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The blizzard from Brussels
Sep 29th 2011, 11:22 by The Economist | LONDON
THE Europeans can rouse themselves occasionally. Two initiatives emerged from
the European Commission this week, one to improve the audit profession, the
other to tax financial transactions. The first raises serious questions about
how best to protect investors; the second serious questions about policymakers
priorities.
Auditing first. A leaked proposal from the directorate-general for the European
Union s single market suggests that Michel Barnier, the commissioner in charge,
thinks the industry needs reform from top to bottom. The proposal envisages
forcing clients to change auditors every so often, so beancounters and bosses
do not get too cosy (although the evidence on whether this helps is weak). It
also wants two auditors to work together on the accounts of especially
important companies.
But by far the most radical proposal in the leaked draft would be to forbid
audit firms from providing non-audit services. In America providing most
non-audit services to audit clients is already forbidden, under the
Sarbanes-Oxley financial reform passed in the wake of the meltdown of Enron, an
energy-trading company. In some European jurisdictions, selling both audit and
(say) consulting to a client is still permissible. Mr Barnier s leaked proposal
would not simply go down the route of Sarbanes-Oxley and forbid this. It would
force the creation of pure audit firms.
This would be a huge change to the business model of the big four audit
firms: PwC, Deloitte Touche Tohmatsu, Ernst & Young and KPMG. These are
technically networks of firms, rather than single global entities. All of them
have seen robust growth in their consulting businesses in recent years, to
around a third of total revenues for most of them. In the year ending in May
2011, for example, Deloitte s consulting business grew by 14.9%, against 4.7%
for the audit business. Forcing the breakout of pure audit firms would separate
an exciting and growing business from a plodding but vital one, in Europe at
least.
Mr Barnier s proposals are still in draft form, and may change before their
formal unveiling in November. After that, the EU s Council of Ministers as well
as the European Parliament will take a crack at modifying them. But in taking
on concerns that auditors are not performing their crucial function in public
markets as well as they might, the commission deserves credit.
Kind words are far harder to find for the commission s other big idea. On
September 28th it formally proposed a financial-transactions tax (FTT),
otherwise known as a Tobin tax after James Tobin, a Nobel economics laureate
who put forward a similar scheme for currency markets in 1972 or a Robin Hood
tax by those who want to use the proceeds for aid purposes.
If adopted, the levy would be applied from January 2014: all securities
transactions involving an EU-based financial institution would be taxed at 0.1%
and all over-the-counter derivatives deals at 0.01% of the notional principal
amount. There are several exemptions, including primary equity and bond issues,
spot foreign-exchange deals and deals involving central clearing-houses. Retail
products such as mortgages will also be exempt. But the commission thinks that
the proposal would still capture around 85% of all inter-dealer transactions in
Europe, raising an estimated 55 billion ($75 billion) for EU and national
coffers.
The big flaw in the plan is that taxable transactions are likely to migrate
outside the EU. Although the commission bills its proposals as the first step
towards a global agreement, it is hard to discern sweeping international
enthusiasm for the idea. The commission s own numbers, partly based on an
unhappy Swedish experiment with an FTT from 1984-91, suggest that derivatives
traders could relocate as much as 90% of their business outside any tax zone.
That gives Britain in particular, as the home of Europe s dominant financial
centre, little incentive to adopt the plan (which requires unanimous support).
Indeed, euro-zone ministers have said they may just press ahead with their own
FTT if they cannot win EU-wide agreement which could mean extra business for
London from the likes of Frankfurt and Paris if Britain vetoes the idea.
Die-hards may not care. They argue that an FTT is a fair way of recouping some
of the costs of bailing out financial institutions during the past three years.
They also believe that it would be no great loss if the tax drives away
high-frequency traders , ultra-fast automated traders whose margins are
razor-thin. But that assumes the FTT will not simply be passed on to
end-customers, either directly by affected institutions or as reduced liquidity
leads to wider bid-ask spreads. The commission s own assessment suggests that
the FTT could reduce long-run GDP in Europe by anywhere from 0.5% to 1.8%. At a
time of economic frailty, that seems perverse.