EC proposals to reform the audit market are seriously flawed, says PWC chairman

Ian Powell

ED European Commission proposals for regulatory changes to the audit market hit the front page yesterday. They represent a significant market intervention and while they have not changed substantially from a Green Paper published last year, if implemented they would risk undermining quality and confidence in the audit market.

Of course, this is an important debate to have. The auditing profession, like every part of the financial system, has to learn lessons from the recent financial crisis.

Audit and audit firms must continue to develop to meet the changing needs of capital markets and to be ever more transparent and accountable.

Some aspects of the proposed reforms are to be welcomed. In particular, we support measures that will promote high quality audits and a dynamic and vibrant profession, and most importantly confidence in the financial information being reported to the markets.

For example, we welcome:

• The idea of auditor “EU passports”, which would improve the portability of auditing qualifications within the European Union to increase mobility for suitably qualified professionals.

• Removing any artificial barriers to entry for smaller audit firms such as legal covenants which require the use of a large audit firm.

• We also support moves to promote greater audit committee transparency in selection of audit and non-audit services.

• Increased dialogue between the regulators and auditors would simultaneously enhance the value of audit while addressing other concerns around independence and market structure.

PwC will support all evidence-based legislative reforms that would enhance audit quality and remove any barriers, real or perceived, that might prevent the operation of a truly competitive audit market.

Furthermore, many of the Commission’s proposed governance reforms reflect aspects of the model that has been implemented in the UK.

We have to ensure that the focus of the debate remains on audit quality and building confidence in reported financial information, avoiding any superficially attractive proposals which could in practice have precisely the opposite effect.

In particular, the proposal to establish “audit only” firms would represent a very significant market intervention that could create severe disruption and undermine quality and confidence. This, as well as a number of the other proposals which were included in the original Commission Green Paper, do not reflect the opinions of many stakeholders who responded to that consultation. Furthermore, many of these ideas were debated and rejected by the European Parliament in their Own Initiative Report that was adopted as recently as 13 September 2011.

The simple fact is: you do not solve any perceived lack of auditor independence by moving to “audit only” firms.

We believe this argument is flawed, but we also recognise that the perception of auditors lacking independence is one that we have not done enough to counter by being more open about what it is that we do in terms of challenge and scepticism.

I believe all stakeholders would recognise that, in the context of today’s fragile markets, it is critical to avoid not only undermining confidence, but also the unwarranted additional costs that could arise. We must, at all costs, avoid imposing reform simply for reforms’ sake, imposing any changes which could weaken the capital markets system and dent audit quality. Changes must be not only informed and considered, but measured.

Many of the proposed reforms that are now being reported in the media would, if adopted, in my view undermine our ability to deliver quality audits, seriously impact the attractiveness of the audit profession to future generations and would likely have serious unintended consequences for business and the wider capital market.

I recognise that there will be some who might say that the largest auditing firms are protecting their own interests. So far we have reports of how the Commission appears to have set out its stall. There is a long way to go before any of these proposals could be adopted and as the discussions move forward I believe we will increasingly hear from businesses in the UK, and indeed across Europe, that support our view that we should avoid reform just for reform’s sake. It is also vital that member states fully engage as the Commission takes its proposals to MEPs and Council of Ministers.

We fully accept the European Commission’s statement that the “status quo is not an option”, but also believe that any reforms must be supported by evidence of their use to those operating in the capital markets and also the investors who drive these markets.

Ian Powell is chairman and senior partner at PwC UK.