European Parliament Approves Mandatory Rotation of Audit Firms

The European Parliament has adopted in plenary session the amended Directive on Statutory Audit and the Regulation on specific requirements regarding the statutory audit of public-interest entities.

Under the new framework, public-interest entities will be required to change their statutory auditors after a maximum engagement period of 10 years. Member States can choose to extend the 10-year period up to 10 additional years if tenders are carried out, and by up to 14 additional years in case of joint audit, i.e. if the audited company appoints more than one audit firm to carry out its audit. Calibrated transitional periods taking into account the duration of the audit engagement are also foreseen to avoid a cliff effect once the new rules apply.

The Asian units of European companies may have to rotate auditors too, and Asian regulators may be inspired to follow the same policy in the future.

The new rules will considerably improve audit quality across the European Union and will ensure that auditors are key contributors to economic and financial stability, according to a statement released by the European Commission.

"These new measures will reduce risks of excessive familiarity between statutory auditors and their clients, encourage fresh thinking, and limit conflicts of interest," says European Internal Market and Services Commissioner Michel Barnier.

In order to reduce the 'expectation gap' between what is expected from statutory auditors and what they are bound to deliver, the new rules will require that audit reports be more detailed and informative, and include meaningful data for investors.

The work of auditors will be closely supervised by strengthened audit committees within audited entities. In addition, the new rules will introduce the possibility for 5% of the shareholders of a company to initiate actions to dismiss the auditors. An improved set of administrative sanctions that can be applied by the competent authorities is also foreseen.

Audit firms will be prohibited from providing certain non-audit services to the PIEs they audit, including tax advice and services linked to the financial and investment strategy of the audit client. The aim is to limit risk of conflicts of interest, when statutory auditors are involved in the making of decisions impacting the management of the PIEs they audit. This will also substantially limit the likelihood that statutory auditors self-review their recommendations to the PIEs they audit.

In order to promote market diversity, the new rules prohibit restrictive 'Big Four only' clauses. Incentives for joint audit and tendering, as well as the prohibition of certain non-audit services to audited PIEs are among some of the measures that will contribute to providing new market opportunities. Tools to monitor the concentration of the audit market are also reinforced.

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