Britain’s accounting watchdog has warned the biggest audit firms against attempting to subvert controversial European rules that require large companies to switch auditors every 20 years.

The Financial Reporting Council sent a letter to the Big Four accounting firms last week that sets out its expectations on how banks based outside Europe and their auditors should respond to the rotation rules.

The letter has been widely interpreted within the sector as an effort to block Goldman Sachs from a potential attempt to hire a smaller accountancy firm in the UK to do a fraction of its European audit while continuing to rely on PwC for the bulk of it. The US bank needs to appoint a new auditor in Europe before 2021.

PwC indicated it wanted to pursue this option, which has been dubbed “top slicing” within the sector, at an industry meeting last year, according to several of its competitors.

Several of PwC’s rivals told the Financial Times that they raised concerns about the plan with the Bank of England late last year. One competitor said the top-slicing approach would mean the smaller firm essentially “hides behind PwC”, adding: “It fundamentally fails the European rotation test.”

Another rival said his firm told the BoE that the top-slicing approach “was not going to fly” and would make a “patsy” of the smaller auditor. Goldman and PwC declined to comment.

The FRC letter — which has been seen by the FT — said audit firms and financial institutions should not enter any arrangement that could be viewed as “a rotation in form but not in substance”.

It added that an auditor of a UK bank “must have freedom to plan and perform their audit as they see fit”. Tenders for audit services “cannot impose preconditions on an auditor”, such as forcing a UK auditor to rely on the work of a group auditor, according to the FRC.

PwC mooted an idea last year involving “shared audits,” which would enable the incumbent auditor — typically a Big Four firm — to continue taking the signing risk of a client’s UK accounts but sharing out the audit work with another, smaller firm.

The warning shot from the FRC comes as pressure intensifies on several large US banks — including Goldman Sachs, JPMorgan Chase and Bank of America — to appoint a new auditor for their European operations or change auditor altogether.

Both options are deeply unpopular as most US banks have been audited by a Big Four firm for decades and rely on the other three for consulting advice. This means the only independent option in Europe is a firm beyond the Big Four, although there are concerns about smaller auditors’ expertise in complicated areas such as bond or derivative valuations.

Goldman is likely to appoint either BDO or Mazars in the UK in the second half of this year, according to several people involved in the tender process.

The aim of the rotation rules — which require listed companies in Europe to appoint a new auditor at least every 20 years — is to prevent companies from becoming too cosy with their auditors and improve confidence in companies’ financial statements.

The reforms also apply to so-called public interest entities, dragging the European arms of US banks into scope.

Additional reporting by Stephen Morris and David Crow

Letter in response to this article:

Underlying causes of audit failures must be assessed / From Rodger Hughes, Epsom, Surrey, UK

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