THE EUROPEAN Commission is on the verge of spearheading the most radical shake-up of the audit profession in decades, but some believe it fails to go far enough and are calling for more layers of regulation.
Director general for the internal market and services division of the EC, Jonathan Faull, was questioned before the parliamentary economic affairs committee, to find out exactly what the European proposals meant, and why they didn’t go far enough on some issues.
Faull sat through over an hour of grilling on the draft audit reform proposals. The committee started its questioning with one of the biggest concerns: financial services audits, in particular why bank auditors didn’t properly communicate their concerns to the regulators before the financial crisis.
Ex-chancellor of the exchequer Lord Lawson (pictured), one of the committee members, was particularly keen to see tougher enforcement on this issue. He introduced discretionary legislation to enable bank auditors to share information with regulators in private, when he was chancellor more than two decades ago. However, the committee believes the principle failed to be utilitised, and “few” discussions were conducted in the run up to the 2008 financial crisis. It now wants to ensure this interaction takes place through enforceable rules.
EC’s half-hearted approach
The committee felt the EC had made a “half-hearted” approach in its proposals to enforce a direct line of communication between auditors and regulators and was “puzzled” it did not include statutory obligation for regulators and bank auditors to share concerns with each other.
An excuse offered up by the committee as to why the discretionary route had failed was because auditors wanted a quiet life and regulators were very busy – so failed to make enough effort to communicate with each other. But, if it was enforceable under the EC’s new audit proposals, attitudes in the future would be different, believes the committee.
Faull said the European parliament, which is about to debate the proposals, would consider the points made. But the committee pushed harder, arguing proposals were more likely to be “watered down” in European parliament than strengthened.
The committee wanted to drive home that they felt auditors camouflaged the seriousness of the financial crisis, and if they been more transparent and communication more commonplace, the crisis would have been revealed earlier and action taken sooner.
Faull, however, argued that “camouflaging” was no longer the case – if it ever was. He also added the audit proposals are aimed at all companies, not just the financial services sector.
Game of monopolies
The committee moved on, wanting more clarification over how the Big Four monopoly could be broken. Faull said he hoped the proposals would improve conditions to enable other firms to get a look in at winning big company audits – but implied it was not the EC’s place to change market conditions.
However, he hoped some elements of the proposal would allow smaller firms to obtain experience in large company audits. Although joint audits are not mandatory, it is encouraged in the proposals.
Currently the proposals set out that companies must change auditor every six years, unless they opt for joint audits which would allow them to keep the same auditors for up to nine years.
Another touchy subject was the possibility of a collapse or merger among the Big Four, and the EU’s role during such circumstances. Faull was pushed on Europe’s potential action if four became three – he warned that a collapse would have “systemic consequences”, outside the control of regulation.
However, if a merger was to take place that would be an issue for competition law and not the EC.
He also pointed out that the commission does not have the power to alter the market – again this is something for competition authorities to look at, which he understood the UK was already undertaking.
Faull seemed to imply that two biggest audit reform issues for the UK – better communication between regulators and auditors in financial service companies; and breaking the Big Four monopoly – would be left to the UK authorities to deal with.
The UK’s imminent exit from the EU that may now put the audit committee to the ultimate test
Audit tendering has turned from good practice to legal practice under the EU audit reforms
Businesses will have to think more strategically about where they can source those non-audit services in the future
The FRC has raised concerns that the FTSE 350 audit market remains highly concentrated among the Big Four despite high levels of tendering and rotation