PCAOB and Other Audit Overseers Must Establish International Arrangements Says UK Regulator

In an age of globally-managed audit firms auditing multinational clients traded on international capital markets, the PCAOB and other audit regulators must think about the regulation of the audit industry in international terms and enhance cross-border cooperation. This was the message delivered by Paul Boyle, Chief Executive of the UK Financial Reporting Council. He maintains that the case for cross-border regulatory co-operation is stronger in the case of auditing than it is in the other regulatory disciplines. He pointed out that the four largest firms in the audit market have a combined global market share which is far greater than the four largest firms in the banking or securities industries.

In remarks at the European Commission International Auditing Conference, the UK official also warned of a growing mismatch between the current, nationally-based audit regulatory regimes and audit firms, which are managed on a global and regional basis. Mr. Boyle is also the chair of the International Form of Independent Audit Regulators (IFIAR).

Another significant risk to audit regulation is the possibility that one or more of the Big Four audit firms might leave the audit market, voluntarily or involuntarily. The market share of each of the Big Four firms is so large that it is not clear how the loss of any one could readily be absorbed by the market. This is particularly true because the collapse of an audit firm, like the collapse of a bank, can happen over a very short period of time. He emphasized that, if a Big Four firm failed, a significant number of people who wish to rely on audit reports might find that the reports were unavailable on a timely basis, or even at all.

In an effort to head off this unfortunate scenario, the FRC launched a global debate on the merits of reducing the restrictions on the ownership of audit firms in order to make it easier for new firms of significant scale to enter the market or for existing firms to grow more rapidly. He reported that the European Commission has launched a public consultation on this issue.

There is also the danger that audit firms may be unable to respond to the complexity and volume of audit risks arising from current market conditions. The audit firms have been putting a great deal of effort into identifying and responding to the increased risks, he said, but the fact remains that the audit risks relating to March 2009 financial statements are going to be significantly higher than they have been in recent years. It is also clear that the risks are no longer concentrated in financial services sector clients, he observed, but are now spread throughout the entire economy. Thus, the FRC chief urged all audit oversight bodies to maintain the intensity of their audit inspections in the next few years.

He also noted the challenge of implementing the European Union’s Statutory Audit Directive, which effectively brings within the FRC’s scope the substantial number of non-EU audit firms that audit companies listed in London. The substantial economies of scale in regulating the UK market are not available when it comes to the regulation of a small number of firms in a large number of countries. The Directive envisages the possibility of EU regulators being able to rely in whole or in part on the work of the PCAOB and other non-EU regulators, noted the official, who pledged that the FRC will take maximum advantage of this possibility.

More broadly, Mr. Boyle called on all audit oversight boards to reach a consensus on a goal of promoting high quality global independent audits. He noted that the global audit firms are each making organizational changes to reinforce their cross-border decision making and resource management capacity.

In that context, he pointed out a regulatory gap in that the firms managing the international audit networks (e.g. PwC International, KPMG International) are currently not subject to regulation or oversight. As a first step, he urged audit overseers to improve their knowledge of the structure and governance of the networks.

Another gap is the lack of formal arrangements for collaboration between the national audit regulators which would be comparable to the colleges of regulators which are being established for the major cross-border financial groups. The current focus of regulation is on the quality of individual audits and on the quality of work done by individual audit firms. Mr. Boyle identified a further gap in the fact that there is no formal mandate to consider the systemic issues facing the audit market, including the risks to the continued availability of independent audit.