On 3 April 2014, the European Parliament adopted modifications to the Statutory Audit Directive (Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts, hereinafter the "Directive") and a new Statutory Audit Regulation on specific requirements regarding statutory audit of public-interest entities  (hereinafter the "Regulation"). After the 16-17 December 2013 tripartite compromise between the Commission, the European Parliament and the European Council, this is an important step towards the entry into effect of the new rules on audits. This newsletter provides a brief summary of the background to the Directive and the Regulation and highlights their key provisions.

Context

Since the European Commission's launch of the Green Paper consultation on audit policy and lessons from the crisis on 13 October 2010, NautaDutilh's dedicated team has been following this subject closely and updating our clients through newsletters and seminars, in cooperation with other actors in the sector (such as the FEE and IBR-IRE). The first legislative texts proposed by the Commission on 7 December 2011 were long awaited by the sector and stakeholders (e.g. 688 respondents provided comments on the 2010 Green Paper, while the 2011 conferences organised by the European Commission were significantly overbooked).

At several events, members of our team personally experienced how important Commissioner Michel Barnier believes the new regulatory framework on audits to be and how he repeatedly demonstrated his personal commitment to bringing about change. All relevant discussion documents, conference materials and much more information can be found on the European Commission's website. On 17 December 2013, the European Council published a 500-page document comparing the Commission's initial proposal, the amendments made by the European Parliament, the results of the COREPER mandate and, finally, the compromise text.

Compromise reached on 17 December 2013

After lengthy discussions and amendments to the initial text, the European Commission, the European Parliament and the European Council reached a formal agreement on two proposals, meaning there will be no second reading. The first reading took place on 25 February 2014, with adoption scheduled for 3 April 2014, before the end of the European Parliament's current session. After approval by the European Parliament, the text will be sent to the Council for approval. Publication in the Official Journal is foreseen for the second quarter of 2014.

Issues to be resolved

During the four-year discussion period, a number of issues were raised, the most important being:

  • the auditor's role and how auditors can provide reasonable assurance while efficiently communicating with stakeholders using the International Standards on Auditing (ISA);
  • the governance and independence of audit firms: how to deal with conflicts of interest when no binding rules on auditor remuneration or rotation exist;
  • the supervision of the transparency of audit firms with respect to fees, additional non-audit services and the cross-border management of audit network operations;
  • the systemic risk caused by the concentration of audit work in the hands of a few players, resulting, amongst other factors, from "Big Four only clauses" and difficult market entry for smaller audit firms;
  • the creation of a truly European single market for audit services enabling cross-border cooperation without approval, registration and aptitude testing in each Member State;
  • the need to adapt the current rules to meet the needs of small and medium-sized companies and practitioners;
  • international cooperation on a European and third-country level.

Most important changes in the final compromise of 17 December 2013 and the adopted texts of 3 April 2014

Commissioner Barnier stated on 17 December 2013 that, even if the agreement reached between the European Parliament and the European Council was less ambitious than initially foreseen, auditors will be key contributors to economic and financial stability.

  1. Obligatory rotation of the auditors and audit firms of public interest entities (PIEs) every 10 years

The purpose of this measure is to reduce excessive familiarity between the auditor and the audited entity and enhance professional scepticism. One extension of the ten-year term is possible in the event of public tendering. The maximum term of the engagement could be 24 years for joint audits involving more than one audit firm. The Regulation provides for transitional arrangements. Please note that this period is much longer than the Commission's originally proposed term of six years. It should further be noted that Member States may provide for a maximum term of less than ten years. In the Netherlands, for example, a rotation period of 8 years will enter into force. The rotation periods of the Member States may influence cross-border audits involving auditors from multiple Member States. Indeed, as multinationals usually prefer to work with a single audit firm (or network) for all their subsidiaries, it is expected in this case that the shortest rotation period applicable in a given Member State will apply to individual auditors from other Member States.

  1. Stricter conflict-of-interest rules

In order to avoid auditors reviewing their own work (self-review), a series of non-audit services are prohibited and blacklisted (including stringent limits on the provision of tax advice and services linked to the client's financial and investment strategy). Please note that the Member States have the option to allow auditors to perform certain blacklisted services, provided the applicable conditions are met (e.g. self-review, materiality test and independence). Moreover, a 70% cap on fees for the provision of non-prohibited non-audit services is introduced, at the level of both the individual entity and the group. In this regard, it may be difficult to predict the fees for audits and other services to be provided over the course of a year by the members of audit firms in various countries, to various subsidiaries of the audited entity.

  1. Prohibition on "Big Four only" clauses

Any contractual clause restricting the choice of the general meeting of shareholders or members to certain categories or lists of auditors or audit firms, with respect to the appointment of the statutory auditor or audit firm, shall be prohibited. Existing clauses of this type shall be deemed null and void. However,  experience in Italy and the Netherlands demonstrates that the obligation to rotate the auditor tends to favour the Big 4 firms. Therefore, the objective of encouraging the involvement of smaller audit firms will most likely not be met.

  1. Enhanced role for the audit committee

Where applicable, the audit committee should issue guidelines with respect to non-audit services to which the materiality test applies. Moreover, the audit committee's recommendation should include at least two possible options for the choice of auditor. The audit committee will also have to adhere to stricter rules e.g. with respect to independence and technical skills.

  1. Enhanced cooperation between audit supervisory authorities and harmonisation of the International Standards on Auditing (ISA)

While ESMA was not retained as the core structure for coordination, it received an initial mandate on international cooperation, within the Committee of European Auditing Oversight Bodies (CEAOB). These rules will help to create a level playing field for auditors at the EU level and enhance cross-border mobility. As supervision is not equally as stringent in all Member States, it is expected to become stricter due to enhanced cooperation.