On 25 September, Sajjad Karim, MEP, hosted a high level roundtable, organised by ACCA (the Association of Chartered Certified Accountants) in partnership with ecoDa (the European Confederation of Directors’ Associations), to discuss the various proposals linked to audit quality and transparency as well as those targeting independence and market structure. It brought together more than 190 participants.
The main conclusions indicate there is a general consensus that any reform needs to improve transparency and audit quality. It must help resolve the gap that exists between what auditors are asked to do and what stakeholders and citizens generally understand under 'audit process'. There are however diverging perspectives on the appropriate tools on how to make auditing more effective and relevant in the 21st Century, especially in the area of auditor independence and market structure.
The first panel on transparency and quality, moderated by Sue Almond, Technical Director, ACCA, was comprised of Liz Murrall, Member of the European Fund and Assets Management Association (EFAMA); Jella Benner-Heinacher, President of Euroshareholders; Dan Montgomery, Task Force Chair of the auditor reporting project, International Auditing and Assurance Standards Board - IAASB; Laurent Degabriel, Head of investment and reporting unit, European Securities and Markets Authority (ESMA); and Hilde Blomme, Deputy CEO of the Federation des Experts-comptables Europeens (FEE).
The second panel on independence and market structure, moderated by Brendan Murtagh, IAASB board member, included Sebastian Valentin Bodu, MEP, shadow rapporteur for the EPP on audit; Kristian Koktvedgaard, Businesseurope; Jos van Huut, President of European Group of International Accounting Networks and associations (EGIAN); Robert Peirce, PwC Partner – Belgium; and Per Lekvall, member of the European Confederation of Directors' Associations (ecoDa). The European Commission was represented by Nathalie Berger, head of the audit unit, DG MARKT.
The European Commission believes that promoting independence and healthy competition, and ensuring the enforcement of legislation supervising the audit sector is key to restoring trust in this service, which plays a pivotal role in business by promoting the causes of transparency, accountability and sound financial management. The EU executive believes that confidence of stakeholders in the audits of financial statements is an essential ingredient for growth and competitiveness. With this in mind, and in order to clarify and reinforce the role of audit, the EU executive published its legislative package on 30 November 2011, which comprises a new Regulation containing specific requirements for the audit of Public Interest Entities (PIEs) and a Directive to amend the current statutory audit Directive. The co-legislators - the European Parliament and the Council - are currently preparing their respective positions on the package.
Sajjad Karim, MEP
- Is the rapporteur in the European Parliament Committee on Legal Affairs (JURI) on two related draft reports on Statutory audits of annual accounts and consolidated accounts and Statutory audit of public-interest entities: specific requirements.
- He welcomed attendees to the standing-room-only event and introduced the debate with some thoughts following on from the presentation of his draft reports in the JURI Committee. He said that the issue of auditing is entering a critically interesting phase, so the timing of these reports and this event is very apt.
- His report follows a clear philosophy: audit quality, transparency and independence should be the foremost considerations when designing an audit regulatory regime. After the 2008 financial crisis the finance sector needs to win back the confidence of investors, who are looking for higher quality auditing, improved value of statutory audits, and more competition in the market.
- By combining greater information and availability of insight into the audit market with a reinforced opportunity to engage, he expects to see a much stronger attitude of involvement from shareholders and investors when it comes to a company's auditor engagement, as they find themselves much better placed to critically assess and comment on what they want to see from their auditors.
- MEP Karim proposes to keep the principle of mandatory rotation to avoid familiarity between the auditor and the audited company, but prefers an engagement limit of 25 years instead of the 6 proposed by the Commission, in order to avoid disruption and high costs. For the rappporteur, mandatory rotation is a backstop, and shareholders should become much more involved in the process through the work of each company’s audit committee, namely through an annual review and the appointment by shareholders of the statutory auditor.
