TIEDOTUS

Uutiset ja tiedotteet 2008

THE EU AUDIT AGENDA AFTER THE STATUTORY AUDIT DIRECTIVE

Jacques Potdevin
President
Fédération des Experts-Comptables Européens FEE

Mr. President,
Dear Colleagues,

Let me first thank you for your invitation.  I am delighted to be here today for the first time since your Institute became a member of FEE.  The objective of our European Federation is to voice the positions of the accountancy profession towards EU Institutions.  That means that we need to be fully aware of the concerns of our national members.  We often see the problems only through the loupe of those who represent you in our Working Parties in Brussels.  This is the only way to work efficiently.  However, it is equally important to understand the preoccupations of practitioners in the field.  Therefore, I am very interested in being here with you today.

It was suggested to me that the most interesting subject for you would be competition in the audit markets in Europe.  I will comment on that but I would like to enlarge the topic of my presentation and cover a few other aspects that became topical since the Statutory Audit Directive was approved.  I would like to say a few words on:

- The simplification project of the EC,
- The agenda that Commissioner Charlie McCreevy defended in the European Parliament in December,
- The situation in the audit market.

1. The EC Simplification Project

The European Commission is committed to providing a response to the proposal of the Head of States in Lisbon to simplify the business environment.  The Commission defined an objective, which is to reduce by 25% the administrative burdens on companies.  One of the sectors where cost cutting seems possible is financial reporting.

Before going further on the issue, I would like to say that this idea is false that financial reporting would be a cost without any benefit in small companies.  Even in an SME, how can a manager take a good decision without reliable figures?  Will a banker lend money to a company that has no reliable accounting?  Do we believe that taxation authorities will not substitute their own requirements to an accounting law that would become optional?

I am sometimes asking myself a question.  As professionals in SMEs, are we explaining enough the importance of good accounting information to our clients?  Are we clear on how they must use a scoreboard of accounting information?  SME managers themselves should go to government and explain that they need good accounting rules.  What they do not need is providing several times the same information to different ministries.  They do not need different and complicated rules for commercial, taxation, statistical and other reporting.  They do not need frequent changes to rules that impose expensive changes to software packages.  I have to say that this is the message that UEAPME, the umbrella organisation for SMEs in Europe, delivered to the Commission in a joint statement with FEE.

The President of the European Commission, Mr. Barroso appointed me as a member of the Stoiber Group of Experts.  This high-level group should reflect on how to simplify further the life of company managers.  I intend to deliver that message to the group.  If you have also examples and suggestions, I would be pleased to consider them in that context.

What will be the outcome of the current proposals of the Commission on simplification of Accounting Directives?  We are still expecting the conclusions of the debate that we had last year.  The Commission published in December a synthesis of the reactions received to its Communication of July 2007.  What are the main conclusions?

“A clear majority of those that reacted to the proposal to repeal certain Company Law Directives did not support it.  The main argument put forward was that these Directives provide legal certainty and that their repeal would rather cause additional costs than lead to savings for companies.”

“Concerning the proposals put forward in the Communication in the areas of accounting and auditing:

- There was clear support from respondents for the proposal to introduce a Member State option to exempt micro-entities from the scope of the Accounting Directives;
- The proposal to extend the transition period to the status of SME to five years met some scepticism.  However, a period of three years was considered acceptable;
- A slight majority of respondents disagreed with the potential relief from publication requirements for small entities;
- Also the idea to allow unlimited liability medium-sized companies to follow the rules for small companies met support whereas respondents were split over the proposal to take the same measure with a view to management-owner companies;
- Finally, the proposals for more minor simplification measures for all companies were supported in respect of audit exemptions under specific circumstances, a clarification of the IAS Regulation as well as the deletion of certain disclosure requirements.”

This gives an idea of what might be the proposal of the Commission.  We continue to be fully sceptical about a new category of micro-enterprises that would be totally scoped out the Directive.  This proposal however is supported in countries where we have two separate systems for financial reporting and taxation reporting.  In any event, if a new category is introduced for micro-entities, the system must be optional for Member States

2. The Audit Regulatory Agenda

My second topic relates to the audit regulation agenda.  As you know, the Directive of 17 May 2006 must be transposed by Member States before the end of June 2008.  In Finland, the new Audit Act is effective since July 2007 but many other Member States still have to do their homework.

This is not the end of the story.  Many aspects of the Directive require implementation measures.  FEE as the most representative voice of the profession is in permanent contact with the Commission to discuss further developments at European level and worldwide.

Commissioner Charlie McCreevy made an excellent summary of the main issues in announcing to the European Parliament his political agenda for 2008.  Besides the implementation of the Directive, the Commissioner mentioned five areas where action is required.  Let us review them quickly.

