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eu

March 2012

Position Paper

EGIAN supports rebalancing of proposals for much needed
reform of the European audit market

Contents

Background

1 Introduction
2 Legislative intervention essential
3 The problems with the current audit market
4 Key features of a more vibrant market

Quality driven
Independent
Transparent
More diverse due to additional players
Progressive
Proportionate and growth-orientated
A Single market
Sustainable

5 Rebalancing of reforms to facilitate additional firms entering
market

Additional players critically underpin the reform programme
Promoting additional players mandatorily or by encouragement
Focussing on large PIEs
The reforms form an interconnected package

Comments on specific proposals

6 Support for regular and fair tendering
7 Mandatory rotation of firms current period too short

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March 2012

8 Provision of non-audit services support for appropriate
limitations
9 Pure audit firm model misleading label

10 Co-audit essential to bringing additional players into the market

Joint audit key measure to reduce concentration
Shared audit a stepping stone to reducing concentration

11 Conclusion working together to come up with workable reforms

Appendix

EGIANs initial views on selected other proposals in the draft
regulation

a Support for use of International Standards on Auditing (ISAs)
b Concern over internal quality control review
c Contingency planning inadequate response to risk of exit of a
dominant firm
d Support for prohibition of Big 4 only contractual clauses
e Support for modification of ownership rules
f Support for creating a single European market for audit
g Support for corporate governance statement
h Audit committees all members should be independent
i Caution on role of ESME
j Clarification needed on sanctioning powers



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March 2012

EGIAN supports rebalancing of proposals for much needed
reform of the European audit market
Background
1. Introduction
The European Group of International Accounting Networks and Associations
(EGIAN), which represents nearly all of the major international networks and
associations of audit firms apart from the Big 4, welcomes the publication by the
European Commission of the draft regulation on specific requirements regarding
statutory audit of public interest entities and of the draft directive amending
Directive 2006/43/EC on statutory audits of annual accounts and consolidated
accounts.
The publication of the draft regulation and directive enables the proposed
measures to be discussed through a transparent and democratic process.
There is an unprecedented opportunity to create a Single Market in the
European Union (EU) in audit which addresses the needs of the principal users
of audit reports and is focused on promoting audit quality, independence and
transparency. EGIAN has concerns, however, that, as the proposed legislation
currently stands, it will not achieve these goals. This paper proposes a practical
way forward to create an open vibrant audit market for Public Interest Entities
(PIEs) involving additional firms and which has serving the public interest at its
heart.
2. Legislative intervention essential
EGIAN believes that legislative intervention is essential to bring about the
necessary change in the PIE audit market across the EU. Voluntary initiatives
have not secured any significant changes and legislative intervention is therefore
now unavoidable. Without it the current unsatisfactory situation will continue to
deteriorate further until it goes beyond the point of being reversible. The situation
would be severely aggravated were one of the four dominant players to leave
the market, a concern regularly voiced by regulators and regulatory capture
would in all likelihood be guaranteed at this point.
3. The problems with the current audit market

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March 2012

Leading investors, the European Commission and a number of reports in some
Member States have identified serious problems with the operation of the
current audit market for PIEs and especially large PIEs. A stagnant audit market
is preventing audit achieving its full potential. The problems include:
excessively high degrees of concentration amongst the dominant firms in the
PIE audit market in nearly all Member States;
the presence of only four firms with a meaningful market share and, in some
sectors, even fewer;
high barriers to building meaningful market share or entry for new players;
low rates of switching and tendering;
a low level of innovation; and
worries about independence and institutional familiarity and bias.

Taken together, these concerns highlight that the current model is not meeting
the needs of shareholders, other stakeholders or the wider public interest.
In support of the above concerns, the European Commissions Impact
Assessment for the draft regulation and directive, highlights that:
the market share of the Big 4 audit firms for listed companies exceeds 85%
in the vast majority of Member States;
all EUROSTOXX50 were audited by the Big 4 in 2010;
in the UK the Big 4 audit 99% of the FTSE100 and around 95% of the
FTSE350
in Germany two firms in the Big 4 have 90% of the mandates in the DAX30;
and
in Spain all of the IBEX35 are audited by the Big 4 with the lead firm
responsible for 46% of those audits as well as all of those related to the
major banks.

