EU demands more from audit firms

cracking down on the conflicts of interest and other shortcomings exposed by the financial crisis.
Policymakers have questioned why auditors had given a clean bill of health to many banks which shortly afterwards needed rescuing by taxpayers as the financial crisis began unfolding.
Just four audit firms – Ernst & Young, Deloitte, KPMG and PricewaterhouseCoopers – check the books of 85 percent of blue-chip companies in most EU states, which the European Commission called “in essence an oligopoly”.
UK data showed that the big four firms’ profit margins were 50 percent higher than the next four audit firms, the commission said.
“Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary,” EU Internal Market Commissioner Michel Barnier said yesterday.
Recent apparent audit failures at Lehman Brothers, BAE Systems and Olympus “would strongly suggest that audit is not working as it should”, he said.
More robust supervision was needed and “more diversity in what is an overly concentrated market, especially at the top end”.
Under Mr Barnier’s plan, the four top firms will have to separate EU-based audit activities from non-audit activities, such as tax and other advisory services – “to avoid all risks of conflict of interest”.
There will have to be legal separation of audit and non-audit services if more than a third of revenue from auditing comes from large listed firms and the network’s total annual audit revenue is more than 1,5 billion pounds in the EU.
Claire Bury, one of Mr Barnier’s top officials, said these conditions, if approved by EU states and the European Parliament, would alter all the big four firms’ business models and even one or two of the next tier down in some member states.
KPMG’s European head, Rolf Nonnenmacher, said yesterday the capability of firms to provide quality audits would be reduced if auditors were separated from advisory expertise, including risk management in the financial sector. PwC’s UK chairman, Ian Powell, said Mr Barnier had not provided “any concrete evidence for any positive impact of these proposals on audit quality or properly assessed the additional cost burdens for business”.
Deloitte said the plans would create an audit regime in Europe inconsistent with those in other markets, while Ernst & Young said they would have a minimal effect in preventing financial crises.
The European Commission said it was difficult to quantify the costs. Public tendering of audit work by listed companies would be compulsory, and include consideration of second-tier auditors.
Commission officials indicated they hoped the new rules would be in place within three to five years. EU states and the European Parliament will have the final say on the draft law, a process that involves haggling and changes.
BDO, one of the next-tier firms, criticised the commission for ditching mandatory joint audits after “lobbying and extensive influence of the largest firms”.
“The remaining proposals appear to be worse for the market than no proposals at all,” senior BDO audit partner James Roberts said yesterday.
Mr Barnier, under pressure from some commissioners, at the last minute dropped a key element of his plans – mandating “joint audits” of listed companies as a way to improve audit quality and give smaller auditors experience in checking big firms’ books.
Instead, he tried to introduce incentives to encourage joint audits by finessing another part of the measure – the mandatory switching or rotation of auditors.
A sole auditor would only be allowed to audit the same firm for up to eight years, but for a joint audit, this mandate could be extended up to 12 years.
Suresh Kana, chief executive of PwC in Southern Africa, said the draft was a missed opportunity to learn the lessons of the financial crisis, meet the needs of investors and to help enhance audit quality.
“Key to any reforms should be whether they aid the auditor’s objectivity, independence and professional scepticism and enhance audit quality,” Dr Kana said yesterday.
Lance Tomlinson, head of assurance for Africa at Ernst & Young, said the proposals would not only damage the quality of audits, but increase audit costs.
“Auditing requires multidisciplinary skills and to simply call on chartered accountants to deliver on all those skills could damage the quality of audits. In practical terms, how should an auditor divorce himself from his non-audit skills?” Mr Tomlinson asked.
He said the question remained how the audit profession could have prevented the latest financial crisis. “What could have been done that has not already been done?” he asked. – Businessday.