Not cleared from scrutiny; further information requested; drawn to the attention of the Committee for Exiting the European Union, the Business, Energy and Industrial Strategy and the Treasury Committees
Report from the Commission to the Council, the European Central Bank, the European Systemic Risk Board and the European Parliament on monitoring developments in the EU market for providing statutory audit services to public-interest entities pursuant to Article 27 of Regulation (EU) 537/2014
Non-legislative; Article 27 of the EU Audit Regulation requires each National Competent Authority (NCA) to report on the statutory audit market in its jurisdiction.
Business, Energy and Industrial Strategy
(39066), 12536/17, COM (17) 464
4.1This chapter considers the implications of EU exit for UK statutory auditors and audit entities. The document that is under scrutiny is a European Commission report which brings together information submitted by National Competent Authorities for statutory audit in each of the EU Member States, in order to assess the market for providing statutory audit services to “Public Interest Entities” (“PIEs”). The Commission’s report is relatively insignificant: it identifies the most common recurring issues with the quality of audit work, and concludes that none represents a major risk to the provision of audits or to financial stability.
4.2In an Explanatory Memorandum submitted on 16 October 2017, the Parliamentary Under Secretary of State for Small Business (Margot James MP) stated that the European Commission’s reports provided a useful indication of any developing risks to audit quality for Public Interest Entities in Europe but also noted that, as the first report of its kind, on its own, and without any indication of developing statistical trends, it provided limited insight. More generally, the Minister noted that the UK is a key location for the provision of statutory audit services in the European Union and worldwide, and that the Commission’s report found that more than half of the revenues generated from the audits of Public Interest Entities in the EU are generated in the UK. However, the Government provided no analysis of the implications of EU exit for the sector.
4.3We have therefore sought in this chapter to draw on other available sources of information to assess the implications of EU exit for statutory audit. In summary, an equivalence and an adequacy decision from the Commission would be needed for the activities of UK audit firms to avoid being disrupted, although further clarification is needed regarding the extent to which these decisions would effectively maintain the status quo in its entirety. In the absence of these approvals, a range of difficulties would arise which would cause problems in a number of specific market situations (group audits, pan-European partnerships, listing of securities for EU companies on UK regulated markets), which would increase costs for UK auditors as well as the companies paying for their services. However, while these developments would damage the sector, features of audit regulation and capital markets mean that the extent to which the EU could force large amounts of UK-based audit activity to relocate to the EU27 is limited.
4.4We thank the Government for its Explanatory Memorandum. The Committee notes the European Commission’s finding that the UK has the largest audit sector in the EU, which accounts for approximately half (€15.3bn) of all turnover of audit firms auditing Public Interest Entities (PIEs) in 25 Member States, and generates around 29% of all fees from statutory audits within in the EU (€3.17bn). It is regrettable therefore that the Government’s Explanatory Memorandum provides no consideration of the implications of EU exit for UK auditors and audit firms.
4.5The Committee considers that the Government’s sectoral assessment understates the amount of UK-EU cross-border economic activity that takes place in statutory audit, as well as the negative implications for UK auditors of an exit which does not ensure that mutual recognition arrangements are in place at the moment of withdrawal. Consequences of this scenario would include:
4.6The sum effect of these impacts would be to increase the cost of providing statutory audits for UK audit firms as well as their customers (including EU businesses).
4.7Market situations in which difficulties would arise in the absence of adequacy and equivalence decisions include: (i) group audits for consolidated accounts, the provision of which is substantially facilitated by the EU framework; (ii) EU registered companies being unable to list securities on UK financial markets, if EU27 audits were not accepted in the UK; and (iii) pan-European partnerships (such as those of EY and Deloitte) that include UK audit firms having to be restructured in line with EU ownership and control requirements. Ernst and Young (EY) has stated that “failure to secure a similar regime [to the status quo] could threaten the UK’s pre-eminent role in accounting and audit in [the] EU.”