Auditor Liability

It is curious that the main argument raised by Mr. McCreevy to recommend limiting auditors’ liability is the risk of further concentration.  There are many other reasons which are not connected to the big firms.  Limiting auditors’ liability is first and foremost useful for smaller firms to help them to get insurance at a reasonable cost.  We know that indemnity insurance is a problem for many professions, not only accountants.  However, there is urgency here due to the importance of the claims and the deep pocket syndrome.

We agree very much with the Commissioner that limiting auditors’ liability is not detrimental to audit quality.  We are looking forward to the recommendation that Mr. McCreevy intends to publish shortly.

Ownership Restrictions

Some people argue that relaxation of ownership restrictions could help them growing.  This could also reduce concentration in the audit market.  The Commission published a study by the consulting firm Oxera last year.

It is certainly too early to expect a change of article 3 of the Audit Directive which requires the majority of voting rights to be in hand of approved statutory auditors.  However, the Commission wants to launch a public consultation on the issue.  This is a difficult question because it could have consequences on the independence of auditors and mainly on the perception of audit firms by companies and third parties.

Audit Quality Inspections

We have worked a lot on this issue with the European Commission in 2007.  They intend to substantially revise the content of the Recommendation of 2000 and to issue a new recommendation limited to listed companies.

I know that the Finnish Central Chamber of Commerce is now responsible for quality assurance of audit firms in your country.  This results from the requirement of the new Directive that quality assurance is monitored by a body independent of the profession.  We agree with that.

However, we want that the system put in place in the Member States remain practicable and do not include unacceptable burdens for smaller firms.  The Commission is pushed by the US-PCAOB to exclude practitioners from the system of external quality assurance.  We do not believe that this is what the Directive says.  It would be expensive and to a large extent subsidised by smaller firms in small Member States.  Also, it will be difficult to find competent people to do the job.

The Commissioner agreed with a transitional period when professional bodies and practitioners will be allowed to take part in the inspection process.  This issue is far from being solved but we cannot forget the objective which is audit quality in larger and in smaller audits.

Auditing Standards

The Commissioner decided to postpone the endorsement of ISAs.  This is disappointing.  He argued that the Clarity Project will not be finalised before next year.  He also said that he needs first impact assessment studies.

We believe at FEE that it is vital to be harmonised in the field of audit standards.  We know today that we cannot wait the Commission.  The profession must move forward at national level and approve clarified ISAs.  This is also very important to make standards applicable at a reasonable cost in SMEs audits.

Cooperation with Third Countries

I will not be long on this last element in the Commissioner’s speech.  We know that finding an agreement with the US is high on the agenda of the Commission.  This is also true for cooperation with other large countries in the world.  There are however difficult questions to solve here, especially the problem of access to audit working papers.

3. Choice in the Audit Market

Let us now arrive to my last topic: Choice in the Audit Market.  When she asked me to address the topic, your Secretary General indicated to me that:

“In Finland, the market is such that we have circa 300 large and PIE companies, not many medium-sized companies and many small and micro-companies.  This means that many auditors are sole practitioners or in very small practices.  Four large firms are increasing their share of the market.”

Ms. Aejmelaeus added that due to the age structure, many practitioners will leave the profession within the next five years.  The entrance requirements are so difficult that the profession is not attractive and also not as lucrative as other professions.

In the Oxera study commissioned by the EC in November 2007, Finland is ranked at the forth place of the most concentrated audit markets in the EU (page 169).

Now the question will be: do we have a problem with the choice in the audit market and what could be done to improve the situation?

I will not speak about Finland at this stage.  Let me come back at a higher level of generalities.  The FEE Council established an Audit Market Task Force and received a report in June 2007 that I want to use as a basis for my comments.

The first issue is: do we have a problem?

Many reasons exist to say yes; there is at least an issue to consider.  Many people consider that the market is highly concentrated in EU Member States but the same applies in other parts of the world.  The UK audit regulator (Financial Reporting Council) commissioned a specific research on the topic and established a market participants group in October 2006.  It is interesting to quote one of its conclusions in its interim report of April 2007.

“The Group noted that due to the level of auditor concentration there is a high degree of concern amongst market participants over the uncertainty and costs that could arise in the event of one or more of the Big Four firms leaving the market.  This risk could be mitigated through increased choice of auditors.  However, a number of current market characteristics, when taken together, reduce the propensity of non-Big Four firms to offer to audit public interest entities and the propensity for public interest entities to select non-Big Four firms as auditors.”

