due to their understanding of clients and it was profitable. Of course, this clearly impacted their independence and, in some cases, lead to poor audit quality.

Cashflow was better managed with predictable revenue from audit as a base and costs were shared across a larger base.

The split’s impact

Audit: Pure audit firms will invest and develop better tools to reduce risk and make their processes more robust.

They will be smaller and less dominant, and we can expect more robust competition.

Audit-only firms will also need specialists in areas like tax and valuation to support audit. Attracting good talent in these support services will be a challenge.

Audit fees are likely to increase initially as firms invest but in the long term expected to reduce as quality improves, bringing down insurance costs. Audit partners will be able to be less deferential and more independent in dealing with clients as they have no risk of losing advisory business once they rotate out.

Advisory: Advisory will be free to pitch without worrying about conflicts. They would be able to raise capital from private equity funds or go public to scale up.They will need to develop strong brands and propositions to compete.

Overall: There will be significant costs of implementing the restructuring including engagement with regulators and convincing global partners. This may affect them as they have invested heavily in their brand, and it will be interesting to see how they deal with the brand and how they split the value generated post-split.

The rationale for the split is strong and this time the temptation to regrow the advisory business will be avoided. So this appears to be a positive move for both companies and the market and regulators are likely to encourage all firms to move in this direction.

The writer is Managing Partner, ECube Investment Advisors