On December 18, 2014 the Department for Business, Innovation & Skills (BIS) published a discussion paper seeking views on a range of reforms to the regulatory framework for statutory audits as introduced by Directive 2014/56/EU amending the Statutory Audit Directive (2006/43/EC) (the Audit Directive) and Regulation 537/2014 on specific requirements regarding the statutory audit of public-interest entities (the Audit Regulation). The discussion paper looks at the legislative and non-legislative changes needed to improve standards for the audit of public interest entities (PIEs), improve confidence in the independence of auditors, avoid excessive concentration in the audit market and make audit reporting more informative. The discussion paper looks at the structure for regulation, oversight and standards, taking into account the new European requirements, recent Competition and Markets Authority measures and recommendations and work by the Financial Reporting Council (FRC) to refine technical and ethical standards. It then considers the necessary steps that will need to be taken to implement the changes via amendments to the Companies Act 2006 (CA 2006) or regulations made under it.
The closing date for comments on the consultation paper is February 19, 2015 and BIS confirms that, after consideration of responses, it will run a formal consultation on detailed proposals to change the audit regulatory regime.
The discussion paper looks at the following areas:
Audits of PIEs and application of the Audit Regulation and Audit Directive
BIS is proposing to amend the application of Part 42 of CA 2006 so that, in addition to the audits of entities already subject to the requirements of that Part, it should also apply to entities (other than companies and other entities already covered) whose securities are admitted to trading on a regulated market, electronic money institutions, payment institutions, MiFiD investment firms, undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs).
The Government is not seeking to expand the definition of a PIE beyond the EU minimum requirement – that is listed companies, banks, building societies and insurers. The main impact of the changes in scope results from the removal of the option to exclude non-listed entities from the definition of a PIE. This means that unlisted insurers and some unlisted banks will have to have an audit committee and auditors of unlisted banks and insurance companies that do not also audit listed entities will be required for the first time to prepare an annual transparency report and be subject to the tighter independence requirements in the Regulation.
Competent authorities – Designation and delegation of tasks
The current provision of powers to the FRC in relation to the regulation of auditors is not consistent with the concept of a single competent authority having ultimate responsibility for the regulatory tasks or with it having the ability to delegate tasks to other bodies. BIS proposes that the FRC should be the single competent authority for these purposes but its responsibilities will need to be allocated directly in legislation. This would require a new statutory framework on audit regulation in a number of areas.
Audit fees and non-audit services
BIS notes that the provision of non-audit services to audit clients is already regulated by the FRC’s ethical standards for auditors to a greater degree than in many Member States and that some significant non-audit services are already prohibited in the UK. BIS proposes that the related rules on non-audit services should be addressed by the FRC through development of the ethical standards framework. As a result, the FRC has now published a consultation document on the changes to the ethical and auditing standards that could give effect to the EU requirements. BIS is seeking views on, among other things, the FRC being able to exempt firms from the 70 per cent non-audit cap for up to two financial years and whether the blacklist of non-audit services should be included in amendments to the FRC’s ethical standards for auditors.
Tendering and duration of audit engagements
BIS is also proposing to make it possible for a company to retender the auditor appointment earlier than ten years, but still be able to extend the maximum duration of the audit engagement beyond ten years. It is proposing to introduce a framework for mandatory tendering at ten years whilst permitting audit committees to provide for a shorter period in the annual report. BIS is also considering provisions so that, where a PIE has stated that it will complete a tender process before the expiry of the maximum duration of ten years, the PIE could still take advantage of an extension of the maximum duration following that tender. The discussion paper contains a diagram explaining how this would work in practice.
BIS is proposing that each year after the auditor’s initial engagement, the audited entity would state in its annual report when it next intends that the auditor appointment should be based on a retender. Where a PIE reports that it intends that the auditor’s appointment in relation to the next but one accounting year following that covered by the report should be based on a retender, this would be binding on the PIE.
BIS is also seeking views as to whether plans on retendering should be part of a new element of the directors’ report setting out key matters for the audit committee on the appointment of auditors. BIS sets out the possible content of such a report including the date of the beginning of the audit engagement, the date the last audit engagement was retendered and the start of the next accounting year in relation to which the company expects that the auditor appointment will be based on a tender.
The small companies and audit exemption
BIS is of the view that the small companies audit exemption thresholds in the UK should be allowed to increase in line with those for the small companies accounting regime.
Audit reporting and additional reporting to the audit committee
BIS is proposing to include in the legislation on auditor reporting a requirement for the auditor to include a statement in the audit report where there is a material uncertainty relating to events or conditions that may cast significant doubt about the entity's ability to continue as a going concern.
BIS confirms that the Financial Conduct Authority (FCA) will be consulting on implementing new requirements on audit committees via amendments to Disclosure and Transparency Rule 7.1 (DTR). BIS confirms that it has agreed with the FCA and the FRC that the DTRs on audit committees will continue to be supported by the FRC’s Guidance on audit committees. BIS notes that the DTRs only apply to entities with securities admitted to trading on a regulated market and that another mechanism may be needed for other banks, building societies and other insurers, adding that it has discussed with the Prudential Regulation Authority (PRA) whether it could include provisions on audit committees to implement the requirements in its rules. The PRA will be consulting separately on this issue in due course.
Dismissal of auditors
BIS is considering amending the CA 2006 to include the changes set out by the Audit Directive in relation to PIEs (which create new powers for shareholders representing five per cent or more of the voting rights of the share capital and “competent authorities” to go to court to seek the dismissal of the auditor of a PIE where there are “proper grounds”). It does not propose to go beyond the terms of the Audit Directive, or to prescribe what may constitute “proper” or “improper” grounds for the dismissal of auditors, other than to state that divergence of opinions on accounting treatments or audit procedures shall not be “proper grounds”.
(BIS, Auditor Regulation, Discussion document on the on the implications of the EU and wider reforms, 18.12.14)