- MEP Karim also considers that robust international standards and international convergence make sense as many of the companies classified as PIEs operate beyond the borders of the EU. On the controversial non-audit services area, looking beyond the 'blacklist' of services, the involvement of the audit committee in the approval of all other non-audit services is essential. MEP Karim also shares shadow rapporteur MEP Bodu’s willingness to open up competition in the area of non-audit services to allow smaller firms to gain a foothold in the upper tiers of the market.
- He recalled that we must remain conscious of the huge variety of domestic companies throughout the EU and the national markets in which they operate, a 'one-size fits all' solution throughout could thus end up representing a 'bad fit for all'.
Panel 1 on transparency and quality
The moderator, Sue Almond, ACCA Technical Director, reminded the audience that it was critical to consider if the Commission proposals on auditing are hitting the required needs. Although there remain, understandably, areas of difference, it is interesting to see a number of areas of consensus - for example, in the critical role of the audit committee in auditor appointment and independence, and in the need for more informative and transparent auditor reporting.
Liz Murrall, member of the European Fund and Assets Management Association (EFAMA), was providing the investors’ perspective on auditing:
- Her main concerns are twofold: the impact on audit quality and independence of the long term office is held, the limited number of players and non-audit services, and also the level of accountability and transparency.
- On the impact on audit quality and independence, investors are still concerned at the potential impact the long term auditors hold office with one client. However, the EU proposal for rotation after 6 years is too frequent and could be disruptive. Investors’ preference would be for a transparent 10 year tender or an explanation as to why the tender should be extended. Some consider there should be an outer limit, with a maximum of 15 to 20 years. EFAMA does not believe in joint audit. During the Q&As she reiterated that she was not in favour of mandatory rotation, due to its impact on quality. She was echoed by Euroshareholders, who prefer regular tendering.
- Non-audit services (NAS) can compromise independence and objectivity: NAS should be banned when there is conflict, and where not they should be subject to audit committee approval or limited to 50 per cent of the audit fees.
- On transparency and scope, investors consider there is a lack of transparency of the audit process and findings. Investors feel excluded from the process and want a more enlightened audit report, describing the current audit report as binary, pass/fail, and boilerplate. Some reports are published months later. This is too little, too late. An improved report should describe more about the audit process and real findings. Either the Audit Committee or the auditor must give more info on accounting judgements and valuations. Accounts are the responsibility of the company and the board. Audit committees are required to do a report and should look at the enhanced disclosure guidelines. We need more on the accounting judgements and their debates with the auditors – and then for auditors to report on the AC statement. Auditors should report more on their work.
- She called on the views of the investment community to be considered, to alleviate their fear of reducing rather than improving audit quality in the future.
Jella Benner-Heinacher, President of Euroshareholders, the organisation of European shareholders associations:
- Shareholders have high expectations for the improvement of auditing services namely on a clear statement on company status, reliable book-keeping and an expression of a true and fair value of the company. The reality was somewhat different, the fair value assessment is forward-looking, but rest is backwards-looking, and essentially written for directors not shareholders. On audit quality, shareholders would greatly appreciate an understandable explanation, in order to deal with the key risks, judgements and major topics that might come up.
- More independence is needed, improvements could include clear limits on NAS, with a blacklist of services (based on the German model) that would be based on harmonised rules applicable to all EU Member States. A limit on fees (50 per cent) and regular tenders/beauty contests could be put in place every 5-7 years. Twenty-five years audit tenure is a 'dinosaur', a maximum length of mandate of 15 years would be better.
- Auditors should give a judgement on the underlying financial assumptions used by the company. A written declaration of independence could be signed before an auditor is introduced.
- Shareholders also support giving more power and expertise to the Audit Committee, with the possibility of an own budget for the Audit Committee, the prior approval of NAS and involvement in the selection procedure (on the tender, the number of candidates and explanations of the selection).
- She indicated during the Q&As the joint audit system is not currently available in Germany, but she was not aware of any extra value (except that it is definitely more expensive).
Dan Montgomery, Taskforce Chair of the auditor reporting project, International Auditing and Assurance Standards Board (IAASB):
- Auditor reporting is of high interest globally, there are many initiatives in the wake of the global financial crisis, including the EC proposed regulation. We can observe common themes in the calls for change, but diverse views on how best to address.