4.8Despite the damage to the UK audit sector that an EU exit without adequacy and equivalence decisions would cause (both with regard to mutually recognised audit qualifications and, separately, audit regulators and underlying regulations), with consequences for the UK audit sector, we observe that the EU’s ability to require UK audit activity to relocate to the EU27 is generally weaker than in some other PBS sectors (e.g. legal and financial services). This is because (i) national regulators require local audits to be signed off by local auditors, meaning that there is a de facto limit on the proportion of UK and EU audit that can be done overseas, and (ii) as long as UK capital markets remain the preferred destination for listings and EU firms continue to list securities on them, group consolidations for UK listed companies will continue to take place here. We also note the strategic importance of effective audit for the integrity, stability and efficient functioning of capital markets. The UK and EU27 therefore have a mutual interest in negotiating an orderly transition and future relationship with respect to audit.
4.9To enable the Committee to conclude its scrutiny of this issue, we ask the Government to clarify:
4.10We ask the Government to respond to the Committee’s questions by 7 March 2017. In the meantime, we retain the proposal under scrutiny. We draw this chapter to the attention of the Committee for Exiting the European Union, the Business, Energy and Industrial Strategy Committee, and the Treasury Committee.
Report from the Commission to the Council, the European Central Bank, the European Systemic Risk Board and the European Parliament on monitoring developments in the EU market for providing statutory audit services to public-interest entities pursuant to Article 27 of Regulation (EU) 537/2014: (39066), , COM (17) 464.
4.11A statutory audit is a legally required review of financial records. The role of a statutory audit is to certify the financial statements of companies or public entities. An audit provides stakeholders such as investors and shareholders with an opinion on the accuracy of companies’ accounts. As a result, statutory audits contribute to the orderly functioning of markets by improving the confidence in the integrity of financial statements.
4.12The current rules consist of:
4.13In the UK, the Financial Reporting Council (FRC) is responsible for the public oversight of statutory auditors, as required under EU law, and is recognised as an appropriate regulatory authority throughout the EU.
4.14As the UK is currently an EU Member State, it automatically benefits from those aspects of the EU audit regulatory framework which reduce non-tariff barriers to trade and facilitate intra-EU market access. Under this regime:
4.15The Statutory Audit Directive means that, in principle, audit qualifications attained in one Member State are recognised across all EU Member States, however, Member States have their own requirements for statutory audits and typically require examination of those areas before auditors from other EU Member States can practice.
4.16The Statutory Audit Directive explains how the EU audit framework applies to auditors in third countries.
4.17Article 27 addresses the statutory audit of consolidated accounts, including evaluation by the group auditor of work performed by third country auditors and the obligations with respect to quality assurance reviews carried out by the competent authorities.
4.18Chapter XI of the EU Statutory Audit Directive covers the treatment of third country auditors, audit firms (the latter being the most relevant) and audit regimes as follows:
4.19Effects of EU exit, without adequacy and equivalence decisions in place, include:
4.20An adequacy decision from the Commission with respect to the UK’s data protection regime would also be necessary for the sharing of data with other European jurisdictions, however it is important to note that this is not in itself sufficient for UK auditors to process audit documentation: although an adequacy decision on data protection would allow UK auditors to continue to receive data from EU jurisdictions, a separate adequacy decision under the Statutory Audit Directive would be necessary in the specific context of audit for UK auditors to receive certain types of audit documentation and to use that documentation in their work.
4.21Three specific situations are potentially affected in the context of EU exit:
4.22The Government’s analysis of the implications of EU exit for audit, provided in full at the end of this chapter, notes the EU audit framework “facilitates cross border supply of audit services by firms” and “provides for some free movement of EU auditors”, but states that, in practice, “cross-border supply of audit services is quite rare.”
4.23UK-based audit organisations are significantly more concerned about the possible implications of EU exit than the Government’s sectoral analysis would suggest is warranted, although there is some variation among organisations.
