29.6.2012

EN

Official Journal of the European Union

C 191/61

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Opinion of the European Economic and Social Committee on the ‘Proposal for a Directive of the European Parliament and of the Council amending Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts’

COM(2011) 778 final — 2011/0389 (COD)

and the ‘Proposal for a Regulation of the European Parliament and of the Council on specific requirements regarding statutory audit of public-interest entities’

COM(2011) 779 final — 2011/0359 (COD)

2012/C 191/12

Rapporteur: Mr MORGAN

On 13 December 2011 the European Parliament and on 26 January 2012 the Council of the European Union decided to consult the European Economic and Social Committee, under Article 50 of the Treaty on the Functioning of the European Union, on the

Proposal for a Directive of the European Parliament and of the Council amending Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts

COM(2011) 778 final — 2011/0389 (COD).

On 15 December 2011 the European Parliament and on 26 January 2012 the Council of the European Union decided to consult the European Economic and Social Committee, under Article 114 of the Treaty on the Functioning of the European Union, on the

Proposal for a Regulation of the European Parliament and of the Council on specific requirements regarding statutory audit of public-interest entities

COM(2011) 779 final — 2011/0359 (COD).

The Section for the Single Market, Production and Consumption, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 17 April 2012.

At its 480th plenary session, held on 25 and 26 April 2012 (meeting of 26 April), the European Economic and Social Committee adopted the following opinion by 110 votes to 18 with 63 abstentions.

1.   Conclusions and recommendations

1.1   Following its Green Paper Opinion (GPO) on Audit Policy (1), the EESC expected that the existing Audit Directive 2006/43/EC (2) would be updated. In the event, the Commission proposes to update the directive in part but also to produce a regulation for the other part.

1.2   The EESC endorses the draft directive. It is consistent with the Committee's GPO. There are also many aspects of the regulation which the EESC does endorse.

1.3   The purpose of the regulatory format appears to be two-fold: to introduce fundamental changes onto the audit market and to prescribe in considerable detail the procedures relative to company audits and the relationships between the board and the audit committee.

1.4   Little account has been taken of the EESC recommendation that audit reform should be integrated with the recommendations on corporate governance. There is no discussion of the way in which both statutory auditors and audit committees should improve stakeholder and shareholder communication.

1.5   The Commission proposes to bring about fundamental changes to the audit market by mandatory rotation of statutory auditors after six years and by structural provisions involving non audit services aimed at capping the market share of specific firms in certain Member States.

1.6   Rather than addressing the state of the audit market with a regulation, the Committee proposed that there should be a reference to the competition authorities. These authorities are equipped to undertake full scale economic assessments and formulate appropriate remedies. In recent months the situation in the UK has been referred to the UK Competition Authority. As outlined in our GPO, the EESC would encourage Germany and Spain to take the same course of action. Nevertheless, the Committee recognises that the regulation will allow for more consistent audits of PIEs in Europe, which it considers to be of paramount importance for financial stability and a stronger internal market.

1.7   In its GPO the EESC did not support mandatory rotation of Statutory Auditors (SA). Instead, it proposed mandatory retendering of the contract every six to eight years. After due consideration of the new proposals, the EESC maintains that position, but welcomes other aspects of the regulation. Since the key audit partner is to rotate after seven years, the EESC proposes that the period for mandatory retendering should also be seven years.

1.8   In its GPO, the Committee expressed a very clear view on non-audit services: statutory auditors should not provide to their statutory audit clients any services which could create a conflict of interests for the statutory auditor, in other words, situations where the statutory auditor would be reviewing its own work. At the same time, statutory auditors should be free to provide the full range of non-audit services to non audit clients. The benefits of the experience gained would accrue to both audit and non audit clients.

1.9   The EESC disagrees with the proposal for audit only firms. The formula to determine when an audit firm is disbarred from offering any non audit services should be discarded. The Commission is concerned about the possible risks from firm dominance in three territories. The EESC recommends that the Commission tackle these few cases directly or via the relevant competent authorities and/or competition authorities.