In marked contrast to the above figures, in France, where there is joint audit, the
Big 4s share of the audit market amongst FTSE350 equivalent companies is a
much more reasonable 58%.
4. Key features of a more open vibrant market
To address the problems outlined above, the EU must create a much more open
vibrant market for the audit of listed companies and other PIEs with additional
players willing to challenge the status quo. Such a reformed market should be
based on the following key attributes:
- Quality driven

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March 2012

A healthy market for the audit of listed companies and other PIEs must have
quality at its heart and promote a culture of continual enhancement in quality
with an emphasis on professional values being placed ahead of business
interests. Members of the Forum of Firms, for instance, which includes a number
of members of EGIAN, have committed themselves to adhere to and promote
the consistent application of high-quality audit practices worldwide and national
regulators thoroughly monitor adherence to the necessary standards. In
addition, a strong focus on innovation at firm and profession-wide levels should
form an integral part of a quality driven approach.
- Independent
There are concerns about the independence of auditors, or the perception of
their independence, in circumstances where the fees for non-audit services,
especially on a large PIE audit, are a high fraction of, and sometimes exceed,
those earned from the audit. These concerns stem from the firm reporting to the
company management in respect of non-audit services as opposed to
shareholders, and the audit committee on their behalf, in the case of the audit.
Whilst the IFAC Code of Ethics provides safeguards with regards to auditors
providing non-audit services, we need to address any reasonable concerns that
remain if auditing is to be widely regarded as achieving the necessary high
standards of independence expected of a profession.
- Transparent
There needs to be much greater transparency in a reformed market with
regards, for example, to the reporting of key issues on the audit; details relating
to when the auditor was first appointed; audit tenders; links between the auditor
and audited entity and the provision of information relating to the audit firm.
- More diverse due to additional players
Merely creating a more competitive environment among the current dominant
players will neither lead to the change in culture or practices that is necessary to
bring about enhanced quality and independence that is called for in the audit
market for listed companies nor will it guard against the exit from the market of
one of the current dominant players. Contingency planning to manage the risk of
such an eventuality is not enough. The introduction of additional players is
essential.


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- Progressive
The changes introduced must be progressive such that within a reasonably short
timeframe, say 3 to 5 years, the additional players will be able to compete on an
equal footing and collectively gain a significant share of the market.
- Proportionate and growth-orientated
Against a background of more robust regulation of auditors, especially with
regards to large PIEs, care is needed to avoid the imposition of inappropriate
burdens on smaller listed companies as well as on unlisted small and medium-
sized undertakings as they have a vital role to play in securing economic growth
and new jobs across the European Union. Concentration issues are far less of a
problem in these segments of the audit market. And account must be taken of
their particular needs which arise from their having less access to in-house
resources as they have a vital role to play in securing economic growth and new
jobs across the European Union.
- A Single Market
To meet stakeholders needs, the market needs to advance from being a series
of separate national markets to a single European market where firms and
individuals can work across frontiers more effectively. The proposed introduction
of the voluntary European Quality Certificate is therefore welcome as are the
proposals for a European Passport, subject to appropriate safeguards being in
place. .
- Sustainable
The combined effect of the reforms should be to create a market that is more
sustainable and stable than is currently the case.
5. Rebalancing of reforms to facilitate additional firms entering market
Additional players critically underpin the reform programme
Reforms proposed should be tested against the criteria set out in Section 4
above. The current proposals need to be rebalanced, especially with regards to
more clearly facilitating the entry of additional players into the market as this
underpins many of the other reforms. In this section, we identify the package of
key reforms we believe are necessary and in the Appendix we discuss other
important measures.

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Promoting additional players mandatorily or by encouragement?
If they are to achieve their objective, the reforms adopted need to offer
reasonable assurance that additional players will have a more significant role in
the PIE audit market in the future. This can be most straightforwardly be
achieved by mandatory measures, or alternatively by encouragement to boards,
to make appointments from among non-dominant players. If the latter approach
is adopted, there will need to be significant encouragement to boards in a
number of areas to promote the necessary change in approach.
Focusing on large PIEs
We believe a number of the proposed measures are best directed primarily
towards large listed companies, where the concerns relating to independence
and concentration in the audit market are greatest, rather than their applying to
all PIEs.
The reforms form an interconnected package
Lastly, the reforms must be considered as a package of interconnected
measures aimed at producing significant change to the structure of the audit
market. Care needs to be taken not to look at individual measures in isolation as
this may lead to their impact not being properly assessed.
Comments on specific proposals
6 Support for regular and fair tendering
We support regular and fair tendering for audits and would suggest that audits
should be subject to tender at periods between 7-9 years recognising that 7
years is the maximum period before rotation of partners under the Eighth
Directive and IFACs Code of Ethics. The tendering process should be fair and
open to a range of firms with the necessary skills in addition to the dominant
players which may go beyond just requiring one non-dominant player to be
included on the tender list. There should also be transparency on when the
auditor was first appointed; when the last competitive audit tender was held; how
the tendering process was conducted, where applicable; and the reasons the
successful firm was chosen. Full information should also be provided of links
between the audited entity and the auditor in order to reduce the current high
levels of familiarity and institutional bias favouring the dominant firms.


