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Gauging the impact of EU audit reform

Navigating a complex course

How can Canadian audit committees prepare?

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Canadian Managing Partner, Audit

KPMG in Canada

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Gauging the impact of EU audit reform

Many are looking at impending EU audit reform as an almost epochal event in audit history. In truth, it’s part of a trend toward auditor independence that’s been underway for some time—discernible in a range of global legislation and initiatives such as Sarbanes-Oxley, Dutch prohibitions on non-audit services, the evolving best practice policies of banks and major corporations, and shareholder activism—and it will almost certainly continue.

Moreover, many Canadian companies may not be directly affected at all. The new rules will apply directly to European Public Interest Entities (PIEs)—which are publicly-listed companies or financial institutions (banks and insurance companies)—and those rules are not extra-territorial. Certain Canadian companies may, however, be affected. For example, major Canadian financial institutions operating European subsidiaries are PIEs in the countries in which they operate, in which case EU audit reform may affect them. Also, since the rules affecting European companies apply to their global network, Canadian subsidiaries of EU PIEs will be impacted and will need to look to their EU head offices for specific implementation policies and procedures.

Navigating a complex course

Unfortunately, such clarification may be a way off for affected Canadian companies. While the date on which EU audit reform will come into effect—June 16, 2016—is fixed, the specifics of implementation will vary from country to country. Each member state has to follow the new rules in areas such as mandatory auditor rotation and restrictions on non-audit services (which include tax, valuation, internal audit advisory, corporate finance, legal and HR, among others), but there is some interpretation involved and member states will be able to make choices in certain areas. For example, while there is a rule stating that auditor rotation should occur every 10 years, some countries may opt for shorter periods. EU countries also have a small amount of leeway in designating which non-audit services they will prohibit; the reforms specify a number of prohibited non-audit services, but countries have a derogation right, meaning they can choose to allow audit firms to provide tax, or other otherwise prohibited, services—but subject to clear safeguards and limits.

Most countries have not set their policies yet, so trying to prepare for specific rules is virtually impossible at this point. There are, however, a number of questions audit committees should be asking going forward to be as ready as possible when particular changes must be put into effect.

  • Has your organization already identified the various services potentially restricted by EU audit reform?
  • Have you established a policy to satisfy the impending requirements?
  • Have you considered how similar organizations have interpreted the guidance?
  • Have you received instructions from your head office?
  • Do you have any concerns around your team’s preparedness—resources, timing, capabilities, guidance interpretation?
  • What portion of the services you now procure will your auditor be able to provide?
  • Do you have a strong transition team in place?

 

Prepare for a “strict-case” scenario

The fact is, the final regulatory environment will be dictated by how each member state interprets the legislation and applies any derogations, and the result is bound to be a highly-complex and potentially-disruptive situation. Many companies remain unprepared to change audit and other service providers and are looking to understand their options. The wisest anticipatory course for ACs—since predicting specific member-state policies is not yet possible—is to assume that the rules will be applied in their strictest form (i.e., that auditor independence will be fully enforced and that prohibited services, such as tax, will have to be performed by a different firm).

With this in mind, strategically savvy organizations have a couple of courses they can take. First, if they immediately have to change their auditor, they should consider retaining that firm, with all its knowledge of and experience with the business, as their provider for tax and other services; everything doesn’t necessarily have to be moved. Second, companies that don’t have to switch auditors, but may have to change their tax and advisory provider, should already be speaking to other firms about delivering those services—inquiring into their relevant capabilities, knowledge and experience and testing the new firm out—so they can transition smoothly to the new audit regime, instead of scrambling to comply when action becomes necessary.

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