25.8.2011   

EN

Official Journal of the European Union

C 248/92

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A majority of committee members and the committee chairman must be independent.

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The competence of some Committee members must be relevant to the sectoral characteristics of the company involved, especially in the banking sector.

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The audit or supervisory committee should not only monitor, but actually take responsibility for the integrity of the audit process.

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clarification of the SA's remit and corresponding responsibility;

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greater clarity and intelligibility in the SA's reporting, especially in respect of existing risks;

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making the audit more of a company health check by a commentary on the analysis prepared by the main or supervisory board of the viability of the business model, its financial strength and the visibility of and approach to business risks;

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better communication between the SA and the company's supervisory bodies during the year, while the audit is still ongoing.

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higher quality narrative reporting, particularly on business strategy and risk management;

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more widespread recognition of the importance of Audit Committees and, therefore, greater emphasis on their contribution to the integrity of financial reporting;

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greater transparency of the way that Audit Committees discharge their responsibilities in relation to the integrity of the Annual Report, including oversight of the external auditors;

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more information about the audit process, both for Audit Committees and for investors and a broadening of the scope of the auditor's responsibilities; and

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more accessible Annual Reports through the use of technology.

1.

Directors will need to describe in more detail the steps that they take to ensure both the reliability of the information on which both the management of a company and the directors' stewardship of the company is based; and provide more transparency about the activities of the business and any associated risks.

2.

Statutory Auditors will need to provide reports that includes a section on the completeness and reasonableness of the Audit Committee report and identifies any matters in the Annual Report that the SA believe are incorrect or inconsistent with the information contained in the financial statements or obtained in the course of their audit.

3.

The growing strength of Audit or Supervisory Committees in holding management and SA to account should be reinforced by greater transparency through fuller reports by these committees explaining, in particular, how they discharged their responsibilities for the integrity of the Annual Report and other aspects of their remit such as their oversight of the external audit process and appointment of SA.

1.

the financial reporting process;

2.

the effectiveness of the company's internal control, internal audit where applicable, and risk management systems;

3.

the statutory audit of the annual and consolidated accounts.

1)

Please refer to section 1 of this opinion.

2)

The veracity of financial statements is the sine qua non of a society which depends largely on the performance of public limited liability companies in a market economy. The public interest requires that companies survive and thrive. There is a complex multiplicity of dependent interests: shareholders, bondholders, banks and other creditors who depend on the statements to judge the safety of their investments and loans; employees who depend on the statements to judge the safety of their jobs and wages; other stakeholders who depend on the statements to judge the security of the company as an employer, supplier or customer; local communities and local and national governments which rely on the accounts as a measure of the company's contribution to society, as well as its taxpaying capacity.

Apart from these considerations, banks and other credit institutions play a fundamental role in the operation of the market economy. During the financial crisis banks failed to fulfil their role of moving money around the economy. As a result, the veracity of their financial statements prior to the crisis has been rightly called into question. True and fair financial statements are the bedrock of EU political, social and economic organisation. Firms which undertake statutory audits are responsible for protecting the public interest.

3)

Yes, audit reports are not meaningful. They do not reflect the work of the SA. With the advent of IFRS, the audited accounts may also be less meaningful, particularly in the case of the banks.

4)

As they stand, audits are not fit for such a purpose. The on-going financial health of a company is a function of the resilience of its business model. Testing the model is mainly the role of institutions and analysts, not the SA. Even so, changes must be made. In their reports, directors need to be more transparent about the actual health of the company. Providing external assurance on these disclosures should then be a function for the SA. To do this, SA will need sector specific understanding of inherent risks which appears to have been lacking as the complexity of banking assets increased. In this context, there should also be an explanation of the judgements made to confirm the going concern.

5)

Yes. SAs make brief statements in the Report and Accounts but these are process oriented and reveal nothing of their findings, concerns or judgements. It is not just a question of explaining methodology. The directors must explain their judgements and decisions and then the SA should explain the process by which they conclude that the accounts do give a true and fair view. In doing this, it will be important to ensure that SA do not once again revert to boiler plate language.