4.24The European Contact Group (ECG) which is an informal regulatory and policy working group of six large audit networks in the EU (BDO, Deloitte, EY, Grant Thornton, KPMG and PwC), has published an FAQ document on EU Audit Legislation. At the end of the briefing, it identifies the following key implications of the UK leaving the European Union for statutory auditors:
4.25The ECG qualifies its concern about the possible loss of equivalence of the UK regime, noting that it would expect that the UK regime would be considered to be equivalent and that, subject to reciprocity, UK auditors of UK incorporated entities listed on regulated markets in the EU might therefore be exempted from the oversight, quality assurance and investigations and penalties regime of the EU Member State of the relevant regulated market.
4.26Other sector stakeholders, including Ernst and Young, the Professional and Business Services Council, and the Institute of Chartered Accountants in England and Wales (ICAEW), provided the House of Lords EU Committee with written evidence which relates to the implications of Brexit for audit, as part of a wider inquiry into the Brexit and future UK-EU trade in non-financial services.
4.27The Professional and Business Services Council states that “it is most important that leaving the single market does not result in currently recognised qualifications becoming unrecognised” and that the recognition of the FRC as an appropriate regulatory authority throughout the EU “allows auditors that it regulates some involvement in audits for overseas entities and reduces barriers to trade”. However, the PBSC also notes in its submission that each Member State has its own requirements for statutory audits, and that barriers to the provision of audit services across EU borders remain.
4.28Ernst and Young (EY) stated that the equivalence of the regulatory framework overseen by the FRC and its equivalence with other EU Member States “reduces barriers and costs to trade.” EY states that, outside the EU, retaining the benefits of the current regime would be a matter for negotiation, and that “failure to secure a similar regime could threaten the UK’s pre-eminent role in accounting and audit in [the] EU.”
4.29The UK-EU Joint report contains the following paragraph (32) on the recognition of professional qualifications, which effectively states that the rights of statutory auditors who exercise rights relating to the recognition of professional qualifications in the UK or any other EU Member State prior to exit day will have those rights protected:
“Decisions on recognition of qualifications granted to persons covered by the scope of the Withdrawal Agreement before the specified date in the host State and, for frontier workers, the State of work (either the UK or an EU27 Member State) under Title III of Directive 2005/36/EC (recognition of professional qualifications where the person concerned was exercising the freedom of establishment), Article 10 of Directive 98/5/EC (lawyers who gained admission to the host State profession and are allowed to practise under the host State title alongside their home State title) and Article 14 of Directive 2006/43/EC (approved statutory auditors) will be grandfathered. Recognition procedures under these Directives that are ongoing on the specified date, in respect of the persons covered, will be completed under Union law and will be grandfathered.”
4.30Article 27 of the EU Audit Regulation requires that each National Competent Authority (NCA) should regularly monitor and report to the Commission on the statutory audit market in its jurisdiction on risks arising in its audit market, market concentration levels, the performance of audit committees of PIEs in that jurisdiction, and a wide range of other factors. Using the information provided the Commission must assemble an overall report in cooperation with the Committee of European Audit Oversight Bodies (CEAOB).
4.31The Commission’s report, which brings together information submitted by the National Competent Authorities for statutory audit in each of the EU Member States, concludes that:
4.32The report does not conclude that any of these recurring issues represent a major risk to the provision of audits or to financial stability. It suggests that the next report should monitor whether any of these recurring issues risks becoming a structural feature of the market.
4.33In the policy implications of her Explanatory Memorandum, the Parliamentary Under Secretary of State for Small Business (Margot James MP) states that the European Commission’s reports provide a useful indication of any developing risks to audit quality for Public Interest Entities in Europe and any threats to the supply in the market for audits of PIEs of appropriate quality; however, the Minister also notes that, as the first report of its kind, on its own, and without any indication of developing statistical trends, it provides only limited insight.
