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EU audit reform

14 December 2015

Following a long drawn-out process over a number of years, the EU finally agreed a package of measures under the umbrella of Audit Reform. These include wide-ranging changes affecting companies of all sizes and their auditors, together with the bodies charged with the regulation of auditors and the audit market. The overall aims of the measures were to improve harmonisation of approach across the EU, improve audit quality and improve competition in the audit market (particularly at the top end).

The measures were encompassed principally in Directive 2014/56/EU which amends Directive 2006/43/EC (the Audit Directive) and in Regulation (EU) 537/2014 (the Audit Regulation). Requirements of the Directives must be transposed into UK law, whereas those of the Audit Regulation apply directly to statutory audits of public interest entities (PIEs). The effective date for implementation of the requirements is 17 June 2016.

To implement the various requirements, a number of bodies are consulting on new rules and regulations,

Department for Business Innovation and Skills

The BIS consultation includes:

  • The Government’s intention not to include additional entities in the definition of a PIE. This means that PIEs will only be those entities with securities admitted to trading on a regulated market, banks, building societies, and insurers. Companies traded on AIM will not be PIEs.
  • A requirement that all PIEs put their audit out to tender at least every 10 years and change their auditor at least every 20 years. Transitional arrangements will apply for PIEs who first appointed their current auditor in the 13 years up to the application date for the Regulation.
  • The underpinning legislation needed for the FRC to introduce changes in ethical and technical standards for auditors as part of the implementation of the new Directive and Regulation.

The draft legislation also includes measures to nullify any agreement with a third party that restricts an audit client’s choice of auditor (a measure was recommended by the Competition and Markets Authority (CMA) as well as the EU).

Further provisions will be included in the final implementing regulations. These will cover:

  • Removal of auditors of PIEs by application to the court by the competent authority (the FRC) or a sufficient minority of shareholders or members
  • Application of the implementation of the 2006 Directive (as amended) to additional entities (other than companies) audited under EU law
  • The reporting by auditors of PIEs to supervisory authorities
  • The role of competent authorities in relation to the functioning of the audit market for PIEs.

Financial Reporting Council

The FRC’s consultation is also fairly wide-ranging. Changes to auditing standards will incorporate requirements of the Audit Directive and Regulation applying in particular to the audit of PIEs. At the same time, the FRC will take the opportunity to update the standards to reflect changes to international standards regarding the audit of disclosures in the financial statements and the content and format of the auditor’s report. Changes will also be made to quality control requirements to which auditors are subject.

A revised Ethical Standard for audit and other public interest assurance engagements is also proposed, incorporating changes required by the Audit Directive and Regulation. The standard covers matters such as how independence of the auditor might be judged, the role of the firm in ensuring ethical conduct, and prohibitions and limits on non-audit services in line with the new requirements. However, the FRC believes that investors’ confidence is enhanced by existing, more stringent UK requirements and, therefore, proposes to retain those requirements where possible.

Further changes to the UK Corporate Governance Code (the Code) are also proposed, to reflect new legislation governing audit retendering for PIEs and to align it with the Audit Directive and Regulation regarding the composition and role of the audit committee. Rewritten ‘Guidance on Audit Committees’ will take account of amendments to the Code and regulatory framework, and recommendations put forward by the CMA, many of which coincide with amendments made by the Audit Regulation and Directive. There are changes to the composition of the audit committee covering sectoral competence; removal of references to audit retendering; changes covering new rules around the prohibition of non-audit services; and consequential changes reflecting amendments to the Ethical and Auditing Standards. The guidance also includes reporting by audit committees of significant matters arising from FRC inspections and reviews.

Financial Conduct Authority and Prudential Regulation Authority

FCA and PRA consultations apply only to those entities subject to regulation by one or both bodies and relate largely to composition and function of the audit committee. The FCA’s consultation also includes proposed amendments to corporate governance rules in the Disclosure and Transparency Rules to reflect transposition of the EU Accounting Directive 2013/34/EU.

Not all the details are yet finalised, but it is clear that there are significant changes in the pipeline. While the most significant changes are aimed at PIEs and their auditors, all audits and auditors will be affected to some extent, and the changes are likely to significantly change the nature of the audit market for listed companies and other PIEs.

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