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7 Mandatory rotation of firms- current period too short
We are not persuaded of the overall benefits of the mandatory rotation of firms
at periods not normally exceeding 6 years. This seems unduly short when
considering the overall cost which will be incurred, and the inevitable learning
curve. We believe a strict rotation of partners combined with fair and regular
tendering would be an appropriate response to concerns about unduly long
periods of tenure. That being said, should the mandatory rotation of firms be
considered necessary , we would suggest a longer period should apply before
rotation, say 14-16 years with rotation not being needed in circumstances where
there was joint audit or, possibly, for smaller PIEs. The period suggested is
based on approximately two terms of 7 years, the period for the rotation of
partners, as discussed above..
8 Provision of non-audit services - support for appropriate limitations
As discussed above, we understand the concerns relating to the provision of
non-audit services by auditors especially to large PIEs. We are concerned,
however, that the 10% cap on fees for audit related services appears unrealistic,
as it for example includes the reviews of interim statements, and is not
necessary as none of the services included in the allowed list to which the cap
applies poses a threat to the auditors independence. The cost of such a review
could exceed 10% of the audit fee, especially for smaller cap companies. In
addition, the auditor is generally best placed to provide them. We also consider
that the list of proposed prohibited services should be reviewed with a view to
reducing it for smaller PIEs given that these entities are not a significant source
of concern to investors with regards to independence issues.
9 Pure audit firm model misleading label
The proposal that firms in large networks which earn more than one third of
their audit income from large PIEs should only provide audit services to their
clients has been misleadingly labelled a pure audit firm model by those
opposed to it. We prefer to call it a balanced audit firm model. It is fully within
the dominant firms control to remain within the proposed limits and so be able
to remain multi-disciplinary if they believe this to be a preferable form of
organisation for the firm. It is very important to bear in mind that this is the only
measure that attempts to address the unacceptably high levels of concentration
in the market.
10 Co-audit- essential to bringing additional players into the market

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We need to move away from the concept of a group of companies having just
one auditor and towards that of two, or occasionally more, firms working
together. This will crucially help to preserve the auditors combined knowledge of
the group when one of the auditors changes, a concern frequently cited by the
largest clients of the dominant firms. Co-audit may take the form of joint audit or
shared audit and these are now explained.
J oint audit - key measure to reduce concentration
The joint audit of large public interest entities, where one of the auditors is not a
dominant player, will lead to a reduction in concentration and provide protection
to large listed companies against the risk of a dominant player leaving the
market unexpectedly. The joint auditors are jointly responsible for the opinion on
the PIEs group financial statements as a whole and thus it brings the merits of
the four eyes principle with additional scrutiny of complex issues arising on the
audit. In the current proposed text, there is only very modest encouragement to
adopt joint audit with the proposed basic period before compulsory rotation
being extended from 6 years in the case of sole audits to 9 years for joint audits.
Mandatory joint audit would form a useful part of a package of measures
designed to lead to more diversity in the PIE market and could be achieved in a
practical way.
If joint audit, including use of a non-dominant firm, is just to be encouraged, our
less preferred alternative, the incentives to adopt it should be markedly
increased, eg abolition of the need for mandatory rotation; longer periods before
tendering is required; less restrictions on the provision of non-audit services as
each joint auditor will need to assess the non-audit services provided by the
other with regards to their impact on independence; and the possibility of not
counting joint audit fees for the calculation of the pure audit firm thresholds.
Shared audit - a stepping stone to reducing concentration
Another way to reduce concentration over time would be by increasing the
number of shared audits under which a different auditor than that of the group
consolidated accounts audits a number of subsidiaries. If it is to be a meaningful
sharing of the total audit work in a group, it is important that the second auditor
be involved in the audit of some important group subsidiaries. Whilst not
immediately reducing the level of concentration amongst the dominant players, if
measured by number of listed audit assignments, it would serve to allow more
PIEs to use and trust more auditing firms. Such a relationship may make it
easier for the subsidiary auditor to build its share of the group audit and over
time to become a credible candidate in subsequent audit tenders for the listed

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PIE. This would be in line with our support for progressive reform which builds
on itself over time.

