Written by Hywel Ball, EY’s Managing Partner of Assurance, UK & Ireland
NOW that EU audit reforms are finally implemented in the UK, companies affected by them are getting to grips with the detail. Many are likely to be encountering the full implications of these changes for the first time. Indeed one aspect in particular, related to the task of mandatory audit firm rotation, seems to have caught some companies by surprise.
Audit tendering is nothing new of course, and many companies – particularly those in the FTSE 100 – tendered in anticipation of the reforms. This was done in the knowledge that they will be required to tender more frequently in the years to come. However, there is an aspect to this which is new for everyone.
The tendering process, and related responsibilities on the part of the directors and audit committee, are now prescribed in law. As far as we know this is a first for the UK and a significant departure from the received wisdom of best practice and guidance that predates the reforms. The intention is to make audit market competition more open, fair and transparent.
The EU reforms require audit tenders to be “competitive”. This change, like others introduced in the EU audit reforms (e.g., audit firm rotation and transition rules), is implemented via amendments to the UK Companies Act 2006. The tendering requirements can be summarised as follows.
The audit committee must first undertake an audit firm selection procedure. This requires the committee to identify its first and second choice candidates for appointment, with explanations for each one (i.e., why they prefer one firm over the other). The committee also has to give written assurances that their recommendation is free from influence by a third party, and that no contractual arrangements have been introduced to limit the selection procedure (e.g., a bank covenant that requires the company to only appoint auditors from a certain size/category of firm (e.g., the Big Four).
Once the committee has agreed on its choices, it has to make its recommendation to the board of directors (including the information mentioned above). The board in turn is required to propose an auditor or auditors for appointment. This must include the recommendation made by the audit committee or, if the directors’ proposal departs from the preference of the committee, the reasons for not following that recommendation.
Given that UK law also states that the tendering process should ‘substantially meet the requirements of Article 16(2) to (5) of the EU Audit Regulation’, companies should also be mindful that the tender process does not in any way preclude the participation of smaller firms (i.e., firms which received ‘less than 15 % of the total audit fees from public-interest entities in the member state concerned in the previous calendar year’). Notice should also be taken that tender documents ‘shall contain transparent and non-discriminatory selection criteria that shall be used by the audited entity to evaluate the proposals made by statutory auditors’.
Apart from outlining how the tender will be undertaken, the law states when it should be undertaken. The reason for this is twofold.
Firstly, the UK government took up an option in the EU reforms for companies to extend their audit tenures from ten years to a maximum of twenty, on the proviso that a “competitive tender” takes place on or before the tenth year of tenure. Companies have the flexibility to decide when that tender should take effect (i.e., the tender process can be for any accounting year up to and including the year following the end of the ten year maximum).
Secondly, the EU reforms come with a set of transition rules, stating when companies caught by the legislation have to switch their auditor for the first time in the new regime. If the external auditor was appointed between 17 June 1994 and the 16 June 2003, the PIE (see footnote 1) needs to appoint a new auditor for financial years beginning on or after 17 June 2023 at the latest. If the PIE appointed its external auditor before 17 June 1994, it needs to appoint a new auditor for financial years beginning on/after 17 June 2020 at the latest.
It should be noted that there are no transitional provisions if the external auditor was first appointed on or after 17 June 2003. For example, if the auditor was appointed between 17 June 2003 and 16 June 2006, the PIE is required to re-tender the audit for financial years beginning on or after 17 June 2016. If the auditor was appointed later (e.g., for 31 December year-end 2009) the audit would have to be re-tendered 10 years hence (e.g., in 2019).
Before these new laws were enacted an Order was issued from the Competition and Markets Authority (CMA) in 2014, requiring UK incorporated FTSE companies to announce the date of their upcoming tenders. This requirement still stands and is now also reflected in the UK Corporate Governance Code 2016, and the FRC’s Revised Guidance on Audit Committees 2016.
These disclosures should be helpful for companies and audit firms alike, who need to keep a broad perspective on the rate of tenders over a given period of time so they can plan ahead accordingly. Similarly, investors will be interested to know if there are any issues or concerns behind a change in the timing of a tender, and those interested in this may also wish to engage with the company as it undertakes the tender process.