An $8B ESG market pits EU lawmakers against audit firms

There’s a standoff brewing between European lawmakers and the Big Four accounting firms as they try to lay claim to an ESG market that may generate fees of as much as $8 billion a year.

Roughly 50,000 European companies — big and small — will need to hire qualified firms to evaluate their ESG reports once new EU sustainability disclosure requirements are finalized. The dispute playing out in Brussels centers on who gets to do that work, with lawmakers worried that global accounting firms will the same dominance in achieving sustainability reports that they already enjoy in financial audits.

KPMG, Ernst & Young, PwC and Deloitte have a “de facto monopoly which will allow them to charge whatever they want in a few years’ time, once they have captured the bulk of the market,” said Pascal Durand, the EU member ushering through the new corporate disclosure rules.

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The European Commission estimates that the annual market for environmental, social and governance audits in Europe may be worth between $4 billion and $8 billion. To reduce the risk of conflicts of interest, lawmakers want to prevent a company’s financial auditor from also reviewing its sustainability reports. They also are keen to open the market to smaller rivals such as Germany’s TÜV Rheinland and Netherlands-based Kiwa. But the proposal is getting pushback from some of the EU’s biggest business and financial organizations.

Those representing the auditing firms have framed their concerns as relating to the quality of the services offered. Accountancy Europe won’t stand in the way of alternative providers as long as they’re required to have the same level of qualifications as traditional audit firms, said Olivier Boutellis-Taft, the group’s chief executive officer. He also said it will be crucial to have measures linking financial and sustainability audits, so that ESG risks aren’t overlooked.

Increased costs

“We aren’t in favor of the separation of statutory audit and the audit of sustainability reporting,” said Alexia Femia, sustainable finance policy advisor at the European Banking Federation. “This gives the impression that sustainability and financial performance aren’t tightly connected” and would “inevitably increase costs.”

Steve Varley, global vice chair of sustainability at EY, said the plan put forward by lawmakers “would restrict companies’ ability to choose.” Any conflicts of interest would be mitigated by other regulatory and ethical requirements “that bind auditors of financial statements,” he said.

The proposed rules are known officially as the Corporate Sustainability Reporting Directive. Once passed, CSRD will increase by roughly fivefold the number of companies that have to produce sustainability reports, compared with a previous requirement. The directive also will demand more information after an EU analysis found companies often omitted material that investors considered financially relevant. And CSRD will require audits, first of a limited nature and then potentially much deeper ones.

Durand said the need for independent auditors was made clear by recent scandals at companies whose accountants had signed off on financial accounts “without any negative reservations.” Last month, DWS Group, the asset management unit of Deutsche Bank AG, was raided by police amid allegations of inflated ESG claims. And the headquarters of Orpea SA, a French retirement-home operator, was searched by police amid suspicions that it mistreated elderly patients.

These examples highlight “whether it is appropriate to systematically confuse the two tasks by entrusting them to the same person or the same audit firm,” Durand said.

Misaligned?

If a compromise isn’t reached and the new rules are delayed, there could be ripple effects throughout the asset management industry, which is already grappling with a steady stream of new reporting demands under the Sustainable Finance Disclosure Requirement and the EU’s list of sustainable activities . The taxonomy is the backbone of efforts to address climate and social challenges, and managers must report how products line up with the list.

Hortense Bioy, global head of sustainability research at Morningstar Inc., said a delay would set back the industry since “asset managers require this information in order to satisfy their own disclosure requirements.” Eric Pedersen, head of responsible investments at Nordea Asset Management, said any postponement “would be a huge disappointment.”

The battle comes amid persistent concerns over the Big Four’s dominance of the market. The UK last month announced sweeping reforms of the accounting industry, including a new watchdog with more powers, while in the US regulators are targeting the firms for potential conflicts of interest.

Negotiations over ESG audits in Europe may result in a compromise before the end of June. That’s when the presidency of the EU Council moves from France to the Czech Republic, potentially pushing CSRD to the back burner. One solution to the problem is a hybrid model that allows companies to choose their financial auditors while requiring third-party reviews for particularly sensitive ESG areas. Members of the EU, council and commission are scheduled to meet Tuesday.

Durand said that while progress is being made on some parts of CSRD, “several topics remain to be unblocked,” and “Tuesday’s trilogue will be crucial to conclude under the French presidency.”

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