Germans reject Commission’s audit proposals

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Key German decision-makers last week (5 May) rejected the scope and content of a planned radical overhaul of corporate governance rules affecting auditors, due to be launched by the European Commission later this year.

In its Green Paper on audit policy – called 'Lessons from the Crisis' – the EU executive included proposals for the mandatory rotation of auditors within listed companies, and to force them to employ at least one firm of auditors.

But speaking at a debate staged by the German state of Hessen last week (4 May), key German decision-makers voiced their concerns about the proposals.

Their comments come at a critical moment in the development of policy, since the Parliament's legal affairs committee will later this month (24 May) adopt a position on the Green Paper in its legal affairs committee.

Rotating auditors will be inefficient

Despite broadly welcoming the idea of new corporate governance rules, Free Democrat MEP Wolf Klinz, who chairs the Parliament's economic and social crisis committee, said governance has to involve not just listed companies – as the Commission suggests – "because large companies such as Bosch and Miele are not listed, but they too need to be covered by corporate governance rules".

Klinz – who will be an influential voice as the Parliament considers its response to the proposals – also criticised the plans to rotate auditors. He said: "The idea of enforcing companies to tender every eight years for their work is not realistic and will not help SMEs."

Joint audits would be difficult to impose legally, Klinz added, insisting: "Companies must be left to make their own decisions and cannot be forced to do this."

Joint audits more expensive

There is no evidence that joint audits produce better quality, but plenty of proof that they are more expensive, Hansrudi Lenz, professor of accounting and auditing at the University of Würzburg, told the meeting.

He said that in France – where joint audits are a requirement – they cost 20% to 50% more than elsewhere in Europe. Meanwhile in Denmark, which abandoned mandatory joint audits in 2005, Lenz said the country subsequently saw a 25% fall in the cost of audits, without any corresponding diminution in the quality of service.

The largest German companies are sceptical of the proposals, Rolf Pohlig, chief financial officer at German utility giant RWE, told the meeting. He said: "I know that board members of the DAX companies have expressed their scepticism."

According to Pohlig, mandatory rotation of auditors was no guarantee of more efficiency. He said: "A new auditor needs more time to understand the company, and it is underestimated how tough it is to audit an international company with the hundreds of balance sheets that need to be considered, and this is a difficult exercise."

A consultation on the Green Paper closed in January this year. In February, Internal Markets Commissioner Michel Barnier stressed that the Commission was still considering mandatory rotation of auditors and joint audits in a speech called 'Audit 2011: The Year of Audacity'.

A Commission official told EURACTIV that a firm proposal – "radical and ambitious" – would be issued by the end of the year.

Broadly welcoming the idea of corporate governance rules, German MEP Wolf Klinz (Alliance of Liberals and Democrats for Europe), chairman of the Parliament's economic and social crisis committee, said: "Without effective corporate governance rules the single market will not be complete, and Europe will not be able to compete globally."

But he added: "Corporate governance has to involve not just listed companies – as the Commission suggests – because large companies such as Bosch and Miele are not listed but they too need to be covered by corporate governance rules."

Claiming that the idea of enforcing companies to tender every eight years is not realistic and will not help the SMEs, Klinz added: "We should also not be saying auditors should not be carrying out non-audit services since these can be necessary. There should clearly not be conflicts of interest and the auditors and supervisory boards should ensure that that does not happen."

On joint audits, Klinz said: "These are already an obligation in some countries, such as Barnier's native France – he thinks that this could be the right thing to do in order to increase competition, but the auditors themselves are opposed to it. I think that it will be difficult to impose it legally and the companies must be left to make their own decisions. They cannot be forced to do this."

"There are clearly no empirical studies tracking what the effects of the proposals would be, because they are just proposals at the moment," said Hansrudi Lenz, professor of accounting and auditing at the University of Würzburg.

However, he said lessons could be drawn from those countries where joint auditing existed or had been used. He explained: "We have studies for joint audits and we can see what will happen as a result of such a rule: the market in France is less concentrated than it is in other countries for example, but audits there are also 20%-50% more expensive than elsewhere in Europe."

"Meanwhile in Denmark, which gave up joint audits in 2005, afterwards they noticed that costs fell by 25% without the quality of the service suffering. You cannot say that quality is a key factor affected by having joint audits," Lenz concluded.

Rolf Pohlig, chief financial officer on the board of German utility giant RWE, said: "There have been no attempts to talk to us [about the proposals by the Commission] but we did express an opinion [in the consultation]. I know that board members of the DAX companies have expressed their scepticism."

"Mandatory rotation is no guarantee for creating more efficiency because a new auditor needs more time to understand the company, and it is underestimated how tough it is to audit an international company with the hundreds of balance sheets that need to be considered, and this is a difficult exercise. This means that the proposals may result in a great deal of inefficiency and miss the key point," he said.

"We support any way that enhances or ensures the independence of external auditors vis-a-vis their management of listed companies, and that discloses and identifies the conflicts of interest with their listed clients," according to Giullaume Prache, secretary-general of Euroshareholders, the umbrella federation of European shareholder associations.

He added: "Therefore we do support the rotation proposal. We are also in favour of the joint audit provided that the cost remains reasonable because ant the end of the day the costs are picked up by shareholders."

"The Association of Chartered Certified Accountants (ACCA) does not believe that the mandatory limit on an audit term is necessary or desirable," according to John Davies, head of technical issues at ACCA.

He said: "Legal requirements for companies to change auditors on a regular basis would amount to a heavy cost burden for them that would be multiplied for group companies with numerous subsidiaries. Research has also shown that there is a cost associated with the amount of time that a new auditor has to spend to become acquainted with the business and procedures of the new client. Instead, we believe that the audit committee's role should be strengthened and that it should be entitled to review and determine whether an auditor’s length of service."

On non-audit services, Davies said: "Similarly, ACCA does not believe that there should be a general ban on the provision of non-audit services, but instead favours requiring the audit committee to review critically whether providing additional services would be likely to affect the auditor's independence. We do, however, acknowledge that the provision of internal audit services presents a particular problem for auditor independence and there may need to be legal measures in that area."

The European Union adopted a directive in 2006 which aimed to restore confidence in capital markets by strengthening the quality and independence of auditing of company accounts.

The directive came in the aftermath of international accounting scandals involving US firm Enron and Italian firm Parmalat.

A year later, Brussels presented plans to limit the liability of audit firms in order to shield them from unrestricted claims. Arthur Andersen, an audit firm, collapsed in 2002 following the Enron scandal.

Last year the European Commission issued its Green Paper targeted specifically at the auditing sector. It proposed mandatory rotation of auditing companies within companies, to ensure that the relationship between audited and auditor did not become too entwined.

It also suggested mandatory joint audits – insisting that more than one audit company carried out the work within companies. Other proposals included banning audit firms from carrying out non-audit functions within companies.

A consultation on the Green Paper ended in January this year. The Parliament will adopt a position in relation to the Green Paper later this month, and the Commission will make concrete proposals by the end of the year.

  • 24 May Parliament's legal affairs committee will agree position on the Green Paper.
  • 22 June Parliament to vote on the Green Paper at plenary session in Strasbourg.
  • By end of year: Commission to issue concrete proposals.

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