14 August 2012

EuropeanIssuers' position on Commission's audit regulation proposal

EuropeanIssuers maintains that there is an undue spill-over of regulation aimed at the financial industry and the banking sector to the end users of capital markets, which are listed companies that produce goods and services for the real economy.

EuropeanIssuers commented on internal control and lessons learned from Sarbanes-Oxley, mandatory audit committees, common standards on audit committees, mandatory rotation of audit firms, pure audit firms/non-audit services, joint audits, supervisory veto right to the appointment of the auditor, and principle of subsidiarity in its position paper.

EuropeanIssuers has concerns with respect to the proposed requirements for the external auditor to assess the company’s internal control system. The focus of the external auditor in the audit should be on the integrity of the financial reporting and its opinion should be based on this.

The assessment of the internal control system is the responsibility of the company, including the internal audit function operating within the company. An additional role for the external auditor in this respect would merely be duplicating the work already undertaken by the internal auditor, at significant expense to the company, without creating a corresponding increase in protection for investors or other stakeholders.

Furthermore, EuropeanIssuers believes these proposals would result in blurring the company’s and the external auditor’s responsibilities and significantly increase the risk that too much reliance is placed on an audit opinion for the wrong reasons. Despite incurring significant additional costs, the review of an external auditor can only be of a limited nature, but may create a false impression of the soundness of internal control systems. Experience in the United States demonstrates that detailed regulations, such as under the Sarbanes-Oxley Act, did not prevent failings in internal control systems and may have created a false impression of internal control systems in some instances. EuropeanIssuers fears that valuable lessons from the United States experience have not been taken into account in the EU proposals.

EuropeanIssuers believes that the position of the audit committee within listed companies is adequately covered in national company laws and corporate governance codes. As far as EuropeanIssuers is aware, the application of these codes has not brought to light significant issues with respect to the composition, the role and the functioning of audit committees. If there had been such issues, these would have been noted by monitoring committees, such as the existing Monitoring Committees on Corporate Governance (in the Netherlands, France, etc.), and resulted in recommendations to the national legislator. EuropeanIssuers does not therefore see the need for such issues to be dealt with at EU level.

Also EuropeanIssuers is particularly concerned that the proposal in Article 31.1 of the proposed Regulation calls into question the fundamental principles underlying the Board’s operations: any specialised committee is set up by the Board and acts under the sole and collective responsibility of the Board. To appoint audit committee members by the general meeting would contradict such principles.

Article 46 3 c) of the proposed Audit Regulation gives ESMA the power to issue common standards on the oversight of audit committees. EuropeanIssuers opposes such common standards for the following reasons:

a. Audit committees in different countries have different structures as recognised in the Audit Directive. Therefore, restraint with respect to common standards is appropriate;

b. Best practices and or common standards would typically emerge through the work of national monitoring bodies on corporate governance, as this is their area of expertise. EuropeanIssuers sees no need for ESMA or national securities regulators to duplicate experience that already exists elsewhere;

c. The US experience has shown that rigid rules on governance do not help companies to have better internal controls and audit systems in place (e.g. Lehman Brothers was subject to the Sarbanes Oxley Act), as this could easily lead to (very costly) tick-the-box behaviour.

d. EuropeanIssuers doubts the benefits of the detailed appointment procedure and fear that this process will lead to additional costs and tie up scarce resources of audit committees.

A system of mandatory rotation of audit firms will reduce the number of audit firms available and lead to a more concentrated market, which is what the Commission intended to avoid by proposing new measures. EuropeanIssuers also believes that a rotation system for audit firms would reduce sound performance by auditors in the long-term.

An introduction of regulation leading to pure Audit Firms (i.e. excluding consultancy) may lead to loss of quality, as the expertise necessary to audit large entities (especially listed) not only requires typical audit skills and knowledge, but also consultancy skills and knowledge. In addition, it is important to acknowledge that the choice of auditor is already extremely limited for certain companies, due to the specific businesses in which they are active. The proposal could also make the audit profession less appealing to graduates and thus lead to a loss of talent.

EuropeanIssuers is of the opinion that the provision of non-audit services should continue to be permitted, subject to appropriate safeguards such as management of potential conflict of interests.

Although the European Commission did not include mandatory joint audits in its proposals and mentioned joint audits only in relation to rotation periods, EuropeanIssuers remains concerned that such proposals are not fully off the table for the future.

Link to position paper

© EuropeanIssuers