- IAASB endeavours to put together a high quality framework, with extensive discussion and debate among stakeholders. Influences on high quality include values of auditors, training, experience, engagement, exploration of auditors’ reports, reporting of management and reports by audit regulators. The contextual factors are to be considered, but the discussion documents are expected to be approved by the end of 2012 or start of 2013.
- For IAASB, the auditor reporting project is the number one priority. It has issued an Invitation to Comment (ITC), unanimously approved, which sets out the IAASB’s indicative direction and rationale, and describes the IAASB’s perspectives on value and impediments
- There are currently two key areas of change:
o Auditor commentary, which would take the form of a new section aimed at improving informational value of the auditor’s report and highlight matters that are, in the auditor’s judgment, likely to be most important to users’ understanding of the audited financial statements or the audit. It would provide a 'roadmap' to help users better navigate complex financial reports, additional context to the matters highlighted and information about key judgments made by the auditor to provide more transparency regarding how the audit was conducted. This call is coming through louder in the EU than in other parts of the world.
o On the going concern assumption, he said there are mixed views on the values of statements. Consistent with ISA 570, the ITC suggests a requirement for all auditor’s reports to include a conclusion about appropriateness of management’s use of going concern (GC) assumption and a statement about whether material uncertainties relating to GC have been identified. Clarification of guidance on GC is likely to be necessary, as we need a common understanding of terms such as 'material uncertainty', 'significant doubt', and 'foreseeable future', and also to better comprehend the relationship (or distinction) between 'use of GC assumption' and 'ability to continue as a GC'. Suggested improvements included a new section on inconsistencies, an explicit statement of compliance and a robust description of auditors’ responsibilities. These are the building blocks to allow flexibility. More information is also needed on internal controls and fraud
- Coordination with IASB is highly desirable, certain clarifications are to be discussed by IFRIC in November 2012.
Laurent Degabriel, head of investment and reporting unit, European Securities and Markets Authority (ESMA):
- Greater transparency from auditors and audit firms themselves is necessary, especially for investors. Auditors need to be able to explain their judgement.
- The independence of the oversight system is key. By issuing guidelines on topics such as best practices, ESMA could play a significant role in promoting a more convergent and integrated supervision of auditors in the EU and in fostering coordination with third countries.
- ESMA stands ready to fulfil the role that European legislative bodies will define for it on audit related matters.
Hilde Blomme, Deputy CEO of the Federation of European Accountants (FEE):
- FEE welcomes MEP Karim’s report, as it is more balanced than the initial Commission proposals, which were too prescriptive in areas such as how to achieve increased independence and auditor’s reporting.
- Other areas however need to be considered further, such as the question of the PIE definition, which is of utmost importance.
- The role of professional bodies is close to the heart of FEE and has an impact on the whole of the accounting profession. It is essential that professional bodies continue to be involved in the activities of the profession under the supervision and oversight of Member States’ competent authorities, which are best placed and sufficiently competent to judge about the level of delegation to professional bodies. There are three main pillars underpinning the continued development of the profession, enhance quality within the profession (with quality control reviews) and instilling values, integrity, independence, balance and discipline. These are especially important for smaller practitioners.
- In practical terms, it is recommended that for delegation to professional bodies under the oversight and supervision of the competent authority:
o Approval and registration of auditors includes the whole process of education, initial qualification and continued professional development as well as the organisation of the public register, to underpin the continued development of the profession.
o Quality assurance reviews for non-public interest entities is reinstated, to enhance quality and instil discipline in members.
- The robust international standard in the areas of auditing, internal quality control, ethics and independence are recommended to be adopted at European level, whereby professional bodies can play a role to provide additional guidance suited for national needs and in the national language. In this respect, the IAASB initiative to enhance the transparency of the auditor’s report is applauded.
