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Profession braces for EU audit reform with mixed expectations

The favourable vote from a qualified majority of members of the Committee of Permanent Representatives (COREPER) has cleared one the final hurdles to finalise the reform of the audit market in the European Union (EU), which has been received with mixed expectations among firms and stakeholders of the accountancy profession.

Under the auspices of the Lithuanian presidency of the EU Council, an agreement on the most controversial parts of the EU audit reform proposed by the EU Commission was reached by negotiators representing the European Parliament (EP) and member states on 17 December and approved by the COREPER the next day.

The agreement determines compulsory rotation of public interest entities' (PIEs) auditors after 10 years, after which period "member states may allow the auditor or audit firm to continue audit of the same PIEs up to the maximum duration of 20 years where a public tendering is conducted and up to 24 years in case of a joint audit," as the COREPER literally stated.

The agreement also proposes a 70% cap on the fees earned for non-audit services rendered to an audit client, therefore an audit firm would not be able to tender for non-audit services worth more than 70% of the audit fee.

In addition, to avoid conflict of interest with the audit client some non-audit services would be banned, such as tax advice and services linked to the financial and investment strategy of the audited PIEs.

Nonetheless in the words of the COREPER, "member states will have the right to allow some tax and valuation services to be provided if they are immaterial and have no direct effect on the audited financial statements".

The Federation of European Accountants (FEE) chief executive Olivier Boutellis-Taft said it was positive that the debate on the EU audit reform came to an end because it has been delaying audit firm's decisions on strategy, business model and recruitment for more than three years.

However he said it was disappointing that "for the sake of reaching agreement" the EU institutions have failed to agree on "truly European solutions", meaning that although a regulation might be adopted, which is directly applicable without transposition into member states' law, there is still room for them to diverge on major issues such as the list of prohibited non-audit services and the duration of the rotation.

"FEE will analyse in detail the provision once finally approved and available. Business national legislators and regulators and the profession will have to work together to limit unnecessary administrative costs for the European economy," Boutellis-Taft said.

One of the most outspoken members of the EP's Committee on Legal Affairs (Juri) and a big supporter of mandatory rotation and joint audits, MEP Antonio Masip said the socialist group in the EP he represents voiced concerns about the way the trialogue was conducted.

"Despite of the complaints of our group and the Green Group, the trialogue was conducted with the absence of Juri's rapporteur [conservative MEP Sajjad Karim]. Lehne [chair of Juri and christian democrat MEP] seemed to have taken over the role of rapporteur instead. But two weeks ago Lehne had agreed on a maximum of 20 years for rotation, including joint audits," he said.

Masip said the agreement is an "odd one" and believed it's the result of informal discussions among representatives of Germany, France and the UK.

"The agreement goes against the spirit of the original EU Commission's proposals. It ignores necessary reforms to promote joint audits and relies on companies' audit committees to define the blacklist of non-audit services," Masip said.

UK experience
The UK Financial Reporting Council (FRC) chief executive Stephen Haddrill said the agreed rotation period was a good compromise made possible by the UK's own experience in the subject, which gave confidence to MEPs and policymakers.

"Other parts of the directive similarly borrow from experience in other member states, including France and Germany," he said. Haddrill went on to say that the FRC introduced its own plan in the UK: retendering of the audit every 10 years for FTSE 350 companies.

"We felt a company had to be able to show to its investors that it had the best available auditor for its business. How could it do so if it did not test the market? But equally how could it do so if it excluded the incumbent, especially when the choice is low? The UK's Competition Commission has been persuaded by the merits of our approach," Haddrill said.

Balanced package
For BDO International global head of regulatory and public policy affairs Noel Clehane the agreed package of measures is more pragmatic than the original proposals from the EU Commission and brings certainty to the audit profession and the corporate community as the process is coming to a close.

Clehane said BDO International would not have lobbied for mandatory firm rotation or non-audit services caps and blacklists, although overall the network believed the package is balanced and likely to be a positive move for audit quality, investors and businesses alike.

"At the same time, we are pleased to see the incentives for periodic voluntary tendering and for joint audits, both of which we at BDO have long championed. Over time, we expect the package of measures to offer further opportunities for firms like BDO to win additional market share and so reduce the dominance of the largest firms, especially as increasingly internationalised clients drive consolidation of the mid-tier audit market," Clehane said.

