Audit reforms “nudge” in right direction but leave many unsatisfied

THE DECISION by the European Parliament’s Legal Affairs Committee (Juri) to force companies to change their auditor every 14 years has been hailed as “nudge in the right direction” by the MEP responsible for negotiating the reforms.

MEP’s voted yesterday to support a package of measures designed to improve audit quality, which included imposing mandatory rotation of auditors of public-interest entities, prohibiting the provision of certain non-audit services and ruling out Big Four-only contractual clauses.

The measures represent a watered down version of proposals initially mooted by the European Commission, which had called for a six year rotation period and a general ban on offering non-auditing services. However, most committee members saw the ban as “counterproductive for audit quality” and concluded that only non-auditing services that could jeopardise independence should be prohibited.

Under the proposed rules, which mirror those set by the International Ethics Standards Board for Accountants, auditing firms would be able to continue providing certification of compliance with tax requirements, but prohibited from supplying tax advisory services which directly affect the company’s financial statements and may be subject to question by national tax authorities.

Additionally, the 14-year rotation period can be extended to 25 years if certain criteria are met, which include tendering after 14 years, a comprehensive assessment by the audit committee or having a joint auditor.

Sajjad Karim (pictured), the Conservative MEP charged with steering the reforms through parliament, said the proposals were about “changing mind-sets” and not “strict intervention” in the market.

“[The proposals] are a nudge in the right direction and are in stark contrast to the European Commission’s heavy-handed approach,” Karim said at a press conference in Brussels yesterday, and added the rules would “strengthen the role of audit committees” in ensuring audit work was up to scratch.

Karim insisted the recommendations did not address competition but were “an issue of raising standards”. Critics, though, were quick to question how mandatory rotation would serve to improve quality.

“Any form of mandatory rotation is bad in principle, it impacts quality,” says Pauline Wallace, head of public policy and regulatory affairs at PwC. “If you have to choose the best audit firm other than the incumbent it is anti-competitive because it removes one firm from the marketplace.”

The Big Four have been fighting tooth and nail to prevent the imposition of mandatory rotation both in Europe and the UK, with similar proposals being considered by the Competition Commission. In February, the UK competition watchdog suggested rotation periods of six, nine or 14 years as part of preliminary findings of its investigation into the large-listed audit market.

Criticism of the EU proposals was not confined to the Big Four. Nick Topazio, head of corporate reporting policy at CIMA, said the institute “simply doesn’t agree with the introduction of mandatory rotation”.

“There is simply no guarantee that the benefits of improved independence and objectivity that may result from changing audit firm will outweigh the costs of change,” he said.

Others were also unimpressed with the stance taken on rotation, but for very different reasons. Steve Maslin head of external and professional affairs at Grant Thornton says there shouldn’t be “a let-out” for Member States to increase the period to 25 years if a public tender or quality assessment is carried out.

“These things should form a critical part of the auditor appointment process in any event,” he says. While Fiona Hotston Moore, corporate partner at City accountants Reeves, says it was “disappointing that the commissions’ proposal for mandatory six yearly rotation of auditor was watered down”. However, she was warmer about some of the other measures.

“I am pleased to see the proposed prohibition of Big 4 only contractual clauses…and that PIEs [portfolio investment entities] will be obliged to call for tenders when switching auditors. This at least is a move towards greater competition and transparency,” Hotston Moore says.

The proposals, which were voted through by 15 votes to ten, will now be negotiated with the Council of Ministers before a common text is agreed. The full reforms should go before the European Parliament later this year, leaving time for horse trading among the conflicted parties.

By reaching a compromised position, which Karim hopes will “tackle the problem of familiarity but avoid disruption”, he has attempted to satisfy most parties. However, it may be that he ends up satisfying none.