4.34The Minister provides some information about the UK’s implementation of the EU Audit Directive and Regulation, noting that the Competition and Markets Authority completed an investigation into the supply of statutory audit services to UK companies in the FTSE 100 and 250 indexes, which resulted in conclusions which are reflected in the UK’s implementation of the EU audit regulatory framework. The Minister also observes that the Government and the Financial Reporting Council keep the UK’s audit regulatory framework under review for any indication that it is failing to fulfil its intended objective of securing high quality audits, particularly for PIEs.
4.35More generally, the Minister observes that that the UK is a key location for the provision of statutory audit services in the European Union and worldwide because it is a global hub for financial services, professional business services, the holding companies of multinational groups and for the financial markets on which they raise capital. The Commission’s report finds that more than half of the revenues generated from the audits of Public Interest Entities in the EU are generated in the UK.
4.36No consideration is provided of the implications of the UK’s decision to leave the European Union, and the Government’s intention to leave the Single Market, for UK-based providers of statutory audit services either domestically or elsewhere in the EU.
4.37By way of background, the Government’s sectoral report on the Professional Business Services sector that describes the EU audit framework and its relevance to UK auditors is reproduced below in its entirety:
Audit Directive (2006/43/EC) (amended by Directive 2014/56/EU) and Regulation (537/2014)
“The UK’s audit regulatory framework has developed out of a series of Directives to harmonise the regulation of professional auditors and audit firms and to impose a considerable body of EU regulation: on auditor appointment; on the maintenance of relations between the auditor and the client’s senior management; on the application of technical standards on audit work; on comparable codes to maintain auditor independence; and on the regulation of auditors through inspections, investigation and enforcement.
“The audit framework provides for some free movement of EU auditors with provision for aptitude tests or adaptation periods by Member State authorities to enable mutual recognition of qualifications. The Audit Directive also makes some provision for the audit of non-EU businesses that are listed on UK capital markets. This framework has developed over time with the objective of protecting investors. The EU framework now recognises that a different approach is needed in respect of UK and other EU firms auditing overseas.
“Cross-border supply of audit services is quite rare because of the significant economic regulatory concerns and the resulting controls in most countries, which restrict supply. In most large economies, auditors are established and regulated within their client’s jurisdiction, though the Directive now facilitates cross border supply of audit services by firms, subject to certain regulatory preconditions. In addition to mutual recognition of qualifications for those permitted to sign audit reports, ownership and management of an audit firm are also subject to requirements that the majority of owners and managers must hold mutually recognised qualifications or, for firms, registrations. Within the confines of this framework, mutual recognition allows audit firms to develop ownership structures across borders.
“The framework also prescribes how national audit regulators (competent authorities) should cooperate internationally, both within and outside the EU, and sets out how auditors of businesses listed on the main capital markets should be regulated if the business is established overseas (this framework primarily affects UK auditors of non-EU businesses listed on UK markets).
“The structure of the UK accountancy sector means that many aspects of this framework indirectly affect almost all services offered by almost all accountancy firms. This is partly because of necessary regulation as to which other services a business may procure from its auditor, and how it can then ensure the auditor’s continued independence. In addition in the UK, the regulatory oversight of audit firms is the starting point for the UK’s non-statutory regulatory framework for wider accountancy services.”
None on this document, but see our earlier Reports on Regulation 2014/537 (EU) on specific requirements regarding statutory audit of public-interest entities and Directive 2014/56 (EU) on statutory audits of annual accounts and consolidated accounts: Nineteenth Report HC 83–xviii (2013–14), (23 October 2013); Eighth Report HC 83–xviii (2013–14), (3 July 2013); Fifty-fourth Report HC 428–xlix (2011–12), (1 February 2012).
24 European Commission, Report from the Commission to the Council, the European Central Bank, the European Systemic Risk Board and the European Parliament on monitoring developments in the EU market for providing statutory audit services to public-interest entities pursuant to Article 27 of Regulation (EU) 537/2014 .
25 Auditing banks and insurers, building societies and companies with securities admitted to trading on a regulated market.
