Last minute deal pushes through EU audit reform

Last minute deal pushes through EU audit reform

EU rules will impose mandatory audit rotation, restrict non-audit services, cap non-audit fees and enhance supervision

YEARS OF WRANGLING over reforming the EU listed audit market came to an end today after politicians were able to strike a last minute deal that saved the reforms from being kicked into the long grass.

A framework of EU audit reform was preliminarily agreed during the final trilogue discussion between the Lithuanian EU Council presidency and the European Parliament, which will see companies forced to change their auditors every ten years, with the possibility of audit tenures extended if certain criteria are met.

The framework, which was agreed earlier today, is now subject to the final agreement by member states later this week.

Listed companies will now be required to change their auditors every ten years, with the option of extending the period by a further ten years if tenders are carried out, and by 14 years if the company being audited appoints more than one firm to carry out the audit.

Sajjad Karim, the British MEP tasked with steering the reforms, said the key objective of improving audit quality had been secured in the proposed packaged, which includes a cap on the provision of non-audit services to firm’s audit clients.

“The European Parliament is optimistic that the proposal can be approved by a majority of member states and MEPs, considering it is a balanced compromise that will go a long way towards restoring confidence in the audit market,” Karim said.

Under the rules, a 70% cap on the fees generated for non-audit work will be introduced, though certain non-audit services, such as tax advice and services linked to financial and investment strategy have been banned altogether.

The black-list of prohibited services, which proved one of the most contentious issues among member states, is designed to limit conflicts of interest in instances where auditors are involved in decisions impacting the way companies are managed.

Last gasp agreement

Indeed, disputes over non-audit services almost derailed the process altogether, when Karim suspended the informal tripartite negotiations between parliament, the EU Council and European Commission earlier this month.

“This week’s trilogue on the audit reform package has been truly encouraging with constructive efforts from all sides to find a way forward,” Karim said on agreement finally being reached.

Originally proposed by EC internal markets commissioner Michel Barnier in 2010, the reforms are intended to improve audit quality and restore investor confidence in financial information after auditors gave a number of banks a clean bill of health prior to them requiring tax payer-backed bailouts.

The rules are now far from the version initially mooted by the EC, which had called for a six year rotation period and a general ban on offering non-audit services. Barnier nevertheless welcomed the decision as first step to restoring confidence in financial institutions.

“Although less ambitious than initially proposed by the Commission, landmark measures to strengthen the independence of auditors have been endorsed, particularly in the auditing of financial institutions and listed companies. This will ensure that auditors will be key contributors to economic and financial stability,” Barnier said.

There will also be enhanced supervision of the audit market, with cooperation between national supervisors enhanced at EU level, with a specific role given to the European Markets and Securities Authority (EMSA) with regard to international cooperation and oversight.

Bad news for the Big Four?

Though ostensibly aimed at improving audit quality rather than competition, the new rules will prohibit restrictive third party clauses that require one of the Big Four – PwC, KPMG, Deloitte and EY – to conduct the audit.

The EU rules follow similar moves taken by UK regulators, which imposed mandatory audit tendering among FTSE 350 companies earlier this year. In October, the Competition Commissioned introduced the requirement for companies to mandatorily tender every ten years, with those that tender less frequently than five years required to report in which financial year they plan to put the audit engagement out to tender.

The competition watchdog rules, which build on ten-year ‘comply or explain’ measures implemented by the FRC last year, are already having an impact on the UK audit market with a number of high profile and lucrative contracts changing hands.

Earlier this month, PwC – the largest of the FTSE 100 auditors – was replaced by Deloitte as auditors of Marks & Spencer after the high street retailer changed its auditors for the first time since it became a public company in 1926, while also being replaced of Land Securities and gas explorer BG Group by EY.

However, PwC was successful in replacing KPMG as auditors of HSBC earlier this year, while also recently picking up the audits of Hargreaves Lansdown, Ladbrokes and Cairn Energy.

“Competition in the audit market is fierce and we do expect to see more companies switch auditor in response to regulatory change,” said a spokesperson from PwC with respect to losing the M&S audit.

A slew of audit tenders are expected to come onto the market with David Sproul, chief executive of Deloitte, the largest FTSE 350 auditor by number of clients, predicting 45 FTSE 100 audit tenders will come out within the next three years.

Next steps
Now the long-awaited reforms have been provisionally completed, attention will shift as to their practical implications and how they will be imposed.

One consequence is that firms will become much more strategic in how they approach the tender process.

“With so many more contracts up for grabs firms will need to selective over which clients they bid for.

“When there were one or two tenders a year, most of the firms would have thrown everything at it. If we are going to have over the next few years a period of ten or fifteen tenders a year, it’s just impossible,” Sproul told Accountancy Age earlier this year.

“There is a cost to this transition that has to be managed. We will not be bidding for every audit that is out there. It’s not right for us, and it’s not right for our clients.”

“For policymakers, there is now hope for all the required follow-up work to be completed before, rather than be stalled by, the EU elections next year,” according to Michael Izza, CEO of the ICAEW.

“The debates on audit reform have been going on for three years; a lot of work has gone into it and it carries with it a lot of new requirements, some of which will automatically be translated into law at country level and some that will take longer to trickle through,” Izza said.

“While we have been concerned about certain parts of the proposals, focus now needs to move to the transition and practical implications. It is important not to underestimate the considerable practical impact the reform package will have – not only on the auditing profession but also on companies across the European Union. It will take time for everybody involved – the profession, businesses, regulators – to work through the details and get to grips with all the changes.”

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