1 Audit policy
(32116)
15274/10
COM(10) 561
| Commission Green Paper: Audit Policy — Lessons from the Crisis
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| Legal base | —
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| Department | Business, Innovation and Skills
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| Basis of consideration | Minister's letter of 10 December 2010
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| Previous Committee Report | HC 428-viii (2010-11), chapter 2 (17 November 2010)
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| To be discussed in Council | No date set
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| Committee's assessment | Politically important
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| Committee's decision | For debate in European Committee B
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Background
1.1 According to the Commission, the measures adopted
in the aftermath of the financial crisis have focussed on the
need to stabilise the financial system, with limited attention
having been given so far to how the audit function could be improved.
It says that some of the failings in the way in which the activities
of banks and others have been audited raise questions about the
adequacy of the present legislative framework, and it therefore
put forward in October 2010 this Green Paper to open up a debate.
1.2 As we noted in our Report of 17 November 2010,
the Commission identified seven headings for discussion —
the role of the auditor (covering assurance for stakeholders,
auditor behaviour, qualified audit reports, better communication,
and Corporate Social and Environmental Responsibility); the governance
and independence of audit firms (including appointments and remuneration,
mandatory rotation, non-audit services, publication of financial
statements, organisational requirements, ownership rules and the
partnership model, and group audits); the supervision of auditors;
the configuration of the audit market (including joint audits
and audit consortia, mandatory rotation and re-tendering, addressing
the "Big Four" bias, contingency planning, and a re-assessment
of previous consolidation); the creation of a single market for
the provision of audit services; the simplification of rules for
small and medium sized enterprises (SMEs) and practitioners (SMPs);
and international cooperation for the supervision of global audit
networks.
1.3 We were told by the Government that, in its response
to the Commission's consultation, the Government would say that
it is wary of large and risky changes which could impose large
costs and have uncertain effects, and that it would suggest more
targeted proposals which would be likely over time to make the
audit market less concentrated, improve the content of information
about risks in company accounts, or reduce unnecessary burdens
on business. It added that these might include mandatory re-tendering
for appointment as auditor every five years; greater emphasis
on the role and content of the report of the Audit Committee,
rather than the report of the auditor; and examination of audit
thresholds to make audits for some, if not all, medium sized companies
voluntary.
1.4 In drawing the Green Paper to the attention of
the House, we said that we did not feel able to reach any more
definite conclusions on the basis of the relatively brief remarks
provided by the Government, but that we assumed its comments to
the Commission would expand on these points. We therefore asked
the Government to let us see its response to the Commission, adding
that we would at that point consider the document further.
Minister's letter of 10 December 2010
1.5 We have now received from
the Minister for Employment Relations, Consumer and Postal Affairs
at the Department for Business, Innovation and Skills (Mr Edward
Davey) a letter of 10 December 2010, enclosing a copy of the Government's
response to the Commission, and the main points in it are summarised
at Annex A.
Conclusion
1.6 We are grateful to the
Minister for this information, which tends to confirm our initial
view that this Green Paper contains a number of potentially significant
recommendations, which it would on balance be right for the House
to consider at this relatively early stage. We are therefore recommending
the document for debate in European Committee.
Annex: Main Points from UK Response
to the Commission's Green Paper on Audit ~
Veracity and quality of audit
The Government believes that audit has an important
role, but that it is one element in a multi-faceted regime of
corporate governance and regulation, alongside accounting standards,
dispersed ownership, risk management committees, audit committees,
internal auditors, credit ratings, insurance markets, investment
analysts, or additional disclosures above those mandated by accounting
standards, the law and regulatory and supervisory bodies. It also
says that the benefits of audit vary according to company size,
and that there is no unambiguous evidence that mandatory audit
provides a benefit across the whole economy: on the other hand,
it suggests that, where a company has an audit voluntarily, it
benefits because of the signalling effect, and that the bigger
the company, the more likely it is to have voluntary audit. It
also says that the role of audit varies according to the sector
involved, there being a clear need for the prudential supervision
of key financial institutions.
As regards audit quality, the Government says that
this might be enhanced by improving auditor scepticism, and the
content of the report of the audit committee of listed companies.
However, in the absence of a robust assessment of the economic
impacts, it is cautious about increasing the scope of audit in
relation to published accounts.
Communication to stakeholders
The Government says that, whilst audit already provides
comfort on the financial health of companies, there has for many
years clearly been an expectation gap regarding the degree of
assurance any system can actually provide. It notes that attempts
have been made to reduce this by increasing the quality of audit
inspections and auditing standards and professional education,
and by publicising the limits of the audit by amendments to audit
report requirements.
The Government believes that information on company-specific
issues — for example about the degree of aggression in a
company's auditing choices, its risk position, and key judgements
taken — might best be disclosed in the report of the audit
committee, which should be required to give a view on the extent
to which accounting standards have been complied with, and to
explain the reasons for auditor (re)appointment. At the same time,
it points out that the audit committee is a sub-committee of the
Board, and that the latter's responsibility needs to be maintained.