The European Group of International Accounting Networks and Associations (EGIAN) chair Jos van Huut said Europe's 500 million citizens, especially listed entities, need an open audit market focused on the public interest.

"As the representative grouping of nearly all the networks and firms apart from the four largest ones, we are reassured by the statement of the Lithuanian Presidency that the reforms are seeking to bring about greater diversity in a currently highly-concentrated market," he said.

Van Huut noted that EGIAN's view is that there is a real need for more choice in the marketplace for large listed audits.

"Additional players are urgently needed to encourage innovation. The reform package is a pragmatic step in the right direction. It is now up to all the stakeholders in the audit market to work together to enable the reforms to achieve their full potential," Van Huut added.

At the Instituto de Censores Jurados de Cuentas de España, which represents 5,200 auditors, president Mario Alonso said the agreed measures are more positive than those originally proposed by the EU Commission and will substantially modify the market strategy of audit firms since the reform will limit the range of services they can offer.

Alonso, who is also the chairman of Auren, Spain's seventh largest accounting network, said although the drawbacks of mandatory rotation outstrips its advantages, "the proposed period is good enough not to put audit quality in jeopardy."

Audit quality
The Association of Chartered Certified Accountants technical director Sue Almond said that it is fair to remember that the feedback on audit has not always been positive.

"The debate was initiated on an 'audit quality' mandate but was largely hijacked by competition debate. Let's get back to articulating audit quality and the value of audit. Audit plays a critical role in supporting global business and it is important that we do not overlook its value," she said.

Almond added that the challenge now for the audit profession is to move on from the detailed debate and to implement the changes in a way that helps restore public confidence in the audit, and in auditors.

The Institute of Chartered Accountants in England and Wales chief executive Michael Izza said auditors and companies may not see in the agreed measures "a Christmas present" as the value of additional services auditors can provide is reduced, he said, and a standard 10 year rotation period has been introduced.

Nonetheless Izza welcomed the agreement, as it was luckily worked out "ahead of a busy 2014 in Europe, with European Parliament elections set to dominate the agenda for much of the year. I was concerned earlier this month that this work would simply get kicked into the long grass."

Izza said that the profession will have to digest the changes, start looking at how to make them work, and move on. "A lot of challenges remain, including how to apply some of the detailed work in the Regulation. As a profession, our purpose is to help create confidence in business and to help business succeed," he said.

Big Four
PwC UK chairman and senior partner Ian Powell urged the EP and the member state governments to look again at the proposed rules and make "significant changes" or face passing a law that would place European business at a competitive disadvantage.

"An imposed regime of mandatory firm rotation over the proposed short transition period, adds cost and complexity for business with global companies, especially those in financial services, being particularly impacted," he said.

Powell added that the proposed package undermines the importance of good governance and the role of audit committees, which for him it's at the heart of the EU corporate governance system.

"Audit committees also have an important role to play in the control, selection and independence of any services to be provided by the auditor. We are strong supporters of independent audit committees and the position taken by the UK Government in this regard," Powell said.

In a statement EY said the EU's proposed regulation could not only impose additional burdens on business but also create a patchwork of regulation that would be costly and difficult to implement for investors.

According to EY, the estimated cost to the EU economy of rotating the auditors of more than 30,000 public interest entities could be more than €16bn ($22bn).

"This is a bad deal for investors, a bad deal for business and for jobs, and a bad deal for the European and global economy. We encourage the EU to undertake an economic analysis and consider the consequences before it moves forward," EY said.

Next steps
The COREPER said that what has been approved "allows reaching a first reading agreement, after the formal voting in the European Parliament and later in the Council."

According the COREPER, the agreement on the audit reform would be listed as an "A item" of the Council's agenda. In the EU jargon "A items", as opposed to "B items", can be approved without the debate of member states ministers in the EU Council.

A meeting of the Competitiveness Council is scheduled for 20 February 2014 and the agreement could be voted at the plenary session of the EP scheduled for 13 January 2014, according to a source with knowledge of the situation.

Both the formal approval in the Council and a plenary vote in the EP will put an end to the EU legislative process.

Grant Thornton International director Nick Jeffrey said the COREPER's agreement was the next single most difficult step, after which "I would believe that there won't be any obstacle for reform".

"This package of measures will have meaningful impact. It will ensure that change happens across the market and remains permanent," he added.

Related articles

EU gives green light to 10 years audit rotation

Profession remains cautious on EU preliminary agreement of audit reform

Agreement reached on the EU audit reform

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