Many studies agree that concentration is especially high in the market of listed companies and subsidiaries of listed companies.  The situation is not similar in other market segments.  This was the conclusion of the competition services at the European Commission.  The accountancy profession is perceived as pro-market and instrumental in a market economy.

Two papers published recently by the European Commission discuss the concentration on the audit market, mainly concerning public interest entities.  They suggest solutions to facilitate access of smaller firms to listed clients but they do not explicitly recognise the existence of a problem.  This is the case of a study of London Economics in September 2006 and Oxera in 2007.

Finally, I would mention a very recent study of the United States Government Accountability Office of January 2008.

GAO prepared this report as part of a continued effort to assist the US Congress in reviewing concentration in the market for public company audits.  It writes that “while the small public company audit market is much less concentrated, the four largest accounting firms continue to audit almost all large public companies.”

GAO does not see a big problem there and write that current concentration does not appear to be having a significant adverse effect.  However, as in the UK, it recognises that “the loss of another large firm would further reduce large companies’ auditor choice and could affect audit fee competitiveness”.

In conclusion, most regulators and studies accept that choice in the audit market is an issue but not a problem unless one of the major audit firms would leave the market of listed companies.

This leads to the second question: can we expect or ask for regulatory intervention to increase audit choice?

Considering the assessment of the market situation, it is not surprising that the US-GAO considers that no action is needed.  You can read the following in their report.  I quote:

“Academics and business groups have put forth proposals to reduce audit market concentration and address challenges facing smaller accounting firms, including capping auditors’ liability and creating an office to share technical expertise.  Market participants raised questions about the overall effectiveness, feasibility, and benefit of these proposals, and none were widely supported.  Given the lack of significant adverse effect of concentration in the current environment and that no clear consensus exists on how to reduce concentration, no compelling need for immediate action appears to exist.”

In Europe, however, Commissioner McCreevy sees an advantage in limiting liability.  This would reduce the risk that one of the major firms collapses, on the condition that the cause of the damage would not be a criminal behaviour.

Except for that recommendation on liability, we can hardly expect regulatory intervention in the near future.  The discussion on ownership will not go further than an open debate at this stage.  The Oxera report is far from demonstrating that it could substantially contribute to the increase of choice in the audit market.  After all, nothing has changed since the Statutory Audit Directive has been approved.

As a Frenchman, I cannot avoid mentioning a technical solution which helps a lot getting smaller networks active in the market for listed companies.  I meant joint audits.  In the FEE audit conference of November 2007, Mr. Michel Prada, Chairman of AMF and IOSCO Technical Committees said that “it is seen by some not only as a mean to open up the market and allow more firms to access the largest global audits, but also, and more importantly, as a help to promote audit quality”.

Anyway, if we cannot expect much from regulators, we can deliver the message that we are concerned with the long-term sustainability of the profession if at least three objectives cannot be reached.

- A solution to the liability problem addressing seriously the situation of small as well as larger firms;
- Market and professional encouragement to the development of networks at a national, European and global levels;
- Enhancement of the attractiveness of the profession.

The last objective must be considered seriously.  Leena Aejmelaeus mentioned the point when she asked me to deliver this speech and she is right.  However, we need to be aware that the responsibility is shared between regulators and the profession.

From the regulators’ side, we would expect them to:

- Avoid over-regulation, as well for companies as for auditors because this provides the wrong perception to young people.  Financial reporting is important for companies.  Accountants deliver useful services and cannot be accused of administrative burdens;
- Ensure a level playing field for all auditors.  If they passed successfully the quality assurance test, there cannot be regulatory differences between audit firms.  Regulators cannot become responsible for more concentration in increasing reputational barriers.

From regulators, we can also expect that they do not intentionally reduce the audit market in scoping out the micro-entities or the small companies.  The audit engagement is a well-developed product.  We should be very careful before substituting a lighter and supposedly cheaper assurance engagement for instance in the form of a review as experienced currently in the UK and the US.

Now, from the professional side, we also have responsibilities in demonstrating attractiveness of the profession to young generations.

We exercise an exceptionally useful and appreciated profession.  Our services are necessary to the economy.  We must demonstrate however that we are able to:

- Keep our competence at the highest level;
- Behave ethically in all circumstances;
- Deliver quality to clients in many kind of services;
- Adapt to the modern world in developing the services that clients really need and expect from a modern and dynamic profession.

This will also be my conclusion.  The accountancy profession has responsibilities towards society.  We need to demonstrate first that we are credible, that we are reliable in delivering the services our clients need.  This is a collective responsibility of all practitioners at any time in our professional career.  This is also the best answer to many regulatory challenges.

I thank you for your attention and I am listening to your questions or comments.