6)

Professional scepticism can be reinforced by training, non-audit experience, peer review of audit findings and the leadership of audit partners. In addition, the greater transparency required of the auditors under the proposals in section 2 will require SA to exercise professional scepticism more rigorously than heretofore. The establishment of a professional disciplinary body in each Member State would reinforce scepticism.

It is likely that professional scepticism would be further enhanced by economic independence. The scale of non-audit services supplied to audit clients should be reviewed and critically assessed by the audit or supervisory committee so as to restrict any conflict of interest between the exercise of professional scepticism and the retention of important client revenues. It is also possible that scepticism would be reinforced if mandatory tendering (question 18) reduced the probability of extended tenure by the incumbent audit firm.

7)

No. Shareholders and stakeholders should be concerned if the report of the directors needs to be qualified by the SA. However, greater transparency in the reporting by the Directors and/or the Audit or Supervisory Committee may provide greater clarity to shareholders as to the reasons why an SA has qualified an audit report.

In the case of banks, a qualification can create a crisis of confidence with potential systemic implications. Therefore any SA concerns should be reported as soon as possible to regulators and supervisors so that potential issues are speedily addressed.

8)

SA have a responsibility to shareholders and by extension to employees and other stakeholders. They do not report separately to stakeholders. The company is responsible for information provided to stakeholders. As proposed in section 2, more information should be provided to the company's supervisory bodies, shareholders employees and other stakeholders by both directors and SA, and with greater transparency.

In addition, the EESC urges that in those audit reports made to main and supervisory board, the SA comments clearly on risks ascertained. The SA should be a source of information that brings to light potential risks to the company's viability. This information should provide a commentary on possible risk scenarios, potential damage levels and their probability. The effects of accounting policies on the company's assets, finances and profits should be assessed in a more transparent way.

9)

The banking crisis would suggest regular and adequate dialogue did not take place in all cases, but in many cases it will have. An enhanced role for the audit committee would result in improved communications.

10)

Possibly, but not before there is EU agreement on what the reporting standards might be.

11)

Stakeholders are covered at Q8 above. Timing is not an issue.

12)

The Commission should review of the impact of the introduction of IFRS, particularly in respect of their application to banks. There is a concern that critical concepts like prudence and accounting conservatism have been superseded in IFRS by process and compliance to standards. There is evidence that, by limiting auditors' scope to exercise prudent judgment, IFRS offers less assurance. IFRS also has specific defects, such as its inability to account for expected losses.

Oral evidence given to the UK House of Lords enquiry into audit market concentration showed that the weaknesses of IFRS are especially serious in relation to bank audits (3).

13)

Supportive. However strict neutrality vis-à-vis the respective national legal systems must be respected.

14)

Yes, possibly by regulation.

15)

Not necessary.

16)

There is a potential conflict, but it is manageable. Greater transparency in relation to the appointment and re-appointment of SA is needed, and this is included in the proposals outlined in section 2. Appointment by the Company (Audit or Supervisory Committee and shareholders) allows for an SA to be appointed that is best able to meet the particular requirements of that company, for example knowledge of the business sector and requisite international reach.

17)

Not in normal circumstances. However, the question might arise in relation to systemically significant (SS) institutions such as large banks. If supervisors are in regular contact with the SA of SS institutions, and they are dissatisfied by their performance or their independence, the supervisor should have the power to require the institution to make a change. This need only be a reserve power, since a company aware of supervisory concern would be likely to make the change itself.

18)

In responding to this question, the EESC first of all expresses a caveat: any proposed change to the status quo should be subject to a rigorous impact assessment.

The rotation of audit teams and leaders and normal life cycles of Chairmen, CEOs and CFOs mean that at an individual level there is a more than adequate sequence of revolving relationships. The issue is corporate to corporate: the SA need to keep its clients and the client's willingness to keep an auditor with which it feels comfortable. These long term relationships are a potential threat to independence and professional scepticism.

