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.
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