1.10   As in any EESC opinion, the position of SMEs has to be considered. If an SME has shares listed on a stock exchange, it is defined as a public interest entity and therefore subject to the extensive and prescriptive provisions of the regulation which are clearly designed for the audit of banks. Point 4.1.1 contains an analysis of firms listed on the London Stock Exchange. London is further advanced than other EU exchanges in providing equity capital to small firms. Equity is more flexible than bank loans. Half of the firms listed in London should either have an exemption or derogation from this regulation, as should listed SMEs elsewhere in Europe.

1.11   Importantly, the EESC highlights that paragraph 2 in Article 14 strictly limits what stakeholders might otherwise have expected from the statutory audit and it raises a question about what the role of audit should be.

1.12   The regulation also cuts across the ethical, accounting and quality standards already operating in the industry and makes no reference to relevant standards development. Does the Commission intend to sideline the work of these bodies?

1.13   In conclusion, the EESC is fully supportive of the revised directive and it finds much in the regulation which it can support. The EESC has a major concern about the applicability of the regulation to SMEs and it recommends that the more radical proposals be given further consideration.

2.   Introduction

2.1   This opinion responds to two parallel Commission proposals: a regulation to increase the quality of audits of financial statements of public interest companies and a directive to enhance the single market for statutory audits. These proposals were developed following a wide ranging consultation based on the Green Paper on Audit Policy: Lessons from the crisis  (3). The EESC made a full response to the Green Paper and so this opinion draws upon that response.

2.2   There is an existing Audit Directive in place (2006/43/EC) (4). The Commission proposes to amend that directive with the new directive and to reinforce the audit of Public-Interest Entities (PIE) with the new regulation. As a consequence, it is proposed that the provisions on the statutory audits of PIEs in Directive 2006/43/EC (5) be deleted from that directive with statutory audits of PIEs being regulated by the new regulation.

2.3   Everything that the EESC would choose to say about the societal role of audit, the role of audit in the financial crisis, the market for audit services, etc., was said in the Committee's response to the Green Paper. This opinion concentrates on the detailed proposals included in the new legislative drafts.

3.   EESC perspective on the Directive

3.1   The main modifications to the Statutory Audit Directive are:

3.1.1

Articulation between the Statutory Audit Directive and an additional legal instrument on specific requirements for the statutory audit of PIEs;

3.1.2

Definition of ‘statutory audit’ in order to take account of the new accountancy directive;

3.1.3

Modification of the ownership rules; Member States should no longer require that a minimum amount of capital in an audit firm is held by statutory auditors or audit firms, provided that only the statutory auditors or audit firms involved have influence over the issuance of audit reports. Member States should nevertheless be able to decide on the appropriateness of such external equity participation with respect to national conditions.

3.1.4

Passport for audit firms;

3.1.5

Passport for statutory auditors and ‘softening’ the conditions for a statutory auditor to be approved in a different Member State;

3.1.6

Requirements to competent authorities to cooperate regarding educational requirements and aptitude test;

3.1.7

Auditing standards and audit reporting;

3.1.8

New rules regarding competent authorities; The EESC supports the establishment of Member State Competent Authorities to be the national independent regulators and supervisors and to be the national counterparties to ESMA. However, where competent independent auditor supervisory bodies (including chambers of public accountants and auditors) are already working well in Member States, the EESC would like to see these bodies equivalently enclosed into the new supervisory framework, and not abandoned.

3.1.9

Prohibition of contractual clauses influencing the appointment of statutory auditors or audit firms;

3.1.10

Special rules for the statutory audit of small and medium-sized undertakings.

3.2   The EESC supports all these changes. Most are consistent with the EESC GPO.

4.   EESC perspective on the Regulation

This section follows the structure of the regulation. Important paragraphs from the text have been reproduced or summarised and then annotated as needed with the opinion of the EESC.

TITLE I:   SUBJECT MATTER, SCOPE AND DEFINITIONS

4.1    Articles 1 to 3 - Subject matter, Scope and Definitions

4.1.1   In addition to credit institutions, insurance undertakings and all other financial services firms, PIEs are defined as all companies with shares listed on public stock exchanges. The EESC believes that the requirements of this regulation are excessive for SMEs. SMEs are defined by employment, revenue and or balance sheet. The Regulation uses market capitalisation to define large companies and the EESC proposes that market capitalisation should also be used to define SMEs for statutory audit purposes. Exemptions or derogations should be permitted for companies with market capital of up to EUR 120 m. An analysis of the companies listed on the London Stock Exchange is given below. The market capitalisation distribution will be similar in other EU exchanges. Similar consideration should also be given to financial SMEs whose activities are unlikely to have a systemic significance.