The EESC does not support the limitation of SA engagement through mandatory rotation but it does recommend that large companies carry out a mandatory tender of their statutory audit contract every six to eight years. The invitation to tender should be sent to at least one firm outside the big four. Such an exercise will not necessarily lead to a change of SA. Therefore the process needs to be transparent. The Audit Committee should explain the basis of its tender and of its decision. It should also hold a meeting with its principal shareholders in this context.

19)

There should be no restriction on SA firms supplying non-audit services to companies other than their statutory audit clients but such services should only be provided to statutory audit clients with the express approval of the audit or supervisory committee. To enhance the independence of the statutory audit of large companies, the SA should not provide risk advice to the client, nor should it be the internal auditor. The provision of tax advice should be curtailed whenever a material conflict of interest could be involved. Broadly speaking, non-audit services involve either consulting or accountancy. Consultancy is less likely than accountancy to raise conflict of interest issues vis a vis the statutory audit. Audit committees should approve all non audit services provided by the SA and avoid conflicts of interest. Committees should also monitor the total value of these non audit services and this figure should be published in the Annual Report.

In the case of SMEs, a more relaxed regime may be envisaged. SMEs come in all shapes and sizes. In many cases, it would make sense for taxation and risk advice to be provided by the SA firm.

20)

This can only be answered in the context of each audit firm's total revenues at the national level. The current threshold of 15 % of a national firm's fees resulting from one client, as contained in the IESBA Code of ethics, is sensible to recognise that audit fees are a function of the scale and complexity of the audited company. Clients are relentless in driving these fees down. Fees for non audit work paid to the audit firm should be reported separately.

21)

Yes, but these rules need to recognise that Big Four networks comprise separate national firms rather than being one entity. Audit firms should publish their accounts, just like the companies they audit.

22)

In some jurisdictions, auditors give a formal annual confirmation of independence. In one Member State they follow a governance code for audit firms. Where a conflict of interests arises, they must withdraw from one or other engagement. In addition, audit firms should employ independent directors and advisors.

23)

The limited liability partnership is an attractive structure for audit firms. The comparator is the public company structure of credit rating agencies which undoubtedly had some bearing on the disastrous rating decisions which led to the financial crisis. If not faced with the threat of unlimited liability in Member State courts, the partnership arrangement should be sufficiently robust. Nevertheless, if other forms of incorporation help to widen the market, they should be encouraged. Limitation of liability could have the double benefit of encouraging the entry of new capital as well as incentivising mid range audit firms to bid aggressively for large company mandates.

24)

Group auditors should certainly have the necessary authority and access to fully discharge their responsibilities towards group shareholders.

25)

There is an international dimension relating to such issues as standards, passports and the international networks of audit firms. Nevertheless, SA firms operate through national units under Member State supervision. The EESC would support a college of national supervisors linked to the new EU framework for financial supervision.

26)

There are already certain statutory requirements, although there is evidence that in the years prior to the crisis, SA / supervisor dialogue had broken down in certain Member States. The EESC recommends that the new European Banking Authority should define banking specific requirements. Furthermore, regulators should hold the chairman and the board responsible for communication with them, with sanctions available if the company fails to communicate key issues.

27)

We consider that there is a real risk of disruption of the market. We do not believe that the failure of any one SA firm presents an immediate systemic risk to the market. However, from the point of view of independence and market, dominance by just three firms would be utterly unacceptable. The recent financial and economic crisis has highlighted the fact that in risk management, every eventuality should be covered.

28)

The legal requirement that companies should be audited by a consortium of at least two firms exists in France. Similar provisions used to be in place in Denmark but were found to be no longer needed. In France this requirement has applied to listed companies since 1966. It was extended to companies obliged to publish consolidated accounts in 1984 at a time when the Anglo American audit firms were rapidly increasing their market share. To an extent, the policy has succeeded. In a 2006 study (4) of 468 French companies based on 2003 data, 54 were audited by two Big Four auditors, 241 (51.5 %) by one Big Four and one French firm while the balance of 173 were covered by various combinations of large and small French firms.