- If FEE was to make amendments to the Commission proposals, it would come up with something close to the Karim reports, which should be recommended for adoption at EU level, as this was the way forward for auditing, but FEE does not express views on reshaping the structure of the audit market.
Panel 2 on independence and market structure
The session was moderated by Brendan Murtagh, IAASB board member, who reminded the audience Commissioner Barnier has said himself the confidence of stakeholders in the audit market is key for growth and competitiveness. Independence is a key element of building that trust, as well as the quality of audits and financials statements.
Sebastian Valentin Bodu, MEP, Shadow rapporteur for the EPP
- There seems to be a consensus the role of audit committees should be strengthened, namely in making them responsible for approving NAS, performed by the same firm that provides audit services. In the Commission revision, there are related, audit and non-audit services (the latter being divided into conflicts of interest and ‘may entail’ conflicts of interest). It should be up to the audit committee to decide whether another firm should perform the task.
- External rotation is a sensitive issue, his position is the same as in the previous green paper, i.e. it is not needed, preferring instead strengthened internal rotation. None of these procedures are perfect, but at this moment, internal rotation can ensure the desired level of independence.
- Splitting the firms into purely audit and non-audit would have more negative implications than positive ones. Having discussed the quasi-monopoly problem in Spain, Germany and the UK, he felt that splitting audit firms into two in these countries would not help competition amongst the audit firms as it would lead to big audit and non-audit firms.
- He intends to table an amendment to put a double cap (a percentage figure calculated on the revenues from the previous financial year) on the turnover from non-audit services provided by the Big Four to public interest entities (PIEs), allowing room for smaller firms to grow and allow them to create a brand name and grow naturally into the audit arena. The proposed figures for this cap are yet to be decided. He knows this is an indirect way of enhancing competition and to increase more penetration of smaller audit firms in the market, but he could not find a solution to concentration in a direct way so far. A firm does not need a good team, a large team, or a network, but just a good idea to do this kind of work. He expects smaller firms would grow into auditing services if they develop in these other ways.
- Joint audit is not a solution, it would increase costs, which are not welcome at this time.
Kristian Koktvedgaard, BUSINESSEUROPE, explained that BUSINESSEUROPE’s starting point on this issue is ensuring efforts to allow access to high quality audits, thus welcoming institutional efforts but warning that they should not pose a threat to quality.
- Most of the measures related to PIEs should be in line with international standards and codes of ethics on auditing.
- BUSINESSEUROPE agrees the rules on provision of non-audit services need to be harmonised in Europe but we should base the legislation on the Code of Ethics. BUSINESSEUROPE does not believe in the 10 per cent cap, it is in favour of an increased role of the audit committee (but not for the extra requirement of requiring someone with the competence in audit on top of the individual with knowledge in accounting and/or auditing due to the fact that the audit committee should have broad coverage, shouldn’t be too large, and in some member states, members of the audit committee have to be members of the supervisory board / those charged with governance), which should be able to choose and set up policies and services. Businesseurope would not support the cap on turnover suggested by MEP Bodu. The key interests for businesses are: access to high quality audits, general knowledge, general access, and sector specific knowledge across the world. Once a firm has invested in these things, it should be able to use them for non-audit services to non-audit clients. There needs to be a market for that knowledge.
- BUSINESSEUROPE is against both mandatory rotation (as rotation doesn't create more choice, but increase costs and decrease audit quality), preferring internal partners’ rotation and tendering monitored by the audit committee on a comply or explain basis. Higher concentration has been seen in Italy as a result of this practice. Tendering takes a lot of effort and resources, it would be better to have the Audit Committee explaining why it suggests to maintain the auditor without tendering after 10 years.
- On market conditions, BUSINESSEUROPE supports some of the initiatives, such as the prohibition of contractual clauses ('Big 4 clauses'), increased transparency and lifting restrictions on ownership.
- Businesses are not against voluntary joint audits, but by no means mandatory ones. BUSINESSEUROPE warns against increasing costs to areas that are not significant to the audit user, as it draws resources away from the key focus points.