Constituent Company Equity Capitalisation (Converted at £1 = EUR 1,20)
	Main market: 985 companies Equity value: EUR 2 336 055 m			AIM Market:1 122 companies Equity value: EUR 85 107 m
Range (EURm)	Number of companies	% of companies	Market value %	Number of companies	% of companies	Market value %
Over 2 400	116	11,8	86,2	1	0,1	4,2
1 200-2 400	87	8,8	6,4	6	0,5	13,1
600-1 200	91	9,2	3,4	16	1,4	16
300 – 600	106	10,6	2	34	3	15,4
120 – 300	169	17,2	1,4	92	8,2	20,4
60 – 120	101	10,3	0,4	133	11,9	13
30 – 60	79	8	0,2	200	17,4	9,9
12 – 30	88	8,9	0,1	229	20,4	5,3
6 – 12	40	4,1	0	156	13,9	1,5
0 – 6	61	6,1	0	240	21,4	0,9
Other	47	4,7		15	1,3
> 120	569	57,7	99,4	149	13,2	69,3
< 120	369	37,5	0,6	958	85,4	30,7
< 60	268	27,2	0,2	825	73,5	17,7
< 30	189	19,2	0,1	625	55,7	7,8
Source: London Stock Exchange Web Site / Statistics

4.2    Article 4 - Large public interest entities

‘a)	The largest 10 issuers of shares in each Member State measured by the market Capitalisation and all issuers of shares that had an average market capitalisation of more than EUR 1 000 000 000 for the previous three calendar years;

b) and c)

Any finance industry entity which on their balance sheet date has a balance sheet total exceeding EUR 1 000 000 000;’

4.2.1   These definitions relate to the provisions of Article 10 paragraph 5.

TITLE II:   CONDITIONS FOR CARRYING OUT STATUTORY AUDIT OF PUBLIC-INTEREST ENTITIES

CHAPTER I:   Independence and Avoidance of Conflicts of Interest

4.3    Articles 5 to 8

4.3.1   The EESC supports these 4 articles in principle.

4.4    Article 9 - Audit fees

4.4.1   The EESC supports the proposals for transparency. However, the 10 % limit in paragraph 2 is arbitrary. The EESC proposes that services related to the audit (see 10.2 below) be part of the audit plan (see paragraph 4.16.2 below) and priced without arbitrary limits in the context of the audit overall.

4.5    Article 10 - Prohibition of the provision of non-audit services

4.5.1   In its GPO the EESC said that SAs should not provide to their statutory audit clients any services which would entail a conflict of interest. While there should be some debate about the nature of the services detailed in 3 (a) and (b) above, the EESC supports the intention of the regulation.

4.5.2   It is not possible to exclude the possibility that there will be circumstances in which it may make overwhelming sense for the SA to provide a service from items (i) to (v) of list (a) to its statutory audit client. An unavoidable event – force majeure – can occur; corporate catastrophes do happen. Services from list (b) may be provided at the discretion of either the AC or the competent authority. The same discretion should be available for items on list (a) in exceptional circumstances.

4.5.3   The EESC understands that the purpose of these provisions is to address the ‘dominant’ market positions of a Big 4 firm in the UK, Germany and Spain (a different firm in each case) and to act as a deterrent to building such positions in future. In its GPO the EESC proposed that market dominance be addressed by reference to competition authorities. An investigation is already under way in the UK. The EESC proposes that Germany and Spain should follow suit, pending the adoption of this Regulation.

4.5.4   The EESC does not support audit only firms. In our opinion, such a change is likely to have a detrimental effect on the quality of audit staff and on the quality of statutory audits. The EESC maintains its position that auditors should be free to provide a full range of non-audit services to entities other than statutory audit clients.

4.5.5   In its GPO, the EESC said that it supported the provision of certain non-audit services to statutory audit clients who were SMEs. Small firms will get better quality, service and value from a single advisor. The EESC maintains its position.

