Members of the European Parliament Committee on Legal Affairs (Juri) have confirmed by vote the directive and regulation document on European audit reform proposals, giving a green light to start negotiations with the European Council.
One of the key points of the document is the suggested mandatory audit firm rotation every 14 years. However, a last minute addition to the document states that if the audit is shared, that a comprehensive assessment of the audit engagement is performed by the audit committee or a public tendering process is carried out. The longest time for an audit engagement can be 25 years.
"The 25 year backstop auditor rotation position should provide added impetus for audit committees to exercise their role, without being so intrusive that it undermines their responsibility," ACCA technical director Sue Almond said in a statement.
Its original audit reform document, the European Commission proposed strict caps on non-audit services, which could have had drastic consequences for some of the larger accounting networks. But controversially, the Juri document does not limit the provision of non-audit services, which some might perceive as a win for the Big Four.
The Juri document states that as long as these services are approved by the audit committee, "and the statutory auditor or audit firm is itself satisfied that provision of those services does not pose a threat to the independence of the statutory auditor or audit firm" they can be offered to the audit client.
"The JURI report rightly suggests that the audit committee should be able to critically assess and approve the provision of additional non-prohibited non-audit services. We believe that the proposed new list of prohibited non-audit services, which is substantially in line with international standards, is sufficiently exhaustive to ensure that independence of the auditor is not threatened," Almond said.
The Juri's reapporteur on the audit reform Sajjad Karim said at a press conference following the vote: "I have said at the beginning that the maintaining of status quo not an option and we stuck to that. The report is a compromise and not everyone got what they wanted, but the outcome is a step towards a better audit market."
Karim said the proposals are not about strict intervention, but about changing mindsets.
"It's a move to nudge the market is the opposite of the European heavy handed approach initially proposed."
Karim said the audit reform document was not an easy brief and that it is paramount for the Parliament and the Council to go through a period of consolidation now.
"We feel the parliament is going to the negotiations strong," he added.
One of the most outspoken members of the Juri committee and a big supporter of mandatory rotation and joint audits, Spanish MEP Masip Hidalgo told the International Accounting Bulletin: "We have lost today but if the ballot would have taken place last week we could have won by one vote on some of the key changes"
"25 years is an eternity in terms of audit rotation. There won't be restrictions for non-audit services either and the proposal to encourage joint audits has been dismissed. The Big Four have given a blow to the reform of a market in need of competition."
Industry response
PwC UK head of regulatory affairs and public policy Pauline Wallace said many of the changes proposed by the Juri are "sensible and will improve the effectiveness of the draft legislation and enhance its impact on audit quality".
"However there are a number of measures, such as mandatory firm rotation, that are counterproductive to audit quality and need to be looked at further. Mandatory firm rotation damages audit quality, reduces choice and competition, increases costs for business and takes decision making away from audit committees and shareholders. This will have a negative impact on European business, particularly listed small and medium size companies which should be the engine of Europe's growth," Wallace said.
CIMA head of corporate reporting policy Nick Topazio echoed the concerns by saying, "we simply don't agree with the introduction of mandatory rotation of audit firms".
"There is no guarantee that the benefits of improved independence and objectivity that may result from changing audit firm will outweigh the costs of change. There is a high probability that a new auditor will have so much less knowledge about the company that it will take years for them to duplicate the understanding that previously existed with the incumbent auditor. As a result, investors and the public will be less, rather than more, protected," he said.
Grant Thornton International welcomed the document and said Juri has gone some way to address investor concerns about long auditor tenure at large companies by recommending a maximum period of 14 years for which their auditor may serve.
"We would expect that quality assessment and regular tendering should form a critical part of the appointment process with a maximum tenure of 14 years, and should not be retained by EU member states as valid grounds for extending maximum tenure."
"We strongly support EU member states retaining the proposed exemption to permit an increase in rotation period up to 25 years where the company uses more than one auditor," Grant Thornton international said in a statement.
BDO expressed disappointment over the vote but said it was not surprised by the outcome: "far from delivering the body blow that the European Commission originally intended them to be".
BDO said although the measures adopted by JURI were weaker than expected, "the surrounding debate has highlighted the desire to have greater competition and choice in the audit market".
BDO added the amendments acknowledge investors' concerns about "long auditor tenure and will undoubtedly lead to more frequent and transparent consideration of auditor appointments over time".
The Institute of Chartered Accountants for England and Wales chief executive Michael Izza said a number of the changes voted through by the MEPs seem to align the EU audit reform proposals more closely with international standards.
"We need a resolution and certainty over what the audit legal reform will entail. A lot of resources have been invested by a broad range of stakeholders in understanding the proposals' possible implications. The vote today takes us one step closer to the end; hopefully an agreement between Council and the full European Parliament, which together have the ultimate say in finalising the law, can be found soon," Izza said.
The final document and consolidated amendments are expected to be issued in full in a couple of weeks, but negotiations on the final regulation document with the European Council are now able to go ahead.