Wednesday, November 19, 2008

European Commission Proposes Methods to Add to Big Four Audit Firms

In an effort to increase the number of global audit firms, the European Commission has embarked on a consultation presenting two possible ways forward: the deregulation of the capitalization of audit firms and lowering other non-capital barriers to access. Internal Market Commissioner Charlie McCreevy has noted that current conditions prevent the entry of new players in the international audit market, as well as threaten existing audit firms. Left alone, noted the commissioner, the combination of high concentration and limited choice of audit firms could lead to damaging consequences for the capital markets.

The Commission has been trying to increase the Big Four for some time now. That was the idea behind proposed limitations on auditor liability. This effort is in response to the increasing trend of litigation and the lack of sufficient insurance coverage in the sector. The proposal is also designed to ensure that enough audit firms are available to carry out the audits of public companies in the European Union. Studies have shown that liability risks for audit firms act as a barrier for mid-tier audit firms entering the market for the audit of listed companies at the international level.

The proposed deregulation of the capitalization of audit firms (unbundling) as the catalyst for opening up the audit market would require changes in the Directive on Statutory Audit, which requires that auditors hold a majority of the voting rights in an audit firm and that a majority of auditors control the management board. A main non-capital proposal designed to allow new players to enter the game is the harmonization of auditor independence rules.

The Commission noted that the current financial turmoil might also contribute to widening the gap between the Big Four and the mid-tier audit firms. Although there is no evidence about the role of auditors in the crisis, and they have not been subject to criticism so far, said the Commission, the risks inherent in the auditor's role might be perceived as higher. This situation might reinforce the lack of interest of mid-tier audit firms for the market of the audit of financial institutions, which is currently even more dominated by the Big Four than the market for large non-financial companies.

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