4.6    Article 11- Preparation for the statutory audit and assessment of threats to independence

4.6.1   Provisions supported by EESC.

CHAPTER II:   Confidentiality and Professional Secrecy

4.7    Articles 12 and 13

4.7.1   Provisions supported by the EESC.

CHAPTER III:   Performance of the Statutory Audit

4.8    Article 14 - Scope of the statutory audit

4.8.1   The EESC calls attention to the paragraph above because it strictly limits what stakeholders might otherwise have expected from the statutory audit and it raises a question about what the role of audit should be.

4.9    Article 15 - Professional scepticism

4.9.1   As in our GPO, the EESC supports the emphasis on professional scepticism.

4.10    Articles 16 to 20

4.10.1   The EESC supports the use of ISAs and the other provisions of Articles 16 to 20.

CHAPTER IV:   Audit Reporting

4.11    Article 21 - Results of the statutory audit

4.12    Article 22 - Audit Report

4.12.1   This report replaces the audit opinion which is presently published as part of the PIE's Annual Report and Accounts. Paragraph 2 specifies 23 elements (a) to (w) to be included in the 4 pages of this report. In its GPO the EESC was critical of the meaningless and boiler plate content of audit opinions, showing little variation from firm to firm and industry to industry. This report will reveal more, perhaps to the discomfort of the audited entities.

4.12.2   There is a requirement to name the audit team. For the largest PIEs, this could involve 100s of people. A report for a very large enterprise must surely be differentiated in scale and scope from that for a company 100th of its size. A number of the requirements seem to be out of step with international accounting standards. The regulation makes no reference to these standards.

4.13    Article 23 - Additional report to the audit committee

4.13.1   In the view of the EESC, it is improbable that audited entities would make a full disclosure of this report. The EESC considers that it should be communicated to the company's social partners, in compliance with the different national systems for the involvement of workers.

4.13.2   This report is based on the long form report used by audit firms in Germany. Its use throughout the EU should improve both the quality of the statutory audit and the audited entity's response to the audit. The EESC supports this report.

4.14    Article 24 -Oversight of the statutory audit by the audit committee Article 25 - Report to supervisors of public-interest entities

4.14.1   Articles 24 and 25 are consistent with the EESC GPO.

CHAPTER V:   Transparency Reporting by Statutory Auditors and Record Keeping

4.15    Articles 26 to 30

4.15.1   Chapter V is consistent with the EESC GPO.

TITLE III:   THE APPOINTMENT OF STATUTORY AUDITORS BY PUBLIC INTEREST ENTITIES

4.16    Article 31 - Audit Committee

4.16.1   Paragraph 1 is completely in line with the recommendations of the EESC in its GPO, given that ‘as a whole’ does not mean ‘all’.

4.16.2   Paragraph 5 details the responsibilities of the audit committee. The EESC suggests two further responsibilities: approval of the plan for the audit, including the provision of audit related services and approval of the related budgets.

4.17    Article 32 - Appointment of the statutory auditors

4.17.1   Whatever the duration of the audit assignment, these guidelines are potentially useful for large PIEs but, as they stand, they are excessively prescriptive for SMEs. SMEs will often not follow the process at (a) and will usually employ second, or third, tier firms. SMEs will feel that they have the freedom at (b) and (d). SMEs will not usually prepare formal tender documents, may often not solicit competitive tenders and will feel no responsibility for explaining themselves to competent authorities. Paragraph 5 does not apply to SMEs. These rules are designed for banks, not SMEs. SMEs will not require input from the galaxy of institutions cited in para 10 in order to arrange their affairs.

4.17.2   There is a requirement that the invitation to tender be sent to at least one second tier firm. This can give second tier firms access to larger clients but there are clearly many issues to be resolved by all the second tier firms which collectively only have the resources to respond in a limited number of instances.

4.18    Article 33 - Duration of the audit engagement

4.18.1   In its GPO the EESC did not support mandatory rotation of SAs. Instead, it proposed mandatory retendering of the contract every six to eight years. After due consideration of the new proposals, the EESC maintains that position, but welcomes other aspects of the regulation.

