The reform of the EU audit legislation introduced through the Directive 2014/56/EU2 and the Regulation (EU) 537/2014 has been converted into national law and published in the Mémorial on 28 July 2016 (hereafter "the Law").
The EU audit reform intends to improve the quality of legal audits within the EU, with the implementation of measures which will reinforce the independence of auditors and improve the information given in the audit report, as well as the supervision of the audit profession. This will be particularly the case for the audit of PIE for which a specific report will have to be issued to their AC.
PIE are impacted by this reform and will have to fulfil the new requirements in terms of composition and competences of their AC, which will have to face more duties including more involvement in the monitoring process of auditors from the tendering and the mandatory audit firm rotation to the oversight of the audit performance and the approval of Non-Audit Services (NAS).
Who is affected and when?
Who
Member States option to broaden list:
- Entities that are both governed by the laws of an EU Member State and listed on a regulated market
- Credit institutions
- Insurance companies
When
Published in the Official Journal on 27 May 2014
- Entry into force: 16 June 2014
- Application: from the first financial year starting on or after 17 June 2016 (except for the transition provisions for rotation which apply from 16 June 2014)
What will change?
On 16 June 2014, new EU audit legislation entered into force. The legislation is wide-ranging and includes a mandatory audit firm rotation for EU Public Interest Entities (PIEs) and significant restrictions on non-audit services an EU PIE can obtain from its auditor.
Mandatory audit firm rotation
Member States option to shorten period
- Maximum engagement period: 10 years
Member States option
- On a tender: possibility to extend
Engagement period by a max of 10 years
- On joint audit: possibility to extend
Engagement period by a max of 14 years
Auditor has been in place for financial years starting:
- Before 16 June 1994 - no renewal after 17 June 2020**
- Between 17 June 1994 to 16 June 2003 - no renewal after 17 June 2023**
- Between 16 June 2003 to 17 June 2006 - change or retender by 16 June 2016 ***
- After 17 June 2006 - change or retender as maximum tenure is reached from the first year of engagement ***
Notes:
* Possibility to extend with 2 more years in exceptional circumstances at the discretion of the Regulator/Supervisor
** The latest date by which this change must occur
*** Subject to the adoption of the member state options above to either shorten the initial engagement period and or to extend the engagement period. This represents the current interpretation by the European Commission of the requirements but is subject to final confirmation
Impact on group companies
Regulation applies to PIE's that are incorporated within the EU.
- If PIE in EU has a PIE subsidiary in EU: subsidiary applies the options of the Regulation decided by its home country and not the ones applied in the home country of its EU parent company (ex: Luxembourg banking subsidiary of a French Bank)
- If PIE in EU has a PIE subsidiary outside EU: Regulation does not apply to subsidiary (however eventual spillover effect)
- An EU subsidiary of a non-EU PIE falls under Regulation if subsidiary is an EU PIE (ex: Luxembourg banking subsidiary of a Swiss Bank)
- An EU branch of a non-EU PIE does not fall under Regulation (ex: Luxembourg Banking Branch of a Chinese Bank)
- An EU branch of an EU PIE falls under Regulation to be applied by its EU head office (ex: Luxembourg Banking Branch of an Italian Bank)
Restrictions on non-audit services provided by the auditor
Prohibited list of non-audit services
The legislation introduces at the EU level a range of changes to prohibitions on the provision of services by the statutory auditor to PIE audit clients, which go beyond existing requirements of the SEC and or IESBA, including:
- Tax compliance services and the provision of tax advice
- Services that involve playing any part in the management or decision-making of the audited entity, including working capital management, providing financial information, business process optimisation, cash management, transfer pricing and creating supply chain efficiency
- Services linked to the financing, capital structure and allocation, and investment strategy of the audited entity (Note: Due diligence would be permitted)
- Human resources services
- Legal services
- Services related to the audited entity’s internal audit function
Prohibited NAS - Territory firm and network
Prohibitions for:
- The statutory auditor and network firms
- The audited entity (PIE), its parent company, and its controlled undertakings within the EU
- Threats and safeguards approach for NAS provided by network firms to the parent and its undertakings outside of the EU
- Type of services that are always prohibited:
- Playing any part in the management or decision making
- Bookkeeping
- Designing and implementing accounting related internal control or risk management procedures
Permissible NAS - Territory firm only - Cap on non-audit fees
Fees received for permissible NAS < to 70% average of group audit fees over the last three consecutive financial years on a rolling basis*
Calculation of the cap includes:
- Fees received for permissible NAS provided by the statutory auditor and audit fees received by this audit firm (i.e. not the network as a whole)
- Fees for services provided to the audited PIE + its parent + its controlled undertakings
- Worldwide audit and non-audit fees i.e. within and outside the EU
- Application of the cap in the fourth financial year which has started on or after 17 June 2016, but only if NAS were provided for previous 3 consecutive years
- If no NAS are provided during one year, the ‘clock‘ starts again
Note:
*The audit firm can provide permitted NAS without limit in the three consecutive financial years before the cap applies
Responsibilities of audit committees
The audit committee has a key role to play if the audit reforms are to be a success; and the new regulations include some new requirements that are difficult to navigate and in some cases will significantly impact the way audit committees of Public Interest Entities (PEI) operate in practice.
The measures that relate to the role and responsibilities of audit committees of EU public interest entities (PIEs) include:
- Rotation period, including transition period
- Tender or joint audit
- Selection of auditor and recommendation to the board and shareholder vote
- Pre-approval for permissible non-audit services
- Monitoring that permissible non-audit services do not exceed 70% of the average group audit fees
- Issuing guidelines for the provision of tax and valuation services (Member State option)
- Monitoring the auditor's assessment of the threats to its independence regarding provision of permissible services
Note:
* from the date of applicability: 17 June 2016
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