EU - Audit reform proposals get go-ahead

10 Apr 2014

After two years of intense discussions, the European Union institutions have reached a political agreement on the European Commission audit reform proposals.

The legislation – composed of a directive and a regulation - means that mandatory rotation of statutory audit firms will be introduced into the EU on a ten yearly basis for all public interest entities. There will also be additional restrictions on the non-audit services that audit firms can provide to their audit clients.

It is expected that the provisions of the legislation will apply two years after they enter into force – in mid-2016. Mandatory firm rotation will be the exception, which due in part to its sheer scale and resulting impacts, will be subject to transitional arrangements.

The Council of Ministers of the EU will need to formally approve the texts before the proposals become law, but this adoption of the proposals by plenary vote in the EU Parliament on 3 April marks more or less the final hurdle for the legislation.

“A number of aspects of the new legislation and in particular those that strengthen the role of audit committees in governance and create greater transparency will enhance audit quality” said Richard Sexton, Global Assurance leader at PwC International. But referring to the principle of ten-yearly audit firm rotation he added: “We remain concerned that other changes will have the effect of reducing competition and shareholder choice.”

On agreement of the draft legislation in January, Mr Sexton had commented that: “It is hard to see how forcing companies to change auditors periodically does anything to improve audit quality…By definition mandatory firm rotation reduces competition and choice.”

There is also concern that the annual 70% cap on non-audit services and the far-reaching restrictions on the provision of non-audit services is not in the interest of investors or the markets.

Following the April vote, Mr Sexton emphasised that ensuring audit quality and strengthening the role of the audit committee is key to ensuring transparency and competition. “Audit committees and shareholders are best place to decide who their auditors and non-audit service providers should be – and this legislation takes power away from them” he said. He then urged a review of the effectiveness of the measures after an appropriate period.

The regulation contains as many as 21 member state options which may lead to a patchwork of rules across the EU, both in the terms of the period for rotation and which services are prohibited.

“The fact that the political discussions have been finalised does not mean that work is now complete” said Mr Sexton. “A great deal remains to be done to ensure that the changes are implemented with clarity, consistency and the minimum of disruption and cost to business and investors.”

Stakeholders are being encouraged to engage with their respective governments to input on the best possible use of the member state options.