All change ahead

The European Commission’s proposals to reform statutory audit are up for debate. Here Susanna Di Feliciantonio takes us through the main points.

The publication of the European Commission’s proposals to reform statutory audit at the end of November marked a new phase in the policymaking process. The proposals, presented by internal market and services commissioner, Michel Barnier, are aimed at addressing “current weaknesses in the EU audit market, by eliminating conflicts of interest, ensuring independence… and by facilitating more diversity in an overly-concentrated market”. The package is a complex one, containing two legislative texts, a draft regulation focusing on public interest entities (PIEs) and an update of the 2006 Statutory Audit Directive. It comes with an impact assessment and an externally-contracted study. The European Parliament and the EU Council of Ministers must now work through the draft provisions and eventually reach consensus on final texts (via the co-decision process).

Undoubtedly, much attention has been centred on aspects relating to independence, competition and choice yet the package is even more far-reaching. A wide range of issues are addressed, including the role of the auditor and the audit committee, the internal organisation and governance of audit firms, and the responsibilities of national competent authorities and the European Securities Market Authority (ESMA).

As stated in ICAEW’s initial response to the draft legislation, while we do not agree with all the Commission’s proposals, we believe a number have merit and should be supported. Helping policymakers understand the possible consequences of eventual legislation on both the audit profession and the wider business community – looking also at how provisions will have to be implemented in practice – promises to be a key aspect of our ongoing engagement in Brussels and beyond.

Greater expectations

A key objective of the package is to “make clearer what an audit is and what should be expected of it”. The draft regulation, in particular, contains a number of provisions relating to the performance of the statutory audit, audit reporting and transparency reporting by auditors and audit firms. Some of these provisions may be in line with existing practices in different member states. The content of the public audit report, for instance, is expanded to include information on methodology, testing, materiality levels, key areas of risk of misstatement, fraud detection and the reasons for any qualified or adverse opinion. A longer and more detailed report is to be prepared for the audit committee and closer cooperation with supervisors is also set out.

The role of audit committees, to include at least two members with relevant experience, looks likely to be beefed up. According to the draft provisions, audit committees should have greater responsibility with regard to evaluating audit quality, assessing non-audit services provided by auditors, the selection and appointment of auditors and negotiation of audit fees. With audit committees only recently required by EU law (under the Statutory Audit Directive), the dissemination of best practice will be important to help bridge the gap between what they currently do and what they may have to do in future.

With a view to also facilitating the single market, the Commission has called for the EU-wide adoption of International Standards on Auditing (ISAs) and the introduction of passports to allow for mutual recognition of audit firms approved in one member state (with some safeguards). The approach taken towards the cross-border provision of services on a temporary or occasional basis is more in line with the principles behind the EU Recognition of Professional Qualifications Directive (which applies to accountancy and tax services, with little evidence of significant application to date). A voluntary pan-European audit quality certification is also proposed for firms carrying out audits of public interest entities (PIEs). It is to be delivered by ESMA.

Independence, competition, choice

Provisions relating to independence and market structure could have a substantial impact as currently drafted. Key are the requirements relating to rotation and the provision of non-audit services. PIEs would be required to change their auditor every six years, extended in some instances to eight or nine years (12 in exceptional circumstances) for PIEs opting for joint audit. A four-year cooling-off period is also introduced. Mandatory tendering on the basis of fair selection is also required when changing the auditor.

The list of prohibited non-audit services to PIE clients is also expanded. For some non-audit services, the audit committee or competent authority will be required to judge whether they may or may not be provided. This is in combination with a 10% limit (of the statutory audit fee) for related financial audit services. Moreover, the draft regulation would oblige audit firms generating more than a third of their annual audit revenues from large PIEs and belonging to a network with combined annual audit revenues in excess of €1,500m to focus on the provision of statutory audit and not undertake non-audit services. The Commission makes a number of additional proposals, such as relaxing audit firm ownership rules and banning third-party covenants in contracts that restrict choice to a Big Four firm. National competent authorities and ESMA are given responsibility to monitor developments in the respective national and EU markets for statutory audit of PIEs. ESMA must also prepare reports reviewing the impact of national liability rules on market structure. The six largest firms in each member state will be required to draw up contingency plans addressing possible threats to the continuity of their operations and provide information on the levels of liability for partners and the potential spread across the national, EU and international network.

SMEs and supervisors

Although the focus is on the implications of the package for large, listed companies, SMEs may also see changes ahead. The draft directive contains measures that would allow member states to apply auditing standards to the statutory audit of medium-sized companies in a way that is “proportionate to the scale and complexity” of their businesses.

The legislative proposals also address the question of supervision. Cooperation between competent authorities to ensure a robust system of public oversight will take place under the aegis of ESMA, which replaces the existing European Group of Auditors’ Oversight Bodies (EGAOB) – although the home state principle for direct regulation is underlined. ESMA is given responsibility for issuing guidelines on issues such as the content and presentation of audit reports, audit committee activities or the conduct of quality assurance reviews. Changes to the role of professional bodies are also proposed, removing delegated responsibilities with regard to oversight.

The debate ahead

Against a difficult economic backdrop, member states and MEPs will spend much of 2012 trying to agree final legislative texts – a process that looks likely to run into 2013. In the European Parliament, the Legal Affairs Committee and the Economic and Monetary Affairs Committee will be leading the deliberations with UK Conservative MEPs playing an important role. In the EU Council of Ministers it will fall to the Danish and Cypriot EU Presidencies to set the pace for negotiations and lead the search for compromise. In London, Brussels and elsewhere in Europe, ICAEW looks forward to sharing its insight and experience in the discussions ahead.

Susanna Di Feliciantonio, Head of EU public affairs, ICAEW