Implications of the European audit reform

After the financial crisis of 2008, it became essential to restore investors’ confidence in audits by eliminating conflicts of interest, ensuring independence, providing sound supervision and facilitating greater competition in what is an overly concentrated market.

The publication of a Green Paper in 2010 entitled 'Audit Policy: Lessons from the Crisis' helped materialise this objective and constituted a stepping stone, setting off a three-year legislative process that led to a final agreement and proposal which was formally voted in by the European Parliament on April 3, 2014.

What does this reform entail? In a nutshell, this EU reform proposes to lay down the framework for the creation of a Single European Audit Market. This will be done through the adoption of two measures. The first refers to the amendment of Directive 2006/43/EC, which applies to all statutory audits, by means of the introduction of Directive 2014/56/EU. This directive would need to be transposed into national law by each member state. The second is a new EU regulation (No 537/2014) which introduces requirements governing statutory audits of Public Interest Entities (PIEs). This would automatically apply throughout the EU without needing to be transposed into member state law. Member states have a two-year window in which to implement the relevant directive and regulation.

What do these changes imply? The spirit behind the reform lies primarily in a desire for reinforced governance by increasing the role of the Audit Committee and introducing a fair and transparent tendering process for the selection of the auditor(s). Proponents of the reform also call for a more elaborated audit report, with the requirement of additional reports. The reform is also a reaction to the need for a system of mandatory rotation of audit firms, and which recognises that joint audit is a system with merits. It is also an effort aimed at highlighting prohibited non-audit services and introducing a threshold on permitted non-audit services provided by the audit firm.

Finally, at a supranational level, the new measures create the space for the setting up of a Committee of European Auditing Oversight Bodies to oversee cooperation between national audit oversight bodies.

Why is this reform so important? Stakeholders backing this reform believe that its effective implementation by member states will be fundamental in ensuring a secure environment in which companies will have the opportunity to improve external control of their financial information. Moreover, investors will be more confident that they are being provided with better and more secure financial reporting. From a European perspective, greater choice, innovation and easier market access should promote the emergence of a competitive and secure European market, reinforced by a European oversight system.

If one were to consider the implications of this audit reform from a local perspective, it is very clear that stakeholders will be affected in different ways. PIEs such as banks, insurance companies and listed companies will need to reinforce their corporate governance structures, while both auditors and PIEs will need to deal with the requirements relating to the introduction of audit rotation and the provision of non-audit services. This implies that local stakeholders cannot sit back and wait, but should rather start gearing up to meet future challenges and opportunities.

This article first appeared on The Times of Malta on 17 March 2015 - Written by Paul Giglio, Tax and Assurance Partner at Forvis Mazars Malta.