EU audit reform reduced to 'paper tiger'

23.01.14 @ 09:29

  1. By Valentina Pop
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Berlin - The EU is close to overhauling rules for financial auditors, but critics say the reform will be a paper tiger unable to break up the dominant position of the world's four biggest audit firms.

  • In Spain, KPMG acted both as advisor and 'independent arbiter' for Bankia in a dispute with angry depositors (Photo: Line Orstavik)

The legal affairs committee of the European Parliament on Tuesday (21 January) approved a draft agreement struck late last year with member states and the European Commission on the so-called audit reform package.

Its proponents are saying that the new rules will weaken the dominance of the "Big Four" audit firms: PriceWaterhouseCoopers (PwC), Deloitte, Ernst&Young and KPMG.

All four are multinationals comprising of a myriad smaller national firms who are - in theory - independent of each other and in competition with the other rival names.

But among the four names, as practice has shown, there is no real competition, as they often work together or subcontract to and from one another - for instance, in the case of the Spanish bank bailout, when all four were hired by the Central Bank of Spain for a total of €19.1 million to assess the value of local banks' credit portfolios.

In addition, failure by the Big Four to properly audit and scrutinise US investment banks in the run-up to the 2008 financial crisis has raised questions about their real motivation: to reveal problems in their clients' books, or to keep lucrative contracts going?

British Conservative MEP Sajjad Karim, who drafted the Parliament's position on the audit reform package, said on Tuesday (21 January) that this reform will have "positive ramifications not just for the audit market, but for the financial sector as a whole."

"We are rebuilding confidence one step at a time,” he said.

The agreed text introduces a prohibition of "Big 4-only" contractual clauses requiring that the audit be done by one of these firms. It also forbids these firms from offering non-audit services to their clients, such as tax advice, which influences the company's financial statements.

In Spain, KPMG has acted both as financial advisor and "neutral arbiter" for Bankia in a dispute with depositors who say they were scammed by the bank to convert their savings into "preferred shares" - a scheme which then went bust.

But apart from the bans, MEPs have failed to put a meaningful cap on the period of time one or several of the Big Four can prolong their contracts with a firm or a public authority.

"To ensure that relations between the auditor and the audited company do not become too cosy," a mandatory rotation rule has been agreed, but the audit firm only has to leave after 10 years.

If it wins a new tender, it can stay for another 10 years, or even for an extra 14 years, if there are joint audits, as it is often the case.

In its original proposal, the EU commission had said firms should be rotated after six years and have "cooling off periods" of four years before being allowed to return to the same client.

“A majority in committee judged that this would be a costly and unwelcome intervention in the audit market," the British Conservative Party said in a press release.

Close to the interests of the financial industry, the Conservatives have fought any provisions that would have upset the Big Four, two of whom - PwC and Ernst&Young - have their global headquarters in London.

German Green MEP Sven Giegold, who sits on the economics committee, where his group tried to push for more scrutiny and for shorter contracting periods, did not hide his disappointment at the deal, which is likely to be adopted by the European Parliament in April.

"The audit file is a strong wind for the financial lobby here in Brussels. Honestly I don't expect any resistance before the plenary," he told this website on Wednesday.

He said the proposal was weak to begin with, and has gradually become even weaker.

"The Big Four will continue to dominate the market. After this failure to regulate it, it is up to the Commission's directorate general for competition to act on this oligopoly. So the battlefield moves to [EU competition commissioner] Almunia," he said.

For his part, Kenneth Haar from Corporate Europe Observatory - a campaign group which monitors lobbying in the EU capital - calls the reform a "paper tiger."

"There has been talk in the EU institutions of breaking the monopoly of the Big Four for about a decade now, and this is what they come up with: rules that will allow companies to have the same auditing company up to 24 years," he said.

"We've seen extensive and aggressive lobbying on this initiative from the very beginning. It's difficult to reach any other conclusion that the financial lobby was successful on this one," he added.

Tom McDonnell, an Irish expert from the Dublin-based think tank Tasc, told this website by email that "auditing firms contributed significantly to Ireland's banking crisis yet there have been no consequences for the offending audit firms."

"Genuine reform means making audit firms accountable for mistakes - with adverse consequences (e.g. fines and suspensions) for the firm in the event of professional negligence," he added, referring to a provision which is missing from the EU package.