26 Explanatory Memorandum from the Minister, BEIS, to the Chairman of the European Scrutiny Committee ().
27 Report from the Commission to the Council, the European Central Bank, the European Systemic Risk Board and the European Parliament on monitoring developments in the EU market for providing statutory audit services to public-interest entities
28 Sectoral Report—Professional and Business Services (Published ).
29 The Government’s assessment (see the final section of this report) states that “Cross-border supply of audit services is quite rare because of the significant economic regulatory concerns and the resulting controls in most countries, which restrict supply.” While regulatory requirements undoubtedly mean that most statutory audits are conducted by local auditors and audit firms, group audits of consolidated accounts are cross-border in character, although not purely so, as local auditors are involved, and work under oversight of the group auditor. Informal industry estimates suggest that the auditor conducting the group-wide consolidation typically takes at least 15% of total revenues for a group audit.
30 Written evidence to the House of Lords European Union Committee, Ernst and Young ().
31 DTR 4.1, a Financial Conduct Authority rule that implements part of the EU Transparency Obligations Directive, and is made under the powers granted to the FCA under the Financial Services and Markets Act 2000, requires parent companies to prepare consolidated financial statements. This would continue to be the case under the Great Withdrawal Bill framework unless and until the FCA changed the law (or the government took the power back from the FCA). It is important to note that the EU27 Member State of incorporation will also require consolidated accounts as a matter of company (rather than securities) law, because it is a condition of the Accounting Directive.
32 Joint report from the negotiators of the European Union and the United Kingdom Government on progress during phase 1 of negotiations under Article 50 TEU on the United Kingdom’s orderly withdrawal from the European Union TF50 (2017) 19—Commission to EU 27 ().
33 Annex to the Recommendation for a Council Decision supplementing the Council Decision of 22 May 2017 authorising the opening of negotiations with the United Kingdom of Great Britain and Northern Ireland for an agreement setting out the arrangements for its withdrawal from the European Union COM (17) 830 final ().
34 The consolidated text of Directive as amended by subsequent legal acts including Directive is available .
35 Regulation of the European Parliament and of the Council of 16 April 2014 on specific requirements regarding statutory audit of public-interest entities and repealing Commission Decision 2005/909/EC.
36 Freshfields Bruckhaus Deringer, The legal impact of Brexit on the UK-based financial services sector ().
37 European Commission, Implementing and delegated acts on Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts— (accessed 22 January 2018)
38 European Commission, Adequacy of the protection of personal data in non-EU countries (accessed )
39 In a letter to the Committee on , the Minister involved in negotiating the proposal (Jo Swinson) wrote that the Regulation and Directive provided for “a pan-European ‘passport’ for statutory audit firms to allow them to provide statutory audits in Member States other than the Member State in which they have been approved”.
40 Sectoral Report—Professional and Business Services (Published ).
41 European Contact Group, European Union Audit Legislation Frequently Asked Questions ().
42 Written evidence, Ernst and Young ().
43 Written evidence, the Professional and Business Services Council ().
44 Written evidence, The Institute of Chartered Accountants in England and Wales (ICAEW) ().
45 House of Lords, Brexit: trade in non-financial services ().
46 Written evidence, the Professional and Business Services Council ().
47 Written evidence, Ernst and Young ().
48 Written evidence, Ernst and Young ().
49 Joint report from the negotiators of the European Union and the United Kingdom Government on progress during phase 1 of negotiations under Article 50 TEU on the United Kingdom’s orderly withdrawal from the European Union TF50 (2017) 19—Commission to EU 27 ().
50 European Commission, Report from the Commission to the Council, the European Central Bank, the European Systemic Risk Board and the European Parliament on monitoring developments in the EU market for providing statutory audit services to public-interest entities pursuant to Article 27 of Regulation (EU) 537/2014 .
51 Explanatory Memorandum from the Minister, BEIS, to the Chairman of the European Scrutiny Committee ().
52 Department for Exiting the European Union, Professional and Business Services Sector Report ().
53 Department for Exiting the European Union, Professional and Business Services Sector Report ().
2 February 2018