The shape of the audit market in France is not just a function of legislative intervention. Company ownership in France is much more concentrated than in Anglo-Saxon countries and this affects the audit requirement. Using the same sample, the single largest investor owns 25 % or more of 73 % of French companies. The largest ownership groups are other companies (34 %), family ownership (25 %) and the general public (21 %) while international investors hold just 8.5 %.

The study found that ‘In particular, the use of Big 4 auditors increases when the ownership structure is less concentrated by a single large block holder, and has more international and public investors; while the use of Big 4 auditors is less likely when there is large family ownership. In addition, a Big 4 auditor is more likely as institutional ownership (banks and pension funds) increases. Importantly, there is evidence that some of these ownership characteristics are also associated with the use of two rather than one Big 4 auditor’.

Given this linkage between ownership and audit, these findings suggest that it is unsafe to conclude that the French legal environment is the sole determinant of the audit market structure in France. However, in this regard, it should be noted that contrary to what the Commission is proposing, under French law there is no obligation to involve a ‘smaller’ firm alongside a ‘larger’ one in the joint audit. As the Commission has acknowledged, the responses to the Green Paper consultation on this question were mixed, particularly as regards whether joint audits would deliver better accounts or add bureaucracy and cost.

In answer to the question, joint audit would increase the involvement of smaller firms in the large company market. As to whether this would actually reduce concentration, and over what timescale the EESC urges the Commission to undertake a profound impact assessment before coming to any conclusion on this point. The EESC believes that competition law can provide an additional way of dealing with the oligopoly.

29)

The EESC does not support mandatory rotation. As regards mandatory tendering please refer to our response to Question 18.

30)

The EESC supports the abolition of any artificial bias towards the ‘Big four’ firms, such as banking covenants. Mandatory assignment of tasks only to the Big Four should be prohibited. The Commission may consider introducing a scheme to certify the large company audit competence of the next rank of audit firms.

31)

There should be contingency plans for both Audit firms and national regulators. Audit firms are international networks. The best strategy would be to focus on containing any failure at the Member State level while maintaining the integrity of the rest of the network. Living wills would be the key to any containment strategy. Early warning of potential problems would facilitate the implementation of contingency plans.

32)

As in our response to Q 18, the EESC is adamant that any action contemplated in this area be subject to a profound impact assessment. As the future Asian superpowers expand worldwide, it is likely that their audit firms will follow their clients. Any government mandated action to force a change in the market for audit should be considered in a 20 year time frame. In addition, the potential impact of the law of unintended consequences should be seriously considered.

It is difficult to envisage a reversal, but the important thing is to enforce competition law in the audit market. The EESC would favour references to Member State competition authorities starting in Germany, the Netherlands and the UK. Competition authorities should also carefully scrutinise any proposed acquisitions by Big Four firms.

33)

Harmonisation of regulations and applicable laws would be a starting point. Introduction of ISA would also help. The variety of the tax, law and language in the 27 Member States is undoubtedly a barrier to full scale cross border mobility.

34)

Yes, but we should not underestimate the difficulties involved. It would be conceivable to have a European auditor passport for the area of statutory IFRS financial reporting. The decision as to which auditor or SA firm could receive such a passport must therefore be based on whether the auditing practice can or will carry out audits of IFRS financial statements.

35)

SMEs come in all shapes and sizes. If there are external investments and or important bank facilities and or major customers and suppliers concerned about the integrity of their value chains, it is difficult to envisage many short cuts. The work of a certified accountant could be adequate for a self financed micro enterprise.

36)

Yes, but the case for prohibition is not made.

37)

See question 35. Small companies have small simple audits anyway.

38)

Involvement with the G20 and the FSB but, to start with, the most important measure would be cooperation at the G8 level, with particular focus on close links with regulatory bodies in the USA.