- On sanctions when businesses read that they can get a 10 per cent global turnover administrative sanction for selecting audit committees that are not up to the task, this is confusing, as the mistakes are the shareholders’. The sanctions seems disproportional and should be under the competence of the Member States and aligned with other similar issues in that member state. On costs, facing a bill of €90,000-€170,000 from audit companies does not lend to one feeling they are getting more quality for that money.
Jos van Huut, President of European Group of International Accounting Networks and associations (EGIAN):
- EGIAN has taken the position that fundamental reform of the auditing profession and audit market is necessary, but this cannot be achieved by the profession on its own. Legislative and regulatory intervention is needed, as well as the involvement of a range of stakeholders especially the shareholders to whom we report.
- EGIAN therefore welcomed the Commission initiative. Two elements are of particular importance as we look at how to move forward, namely trust and relevance.
- Perceptions are a part of reality, and so this must be considered, especially as regards independence. EGIAN feels that MEP Karim’s amendments do not lead the debate in the right direction. Measures should not be seen individually, but together. For example, the delivery of non-audit services could be less restricted if combined with joint audit. For EGIAN the legislation should include:
o Co-audit, two auditors working together in a balanced fashion, especially at the top end of the listed market. Joint audit, for example, would enhance audit quality with all major issues on an audit subject to review by both auditors, particularly beneficial on complex audits requiring high levels of judgement.
o Regular and fair tendering at intervals not exceeding, say, 8 years, with tenders to involve a range of firms, not just dominant players.
o A cap of 15 years for the audit tenure.
o So-called ‘pure audit firm’ model needs to stay. Mis-named as Big 4, it just needs to stay within the limits set down in the proposed regulation, i.e. not too high a share of their audit income from large PIEs, in order to remain multi-service firms. It is important that firms do not see audit as a commodity
- EGIAN encourages the adoption of ISAs, and in principle their proportional application to SMEs, which have a critical role to play in growth and job creation in Europe. We need to look at in integrated fashion alongside the discussion on audit exemption for SMEs and accounting standards for them. One size does not fit all.
Robert Peirce, PwC Partner–Belgium.
- Auditors have been blamed for not doing their work in the financial crisis, but the question was not about independence or mandatory rotation at the time. Many people think asking auditors to extend their work to other fields is not realistic because there are no existing standards to go by, but then why not set those up instead of drafting limiting regulations?
- Any kind of joint audit or mandatory rotation will not work (3-4 companies could address different fields on the same audit, but they would not need to work on the same elements), we should instead focus on enhanced communication and cooperation. Quality is a matter of skills and competencies and not of independence per se.
- The financial crises have shifted the way the world views the capital market systems, highlighted significant shortcomings in the corporate reporting and criticised the relevance of today’s financial statements.
- PwC carried out a survey among investors which finds that investors would value more engagement and communication with the auditors, that there is an appetite for more timely assurance and that assurance is sought on metrics and narrative that currently fall outside the audit’s scope, such as on geographical variations, industry-specific metrics and directors’ remuneration reports.
- Investors, with the exception of emerging countries, are nonetheless still showing little appetite for extended assurance unless it is value relevant, while other stakeholders are looking at the auditors to take responsibility over the missing information.
- Auditors should however not be the original source of factual data as there may be liability or confidentiality implications to disclosures and auditors could end up competing with management information. There is an urgent need for a holistic reform of corporate reporting with investment and new standards, the accounting profession has to act in the public interest and provide financial stability. It will have to move from compliance to a more valuable business assurance, build new standards in an open and transparent way, and play a more active education role.
- Some changes can be made in the short term, eg. in Belgium, audit firms are working with regulators to comply with the MiFID directive, but radical reforms need to be framed into a new corporate model and combined with a greater two way dialogue with supervisors on macro-economic issues and a bigger role for audit committees.
