Audit firms in the EU will face increased supervision and more stringent requirements

for transparency and independence, under reforms agreed to this week by European Parliament and member states.

Calls for reforms to the audit sector intensified after it was revealed following the

financial collapse that many large banks were said to be in sound financial

health despite suffering major losses. National regulators found the often

long-term relationships between auditors and their clients led to a lack of

professional skepticism and misstatements in audits.

According to information posted by the European Commission following the agreement, audit

firms will be forced to rotate every 10 years. The period can be extended for a

second engagement of up to 10 years if tenders are issued, and up to 14 years

in cases of joint audits. Officials said they will use a “calibrated

transitional period” as the new rules take effect.

Firms will not be allowed to provide certain non-audit services to audit clients,

including tax advice and services tied to a client's financial or investment

strategy. Lawmakers said this provision will limit self-review risks for

auditors, as well as limit potential conflicts of interest by keeping auditors

away from a client's management decisions.

Another provision aimed at reducing conflicts of interest is a cap of 70 percent on

fees generated for permitted non-audit services, based on a three-year average.

Auditors will be required to issue more detailed and informative audit reports, focusing

on information relevant to investors. Auditors will face greater transparency

through stricter reporting requirements to supervisors.

Auditors also will have to communicate more closely with the audit committees of their

clients. The audit committees will have their powers strengthened. A new

provision will allow 5 percent of a company's shareholders to initiate a

process to dismiss auditors, and new sanctions will be available to regulators

to enforce the audit requirements.

Proponents say the reforms will create a more competitive market for the audit sector. A

single market for statutory audits will allow cross-border mobility for

auditors, and practices will be unified under the International Standards on

Auditing (ISAs). Similar to a ruling issued last month in the United Kingdom,

the new rules ban companies from using “Big Four only” third party clauses. New

incentives will be created for joint audits and tendering. Authorities will

continue to keep tabs on the concentration of the audit sector.

In order to avoid undue burden on small and mid-sized audit firms, the new rules will be

applied proportionately to these firms, officials said.

“It is now high time for auditors to meet the challenges of their role – a societal

role,” Michel Barnier, commissioner for internal markets and services, said in

a statement following the agreement. Barnier called the trilogue's agreement an

important step in re-establishing investor confidence in financial reporting

and improving the quality of audits.

“Although

less ambitious than initially proposed by the Commission, landmark measures to

strengthen the independence of auditors have been endorsed, particularly in the

auditing of financial institutions and listed companies,” Barnier said in a

statement. “This will ensure that auditors will be key contributors to economic

and financial stability.”

In particular, Barnier praised the provisions to prevent potential conflicts of

interest, including the ban on certain non-audit services and cap on permitted

non-audit services. He said he was disappointed that the European Securities and

Markets Authority (ESMA) was not endorsed as the permanent body to coordinate

cooperation between national audit regulators as opposed to its initial mandate

to do so.

The informal agreement reached this week needs formal approval by co-legislators

before it will take effect.

Topics