EU eyes tighter regulation of audit industry

AP News
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Posted: Oct 13, 2010 5:42 PM
EU eyes tighter regulation of audit industry

The European Union on Wednesday fired the first shot in a process that could lead to tighter supervision of auditing firms, saying that the dominance of four big companies poses "systemic risks" to the financial system.

Announcing a consultation on the role of the industry, EU markets commissioner Michel Barnier questioned whether firms that both examine a company's financial statements and provide consultancy work for the same company can truly be independent.

"We want to strengthen this profession and its credibility," Barnier said. A review of current regulations is necessary since "audit firms didn't see (the crisis) any more than anyone else," even though they checked the accounts of big banks like Lehman Brothers, the U.S. investment bank whose 2008 bankruptcy deepened the crisis, he added.

With the publication of a so-called "green paper," the European Commission is kicking off early-stage discussion on issues it has identified in the auditing industry.

Among these, Barnier said, was whether the handful of firms that dominate the audit market have become too big too fail, potentially causing serious disruptions in the business world or even forcing government bailouts if one of them ran into trouble.

Four big firms _ Deloitte, PricewaterhouseCoopers, KPMG and Ernst & Young _ control 70 percent of the European auditing market, Barnier said. In the U.K., 99 percent of FTSE 100 companies use the "Big Four" as their auditors.

In practice, many large listed companies are even more limited in their choice of an auditing firm, because they don't want to use the same auditor as their competitors, said Gunnar Niels, director of Oxford-based economic consultancy Oxera, who has directed two studies on the auditing industry for the European Commission.

"We think that this sort of concentration can lead to systemic risks," Barnier said. "We need more competition; we need more diversity."

As part of that, the "pros and cons of 'downsizing' or 'restructuring' systemic firms should be further examined," the commission said in its green paper.

Another way to create more competition and diversity would be to promote the creation of new auditing firms and help smaller companies grow, Barnier said.

The big four auditing firms said they welcomed the opportunity to discuss the role of their industry in the aftermath of the financial crisis.

"It is clear that there are lessons to be learned from the financial crisis by all those engaged with the capital markets," PricewaterhouseCoopers said in a statement.

Ernst & Young said that it will "look forward to working with all stakeholders to ensure that financial reporting and the audit continue to benefit investors and the capital markets."

However, KPMG stressed that "market interventions, such as reducing the scale of the existing firms, would be prejudicial to audit quality."

Deloitte Chief Executive Jim Quigley said in a statement that the consultation represents "a unique opportunity for the profession, the Commission, and others to work together to shape the future role of audit and its regulatory framework."

The consultation could eventually also lead to the introduction of a "European passport" for auditing firms, similar to one envisaged for hedge funds, Barnier said. A European passport would require firms to fulfill certain requirements before getting access to the entire European market.

The EU's consultation on auditing firms comes after the House of Lords in the U.K. launched a similar investigation in the dominance of the Big Four over the summer. It also comes as the commission is examining the role credit ratings agencies played in the global financial crisis as well as the European government debt crisis.

Barnier said that in the audit sector, "the status quo is not an option."

Interested parties now have until Dec. 8 to comment on the paper, which will be followed by a commission conference on the audit industry in February.

(This version corrects day of week in the first paragraph.)