Per Lekvall, member of the European Confederation of Directors' Associations (ecoDa):
- ecoDa welcomes the JURI committee’s review of the Commission’s proposed audit reform, which demonstrates a significantly better insight into and a more realistic understanding of the complex issues of auditing of major business corporations than the Commission’s proposal. ecoDa is particularly satisfied to see proposed amendments of several of the most problematic and cost-driving proposals, such as the removal of the proposed cap of 10 per cent, the extension of the timescale for rotation from 6 to 25 years (ecoDa, however, asked whether encouraging the review of auditors would be better than having time defined rotation), the new lists of permitted and prohibited non-audit services.
- However, ecoDa is disappointed about the Committee’s draft report on two main accounts:
o The uncritical acceptance of an EU Regulation, which would impose a 'one-size-fits-all' regulatory regime at a very detailed level which will cause considerable difficulties when being forced upon the very diverse corporate governance systems across the 27 member states. Instead many of the issues addressed could be more effectively dealt with through national corporate governance codes, based on the comply-or-explain principle, whereas those where mandatory regulation is deemed necessary should be regulated through an EU Directive.
o The widely expanded role of the audit committee in the Commission proposal, only marginally challenged by the JURI committee. Audit committees play a vital role in many companies, not least to mitigate the integrity problem of mixed boards towards the company management in one-tier governance structures. However, in other jurisdictions, particularly in those with entirely or predominantly non-executive boards, the rationale of the audit committee is of a more practical nature. For example, the Nordic member states where the audit committee is a subcommittee within the board that can only deal with matters within the board’s scope of responsibilities and for the actions of whom the board as a whole is accountable. In these jurisdictions, the auditor is appointed by the shareholders at the AGM with the express duty to review the work of not only the CEO but also of the board. The extensive duties assigned the audit committee in the proposed regulation, referring to the audit committee as a more or less separate governance body with duties inter alia to oversee the audit, to appoint and dismiss the auditor and to supervise the audit report, is hence not consistent with current legal and/or code-based regulation in the Nordic area. Similar implementation difficulties might arise in other parts of the EU as well.
o It would be most timely if the ECON committee would include some in-depth considerations of these two issues in its review of the Commission proposal.
Nathalie Berger, Head of the Audit unit at the European Commission indicated that:
- The European Commission very much appreciates MEP Karim’s efforts to bring the audit reform forward. He rightly highlighted that the status quo is not an option. From today's debate, we all seem to agree on the objectives of clarifying the role of auditors and strengthening auditors' independence. Auditors play a societal role. Improved audit quality will enhance the single market, it will be key to strengthen auditors' confidence in order to ultimately enhance financial stability.
- There may still be some opposition, especially on independence and market structure. Some critics have remained consistent, but there had been some interesting options suggested in the session.
- Merely using corporate governance codes and the comply and explain system is not appropriate for improving the legislative framework in the EU. The Commission welcomes the wish to strengthen audit committees, considering it essential that they have the necessary competence to fulfil their task appropriately. It is also important to improve the auditors’ reporting to the public, to serve its purpose.
- Rotation is seen as a cornerstone of the audit proposals by the EU Executive, an essential ingredient of enhanced audit quality and independence. It is important to have a maximum duration of audit engagement and the Commission welcomes the rapporteur keeping it within the report, but looks with concern at the proposed backstop of 25 years. To reinforce independence and avoid familiarity, it is not sufficient that audit committees assess the threats irregularly, and a much shorter term should be considered. The Commission does not support either the concept of 'voluntary rotation'.
- On the provision of NAS, the Commission understands that services required under national law should be permitted, but the provision of consultancy and tax services pose a threat to independence (inherent self-review or risk of being in a position where the auditor would need to defend the audited entity’s view on certain issues).
- The Commission also regrets that the draft EP report does not consider that certain firms above a certain size would only be allowed to provide audit services.
- Joint audit should be incentivised and appear as an option as it raises audit quality. Four eyes see better than two.
- The Commission does not blame the audit sector for having caused the financial crisis, but society as a whole will benefit from the stronger role auditors could play in the prevention of future crises.
The Legal Affairs Committee will now consider the input from other committees and amendments from other MEPs. The deadline for these has been deferred until 7 November.