Interview: Euro MP Sajjad Karim on steering audit reform

AT TIMES IT MUST FEEL to Sajjad Karim like he has been tasked with pushing an elephant up a staircase.

The British MEP is currently steering the European Commission’s contentious planned reform of the audit market through the European parliament. As the rapporteur – Karim inherited the brief in January – he has the unenviable task of agreeing a text that is acceptable to the EC and can feasibly be navigated through the entrenched positions of Europe’s policymakers.

The plans, initially put forward by internal markets commissioner Michel Barnier in November 2011, proposed a raft of changes to the structure of the EU audit market, which included the imposition of mandatory audit rotation, joint audits and constricting the provision of non-audit services.

Part of the commission’s justification for the reform came in reaction to losses sustained by banks in the run-up to the financial crisis. Karim explains that the “political cover” of the financial crisis was used to “place all the responsibility on the doorstep of auditors”.

“The commission took the approach that market manipulation was needed to address how the market operates following the financial crisis,” Karim tells Accountancy Age. “There was a need to be seen to be doing something, but that is the worst form of politics you can have.”

On inheriting the brief in January, Karim says his first priority was to release some of the “stress out of this highly technical area”. The lobbying and political pressure had managed to reach such a point that on 1 July, Spanish MEP Antonio Hidalgo wrote to the then EP president Jerzy Buzek, claiming he had been threatened by a lobbyist belonging to a Spanish audit firm.

“I needed to deal with the politics of the situation. Because of the technicality we have to get this right and there is no way to deliver this unless we get it on a professional setting,” Karim says.

As a result, Karim says he opened up his door to all stakeholders – a process which took several months – so that everyone could have their say.

However, the extent of the divisions that still exist, with final amendments to the EC’s proposal due out by 11 November, were exposed after Karim published a working paper on behalf of the parliament’s legal affairs committee which suggested auditor rotation should only have to take place every 25 years.

Watering rotation rules down to 25 years – the commission initially called for six years – may be seen as a sop to the Big Four, the cabal of firms most likely to lose out by the enforcement of strict rotation rules. Karim says it should not be seen this way. Leaving the market as it is will not be an option.

“The end conclusion I came to is that neither is it a healthy situation that we deliver on a political path where we do something because we need to be seen to do so, nor is it that we maintain the status quo. I don’t want that to be seen as the eventual outcome,” he says.

Nevertheless, Karim’s ideas on audit tenures have proved to be a divisive issue. Shortly after Karim produced his working paper, German MEP Jürgen Creutzmann, member of the European parliament’s committee on industry, research and energy, produced a report that called for audit tenures to last no more than seven years as it would render “the selection process more transparent” and give the audit committee more choice.

Creutzmann was not the only one taking pot shots at the proposals. Ahead of the publication of Karim’s report, a collection of the largest investors in Europe ganged together to urge the EC to push ahead with tougher audit reforms.

Signatories of a joint letter sent to the EC included Euroshareholders, a group of about 30 European national shareholder associations, the investment arm of Legal & General and the Universities Superannuation Scheme. High on their agenda is that auditors need to rotate every six years, although this could be extended to nine years if there are joint audits, with a cooling-off period of four years.

However, Karim believes the commission six-year option is “designed to get the market place broken up”.

“I am resisting that. A 25-year proposal will add quality to the audit process but take away from the competition issue. The reforms should be about quality, not competition,” he says.

Nor should stakeholders get caught up on the rotation issue in “isolation”. Karim says his proposals should be looked at as a whole package, which includes improving auditor communication and reporting, scrapping market share caps that would trigger splitting up the Big Four, and a willingness to open competition for non-audit services.

“Everyone is focusing on the 25-year timescale, but it is about the overall picture. It is too easy to focus on 25 years. The reality is very different,” he says. “We want to strengthen the audit committee’s role and we have to be careful that the changes don’t end up being a bad fit for everything.”

Karim also conceded there are “substantial” differences between his position and that of the EC, while issues such as joint audits, where two firms are involved in auditing a company’s accounts, and non-audit services remain to be hammered out.

A lot of horse trading between Karim and Barnier – with whom he has regular one-on-one meetings – should be expected before the final package is put before parliament for ratification. Yet even at this late stage, progress is being hampered by the politics of the situation and the tactics being employed by the EC.

“Barnier’s position is very clear. There are areas we agree substantively, areas that need negotiation, and areas where red lines have been drawn,” Karim says. “But what Barnier can say to me in private and away from public consumption is very different from the public stance taken by EC officials.

“The commission wants to keep the issue alive and keep negotiating. I can’t split that way.”

Karim won’t be drawn on what those red lines are, yet it is essential that he and Barnier find a position that is mutually acceptable. Without it, the proposals will never make it through the parliamentary ratification process.

The irony of the EC reforms, which will not be lost on the Big Four if they should suffer from the changes, is that – while the end result may be an improvement in audit quality and auditor independence – it is unlikely these reforms would have been able to prevent the financial crisis even if they had been in place.

“It is difficult to identify evidence which substantiates the proposition that audit failure led us to where we are today,” Karim says.

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