A period of 10 years mandatory rotation is among the key elements of the agreement reached earlier today between the Lithuanian presidency of the Council of the European Union (EU) and the European Parliament (EP) on the framework of the EU audit reform, the EU Commissioner Michel Barnier has announced.

Under the agreement, audit firms will be required to rotate every 10 years but public listed companies will only be able to extend the audit tenure for another 10 years upon tender. In the case of joint audits the extension period will be 14 years, rising to a maximum of 24 years, according to Barnier.

"Despite the extension of the rotation period, this principle will have a major impact in reducing excessive familiarity between the auditors and their clients and in enhancing professional skepticism," Barnier said.

Audit firms will be strictly prohibited from providing non-audit services to their audit clients, including stringent limits on tax advice and services linked to the financial and investment strategy of the audit client.

This measure aims at limiting risk derived from conflicts of interest, when auditors are involved in decisions impacting the management of a company. It would also limit substantially the ‘self-review’ risks for auditors.

Also, in order to reduce the risks of conflicts of interest, the rules propose the introduction of a cap of 70% on the fees generated for non-audit services, other than those prohibited based on a three-year average at the group level.

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The Committee of European Auditing Oversight Bodies (CEAOB) will coordinate the cooperation between audit supervisory authorities. Barnier said: "I regret that ESMA [the European Securities and Markets Authority] has not been endorsed as the core structure for coordination but I am pleased that it has been granted an initial mandate on international cooperation."

"Although less ambitious than initially proposed by the EU Commission, the agreed measures, taken together, will considerably strengthen audit quality across the European Union," Barnier said.

Before the preliminary agreement becomes European law, it needs to be approved by the Committee of Permanent Representatives (COREPER) and the College of Commissioners before it’s voted in the EP at the beginning of next year.

Industry reactions
Grant Thornton International director Nick Jeffrey said: "To obtain COREPER agreement tomorrow is the next single most difficult thing, after that I would believe that there won’t be any obstacle for reform."

"And I think it will get approved, everything we hear suggest it will get approved," he added. "This package of measures will have meaningful impact. It will ensure that change happens across the market and remains permanent."

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.

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