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BIS issues Discussion Paper on audit reform

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18 Dec 2014

The Department for Business Innovation & Skills (BIS) has issued a paper on audit reform. "Audit regulation - discussion document on the implications of the EU and wider reforms" proposes changes in the UK to implement the EU Audit Directive (‘the Directive’) and Audit Regulation (‘the Regulation’), as well as other changes that may be made to enhance confidence and strengthen the audit regime. The Financial Reporting Council (FRC) has also issued a consultation document on the same topic.

In its discussion paper, BIS is seeking views on implementation of the mandatory requirements of European law and on which of the optional requirements should be introduced into UK law. The Directive applies to all statutory audits and may, in particular, require changes to financial services law to broaden the application of the law to such companies; the Regulation only applies to the audits of public interest entities.

The discussion paper (link to BIS website) focuses on identifying legislative and non-legislative actions necessary to:

  • strengthen standards for the audit of public interest entities;
  • improve confidence in the independence of auditors;
  • avoid excessive concentration in the audit market; and
  • make audit reporting more informative.

Key points raised by BIS include:

  • Whether the definition of “public interest entity” (PIE) in law should be extended beyond entities with securities admitted to trading on a regulated market, credit institutions (including banks and insurance companies) and insurers. The Government is not minded to extend the definition to a wider class of entities.
  • Changes to the regulation and oversight of audit are necessary. The Government is proposing that, rather than the current regime whereby major audits are inspected by the FRC and others by recognised supervisory bodies (RSBs) such as the ICAEW, the FRC should be responsible for all inspections but delegate these back to RSBs for most non-public interest entities. Similar arrangements are suggested for investigation and discipline and a range of other regulatory functions. In the area of standard setting, the indirect force of FRC standards whereby RSBs must require their members to follow those standards will be changed so that FRC standards apply to statutory auditors directly as a matter of law.
  • The Regulation introduces a ‘blacklist’ of prohibited non-audit services for the auditors of public interest entities, and a 70% cap on permissible non-audit services performed by the auditor where there is no requirement that they are carried out by the auditor. The Government is proposing to give the FRC the power to implement the relevant requirements. There has been some question as to when the 70% cap will first apply; BIS have clarified that it expects it to apply first for financial years commencing on or after 17 June 2019 based on audit fees for the preceding three financial years.
  • The Government is proposing to take up the member state option to allow audit firms to serve a PIE for a maximum of twenty years, rather than ten, provided that a tender is undertaken after ten years. They are not proposing to take up the option to extend to twenty four years where there are joint auditors. Consistent with the Competition and Markets Authority Order on auditor tendering, BIS is seeking views on steps to encourage tendering earlier than ten years. The directors’ report of a PIE will be required to include key matters for the audit committee on the appointment of auditors, including tenure, date of last tender, expected year of next tender and reasons why this is thought to be in the shareholders’ interests.
  • Both the Regulation and Directive make changes to the requirements for auditors’ reports to shareholders and to audit committees of PIEs. Many of these have already been implemented in UK auditing standards; the FRC will be given legal powers to make standards covering the remaining matters.
  • The previous legal requirement for listed companies to have an audit committee was implemented in Disclosure and Transparency Rule 7.1. The UK is proposing that the Financial Conduct Authority (‘FCA’) should amend DTR 7.1 to implement the necessary changes which will put on a statutory footing the requirement for the majority of audit committee members to be independent, to allow audit committees to include those not on the board but appointed by a general meeting of shareholders. The FCA will consult on these changes in due course. The UK has previously taken an option to exempt unlisted banks and insurers from the requirement to have an audit committee. As this option is no longer available, BIS suggests that the requirement be introduced via the rules of the Prudential Regulation Authority.
  • The Regulation requires auditors to report information to the supervisory authorities of PIEs concerning legal breaches or breaches of administrative rules, doubts over continuous functioning or the issue of a qualified audit report. These duties are broadly in place for banks, building societies and insurers in the UK, but changes will be need, for example for unregulated listed companies. It is suggested that FCA rules will implement these requirements.
  • The Government proposes to make the minimum changes necessary to implement the new powers for minority shareholders holding more than 5% of voting rights and competent authorities to go to court to seek removal of an auditor on “proper grounds”. They do not intend to provide guidance on what are “proper” and “improper” grounds, other than noting that divergence of opinions on accounting treatments or audit procedures are not “proper grounds”.
  • The Directive allows for ‘passporting’ of audit firms and individual auditors. This means that another EEA audit firm could, subject to meeting requirements, register to audit UK companies. Similar changes would work the other way around; however, little detail is provided on the competence requirements for individual audit partners which would affect how this works in practice.

In its earlier consultation on implementing the EU Accounting Directive, BIS suggested that it might raise the size limits for small company audit exemption later than those for small company accounting exemptions. Feedback from that consultation suggested that the timing for these changes should be aligned. As the audit exemption limits in UK would increase automatically if the accounting limits were changed, BIS is asking whether action should be taken to introduce separate limits. In a change to their assessment at the time of their earlier consultation, BIS believe this change might lead to 7,400 companies becoming newly audit exempt.

Comments are invited by 19 February 2015, leading to a formal consultation on draft regulations in the summer of 2015.

* The comment period has now been extended by one month to 19 March 2015*

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