4.18.2   Since the key audit partner is to rotate after seven years (4 below), the EESC proposes that the period for mandatory retendering should also be seven years. There is an issue as to whether the incumbent SA should have a fixed tenure of seven years. In many Member States, the SA is reappointed each year and the Regulation should contain the option to continue this practice. Accordingly there should be flexibility relative to tenure in the seven year period, but mandatory retendering would be required after seven years of continuous tenure. The EESC emphasises that when the mandatory retender is triggered, the proceedings must be transparent and that, in the case of credit institutions, the competent authority must approve the outcome.

4.18.3   This rotation was supported in the EESC GPO but the gradual rotation of the rest of the ream should be at the discretion of the statutory auditor.

4.19    Article 34 - Dismissal and resignation of the statutory auditors

TITLE IV:   SURVEILLANCE OF THE ACTIVITIES OF AUDITORS AND AUDIT FIRMS CARRYING OUT STATUTORY AUDIT OF PUBLIC-INTEREST ENTITIES

CHAPTER I:   Competent Authorities

4.20    Articles 35 to 39

4.20.1   The EESC supports the provisions relating to competent authorities.

CHAPTER II:   Quality Assurance, Investigation, Market Monitoring, Contingency Planning and Transparency of Competent Authorities Tasks

4.21    Article 40 to 44

4.21.1   The proposal that the competent authorities should work with the largest firms in each jurisdiction to develop contingency plans is consistent with the EESC GPS.

CHAPTER III:   Cooperation between Competent Authorities and Relations with the European Supervisory Authorities

4.22    Articles 45 to 56

‘a)

The regulation requires that the EU-wide cooperation between competent authorities takes place within ESMA, thus taking over the current EU-wide cooperation mechanism under the aegis of the European Group of Auditors' Oversight Bodies (EGAOB). ESMA should issue guidance on several issues: e.g. on the content and presentation of the audit report and the additional report to the audit committee, on the oversight activity of the audit committee or for conducting quality assurance reviews.

b)	Under the auspices of ESMA, A “voluntary” pan-European audit quality certification is to be introduced to increase the visibility, recognition and reputation of all audit firms having capacities to conduct high quality audits of PIEs.’

4.22.1   The EESC endorses this proposal.

CHAPTER IV:   Cooperation with third country auditors and with international organisations and bodies

4.23    Articles 57 to 60

4.23.1   The EESC endorses the proposals contained in Chapter IV.

TITLE V:   ADMINISTRATIVE SANCTIONS AND MEASURES

4.24    Article 61 - Administrative sanctions and measures

4.25    Article 62 - Sanctioning powers

4.26    Article 63 - Effective application of sanctions

4.27    Article 64 - Publication of sanctions and measures

4.28    Article 65 - Appeal

4.29    Article 66 - Reporting of breaches

4.29.1   In its GPO the EESC had envisaged the establishment of a professional disciplinary body in each Member State. The Committee supports these proposals. In effect, these proposals provide for ‘naming and shaming’ in cases of malfeasance.

TITLE VI:   DELEGATED ACTS, REPORTING AND TRANSITIONAL AND FINAL PROVISIONS

4.30    Articles 68 to 72

4.30.1   A transitional regime is introduced regarding the entry into force of the obligation to rotate audit firms, the obligation to organise a selection procedure for the choice of audit firm and the establishment of audit firms that only provide audit services.

4.31    ANNEX: I. Breaches by statutory auditors or key audit partners

The breaches envisaged are essentially procedural and administrative relating to: conflicts of interest, organisational or operational requirements, the performance of the statutory audit, audit reporting, disclosure provisions, the appointment of statutory auditors or audit firms by public-interest entities and quality assurance. It is not clear how an auditor failure (such as the recent failure to pick up JP Morgan mishandling of client funds) will be handled under these provisions.

4.32    ANNEX II. Breaches by PIEs

The breaches envisaged relate to the appointment of statutory auditors or audit firms.

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(1)  OJ C 248, 25.8.2011, p. 92.

(2)  OJ L 157, 9.6.2006, p. 87.

(3)  COM(2010) 561 final.

(4)  OJ L 157, 9.6.2006, p. 87.

(5)  See footnote 4.

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