The legislative process and timing
The European Commission, Parliament and the Council of Ministers reached agreement in trilogue discussion on 17 December on draft legislation to reform the audit market within the EU. The draft was subsequently approved by a vote of the JURI (Legal Affairs) Committee on 21 January and a parliamentary plenary vote is scheduled for early April.
This means that it’s now highly likely that the new legislation will be introduced later this year. Although at that point the new legislation has official stature, no provisions will become binding until two years later, in mid-2016.
The draft legislation consists of a directive and a regulation, both of which contain numerous member state options. In the UK, constraints on parliamentary time pre-general election will probably mean that primary legislation to introduce the new rules will not be brought to parliament until after the election, possibly in early 2016. BIS will work closely with the FRC in drafting the necessary UK legislation and is planning to hold a public consultation process during 2014.
The number of member state options in the draft legislation, together with the ambiguity of much of the drafting, means that extensive interpretation will be needed. This creates the risk of different application in each of the 28 member states. This will increase the complexity for business and the audit profession in responding to the new requirements.
The sections below highlight the areas of greatest uncertainty.
Restrictions on non-audit services
The new legislation restricts the non-audit services that can be provided by the auditor of a public interest entity, and by the auditor’s network firms. These restrictions will apply from mid-2016 and have the potential to be much more stringent than the current regime in the UK.
In this area, there are a number of options for member states and national supervisors (the FRC in the UK) whereby they can make national application less onerous or more stringent. There will also be a need for national guidance on interpreting the text where it is imprecise.
Fees received for non-audit services will not be allowed to exceed 70% of the audit fees received (there is some ambiguity around the precise operation of this cap). There is also a list of non-audit services that cannot be provided to public interest entities, or to parents and subsidiaries in the EU. These were summarised in the January briefing.
Mandatory audit firm rotation
The core legislation mandates that the maximum period for which a firm can be appointed auditor of a public interest entity is 10 years. Member states can choose to make this period shorter, or they can choose to allow extensions: to 20 years if a competitive tender is held at the 10 year point, or to 24 years in the case of a joint audit appointment. Transition arrangements vary depending on the length of time auditors have been incumbent, with the first rotations required in 2020.
The audit proposals have now reached almost the final stage of their passage through the EU institutions. The focus now shifts to issues of national implementation and the corporate community should be prepared to engage with the BIS and the FRC in the coming months on matters such as the exercise of member state options.
There remain significant areas of ambiguity in the current text. Some of these may be corrected or clarified as the legislation is finalised. It is important that Management teams exercise caution in interpreting the current wording in the proposals.