Commission braced for battle with big audit firms

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The European Commission has set itself on collision course with the largest audit companies with its proposed regulation that will radically overhaul the management and structure of the service sector, despite controversial plans for joint auditing being dropped.

A rule stipulating that banks and other large institutions must use joint audits – strongly opposed by the larger audit firms – was scrapped in the draft regulation published yesterday (30 November).

It nevertheless contains measures which, if implemented, would radically affect the sector, including:

  • Mandatory rotation of audit firms after a maximum engagement period of six years, with limited exceptions;

  • Mandatory tendering for auditing contracts;

  • Stricter rules for oversight and appointment of auditors by auditing committees;

  • A prohibition on audit firms providing non-audit services to their audit clients;

  • A requirement that larger audit firms split off their non-audit services; and

  • Compliance with the International Standards on Auditing by all statutory auditors and audit firms.

The Commission is also proposing to create a single market for statutory audit services allowing auditors to exercise their profession freely and easily across Europe, once licensed in one member state, by amending the 2006 auditing directive.

Internal Market and Services Commissioner Michel Barnier said the measures were necessary to counter shaky investor confidence in audits highlighted by the financial crisis.

Rule would require change in five years

“[These] proposals address the current weaknesses in the EU audit market, by eliminating conflicts of interest, ensuring independence and robust supervision and by facilitating more diversity in what is an overly concentrated market, especially at the top-end,” Barnier said.

EU officials stressed that the regulation, if adopted according to schedule, would require the audit companies' compliance within a maximum of five years, accounting for a phase-in period of two years included within the regulation.

“We are under no illusion that there are plenty of significant issues on the table at the moment, but we want to achieve a result as quickly as possible,” one official said.

The regulation falls under Barnier's raft of single market instruments, which he wants to present as a fait accompli before the end of next year, the 20th anniversary of the first Single Market Act.

Heated exchanges likely over next six months

A tightly contested fight with Europe's largest auditing companies – Deloitte, KPMG, Ernst & Young and PwC – is envisaged. The four largest audit firms share the work of more than 85% of listed companies in the vast majority of member states.

These firms stand to lose from proposals that they rotate their work regularly and spin off consultancy work, measures that would favour smaller audit outfits.

“The larger firms have put up a big fight against joint audits, and now we assume that they will turn their primary attention to attacking the provisions for rotating auditors and for 'pure' audit companies,” an EU official told EURACTIV.

The larger firms have already won a strategic battle in the European Parliament, however, where the proposal will now be debated.

The draft regulation will be subject to a main report by the legal affairs committee, and another report by the economic affairs committee. Both rapporteurs selected for the task are British  Conservatives, who traditionally oppose measures to rein-in larger audit firms.

While welcoming the removal of the mandatory joint audit from the EC’s proposals, the a statement from the Association of Chartered Certified Accountants (ACCA) expressed concern that the mandatory rotation of audit firms, along with a ban on firms providing non-audit services could present major implementation challenges to the audit profession and could prove counter-productive.

“Audit quality should be subject to regular review, but it is overly simplistic to argue that the quality of audit work can be enhanced simply by setting arbitrary limits to the duration of a professional relationship. Since the auditor is appointed to protect the interests of a company’s shareholders, it is also logical for them to review this and decide which auditor they wish to appoint, at what time and on what terms,” according to Sue Almond, ACCA’s technical director.

BDO, the world’s fifth largest accountancy network, issued a statement welcoming the proposals, “particularly those to address the issue of market concentration and to rebuild trust in auditing”.

But BDO’s CEO Martin van Roekel added: “It is extremely unfortunate that certain of the draft proposals relating to the reform of the market structure, including joint audit and other measures that would strengthen the independence of the auditor, have been removed or watered down.”

“We need now to devote the necessary time to conduct a valid analysis of the current proposals for our network and for the profession as a whole. It is likely, however, that we will be strongly recommending that the European Parliament restores the progressive proposals that have been deleted, both in the interests of investors and in order to ensure the enactment of game-changing policies, rather than half-hearted ones,” van Roekel added.

“There is a glaring need to shake up the audit market and dismantle the damaging dominance of the four major firms, and the intense lobbying that led to the watering-down of the Commission's proposals only underlines this,” said Sven Giegold MEP (Germany; Greens) , who acts as the financial spokesman for his party in the European Parliament. “Whether as a result of complacency, conflict of interests or negligence, the auditing oligopoly has clearly failed to provide the rigorous oversight needed, with the financial sector being a case in point. With the Commission's proposals having been scaled-back, it is now the duty of the EP to ensure tougher audit rules,” concluded Giegold.

“We are encouraged that the Commission recognises that the creation of a more dynamic audit market is necessary,” said Jean Stephens, CEO of RSM International, the sixth largest global accounting network.

“We have concerns that the initial proposals have already been weakened, particularly with regard to mandatory joint audit and whilst we agree with mandatory rotation of audit firms in principle, we are also concerned that rotation every six years is overly aggressive,” Stephens added.

 

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 which brought to collapse one of the top global auditing firms, Arthur Andersen.

In 2008, Brussels reviewed for the first time the auditing directive. But immediately after the entry into force of the new rules, and on the wake of the US subprime crisis, the European Commission started a new review of the sector which ended up in December 2010 with the collection of responses to a wide public consultation aimed at changing again the key piece of EU legislation on auditing.

  • Next six months: Proposals will be debated in the European Parliament and the Council 

 

 

 

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