The Government also says that audit works best in
normal environments, when normal procedures can be expected to
uncover normal errors and managerial misstatements, but that it
is unlikely to provide a defence against systemic risk, or against
material fraud, especially where there is significant collusion
by senior management. It adds that professional scepticism is
the key to maximising the usefulness of audit; that one difficulty
for auditors is the lack of the more finely tuned and graduated
forms of reporting found in other fields, such as health and safety,
and that it favours an alternative approach involving increased
disclosure by directors, and fuller explanations by audit committees
(including the length of time an auditor has been in office, and
why they have been re-appointed. However, it notes that there
are clearly costs associated with the various routes and that
it may be hard to achieve the desired benefits swiftly, adding
that additional disclosure by directors in the audit committee's
report may be the most successful route to follow.
The Government says that there is already adequate
and regular dialogue in the UK between internal and external auditors
and the audit committee; that it is not yet convinced that the
auditor has any role as regards Corporate and Social Responsibility;
and that in general there are already well established channels
of communication in the UK between auditors ands stakeholders.
International Standards on Auditing (ISAs)
The Government says that the UK has updated its auditing
standards to align with new clarified ISAs, and that, since the
use of ISAs is currently widespread in the EU, their use by non-binding
legal instruments should be encouraged if there was a perceived
need for an EU endorsement process. It adds that, if small and
medium-sized enterprises (SMEs) continue to be subject fully to
statutory audit procedures, it would favour some adjustment as
regards the application of ISAs.
Governance and independence of audit firms
The Government notes that auditors are appointed
not by the audited company, but by its shareholders, and it has
no evidence of systematic problems of auditor independence, adding
that the audit committee is best placed to preserve this. However,
it would not be opposed to regulators including restrictions on
the firms or individuals permitted to conduct public interest
audits, or the audit of banks, if a cost-benefit analysis showed
this was appropriate. As regards time limits on auditor appointments,
the Government does not believe this would promote independence,
but says that issues of rotation and compulsory tendering need
to be examined in relation to the current concentration in the
audit market.
As regards the possible prohibition of non-audit
services by audit forms, the Government notes the major changes
in the EU regulatory regime since the Enron collapse in 2002,
and that requirements on auditor independence are now more explicit,
with greater disclosure and transparency. It adds that a consultation
earlier this year showed an overwhelming opposition to a ban on
non-audit services, and that the UK would not support this.
The Government says that the present system in the
UK — which limits to 10% the fees a listed audit firm can
receive from a single client (or 15% for unlisted companies) —
ensures continuing independence; that audit firms in the UK are
subject to a voluntary code of practice regarding disclosure of
audit profitability, with those established as limited liability
partnerships or companies obliged to publish accounts; that there
is a formal benchmark of good governance practice against which
the eight audit firms which together audit about 95% of the companies
listed on the main London Stock Exchange market can report for
the benefit of shareholders; that it would support an examination
of the case for alternative structures allowing firms to recapitalise
or to grow their practices so as to enter the audit market for
the largest companies; and that it supports the proposals regarding
group auditors.
Supervision
The Government supports increased cooperation between
national regulators, and the establishment of a closer working
relationship between auditors and financial service regulators.
Concentration and market structure
The Government suggests that, whilst the market for
the auditing of public interest entities in the UK is highly concentrated,
it is doubtful whether a failure of a Big Four firm would cause
systematic risk, partly because audit is only one element of corporate
governance. It notes that joint audits are already legal in the
UK, but adds that their use has declined because companies found
that a single auditor model was more effective. It is not therefore
convinced of the need for mandation in this area: and it questions
whether mandatory rotation of audit firms would increase competition
in the audit market, suggesting that it would increase costs.
It adds that any question of companies using "Big Four only"
clauses would be a matter for the competition authorities; and
it points out that any enforced break up of firms to reverse past
consolidation would have to be on a global scale and could pose
a very high risk of unintended consequences.
Creation of a European market
The Government says that it is unaware of any significant
problems requiring action at EU level, and that it is vital any
changes are backed up by an assessment demonstrating that the
benefits outweigh the costs. It adds that, whilst it is favour
of harmonisation of audit services, standards would need to be
set to preserve audit quality, and that, whilst it also welcomes
the creation of a single European passport for auditors and audit
firms, this should not be obligatory for smaller firms operating
only within one Member State.
Simplification for SMEs
The Government notes that the UK has successfully
introduced audit exemptions for small companies without ill effects,
as have other countries outside the EU, and it sees no systemic
risks from reducing mandatory audit requirements for unlisted
companies. It also believes that auditors of SMEs should be allowed
to provide a wider range of non-audit services than in the case
of listed companies, although it adds that it does not favour
a general prohibition on such services for large companies. However,
the Government says that the UK has experimented with forms of
limited audit, but that these have not proved effective.
International cooperation
The Government says that it supports greater cooperation
between national regulators on audit inspections and the oversight
of global network bodies, and that such cooperation would be vital
if a large firm found itself in difficulty.
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