11 Conclusion- working together to come up with workable reforms
The current review of the audit market in the European Union provides a unique
opportunity to tackle problems with its functioning that have built up over many
years and which, if not addressed, will continue to get progressively worse.
Whether one analyses the current situation from an audit regulatory or a
competition perspective, the issues giving rise to concern and the proposed
remedies, such as the need for additional players in the large listed audit
marketplace, are the same.
The current audit market is not currently meeting the needs of shareholders or
the wider public interest, or those of the Single Market. We cannot allow this
situation to continue. At EGIAN, we firmly believe in the concept of different firms
working together and we believe that to move the audit reform agenda forward it
is vital that members of EGIAN, the Big 4 and professional auditing bodies work
together and with board representatives, governmental representatives,
investors, parliamentarians and regulators to develop a programme of workable
reforms that will bring benefits to investors, the capital markets generally and
wider society.



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Appendix

EGIANs initial views on selected other proposals in the draft
regulation
a. Support for use of International Standards on Auditing
We support the proposal that auditing should be undertaken in accordance with
International Standards on Auditing and, in full respect of the Union sovereignty,
would welcome it being clear that this reference is to the IAASBs clarified
International Standards on Auditing which are widely recognised and have been
developed after extensive due process under a respected governance structure
enjoying European Commission support.
b. Concern over internal quality control review
We have serious concerns about the proposal in Article 22.2(m) which calls for
the auditor to report on the internal control system. There is a risk that such a
proposal will lead to significant additional costs for the audited entity without
commensurate benefits for shareholders and others and be a move in the
direction of the Sarbanes-Oxley-driven approach in the US, or indeed beyond it,
which would be most unfortunate.
c. Contingency planning - inadequate response to risk of exit of a
dominant firm
Whilst we support contingency planning for the largest firms we do not believe it
is a sufficient response on its own to address the risk of one of the dominant
players leaving the market unexpectedly. Moreover, the contingency planning
should take account of the need for concentration in the market not to be
increased following such an exit. Creating the conditions for additional players to
win a significant market share collectively is the best way to address the issue of
a dominant player exiting the market.
d. Support for prohibition of Big 4 only contractual clauses
We strongly support the prohibition of Big 4 only contractual clauses in loan and
other agreements, a proposal for which there is widespread support. Non
contractual restrictions must also be disclosed by the company.

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e. Support for modification of ownership rules
We support the relaxation of the current ownership rules so that audit firms
which wish to do so may avail themselves of the change in order ot be able to
raise increased amounts of external funding. We do not, however, think it will
have a substantial impact in practice as most firms seem to prefer the current
partnership model. We would also counsel that statutory limitation of auditors
liabilities would need to be considered alongside the relaxation in order to make
the latter of realistic interest.
f. Support for creating a single European market for audit
It is essential that a single audit market for Europe be created and we therefore
support the proposed introduction on a voluntary basis of the European quality
certificate and of the move to home country supervision coupled with a
European passport to make it more easy for audit firms and auditors in the
European Union to work across Member State frontiers. We do, however,
consider that where the adaptation procedure is adopted that care is needed to
ensure the auditors involved have the necessary understanding of relevant laws
and regulations in their host country and possess the necessary language
capabilities.
g. Support for Corporate Governance Statement
We support the proposals that audit firms with significant revenues from large
PIEs should publish corporate governance statements.
h. Audit Committees - all members should be independent
The Audit Committee has an important role in supporting audit effectiveness. In
this context we support the audit committee being composed of non-executive
members of the governing body of the audited entity but we believe that all
members and not just a majority should be independent. We agree that at least
one member of the Audit Committee should have relevant accounting and/or
auditing expertise. We are not sure, however, that it also needs to be specified
that another member should have auditing expertise.
i. Caution on role of ESMA
We support the proposal that co-operation between competent authorities
should be organised within the framework of ESMA but caution is needed to

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ensure ESMAs role does not become too pervasive. We would not support
ESMA being cast in the role of standard setter.

j. Clarification needed on sanctioning powers
Whilst welcoming the statement in Article 61 that sanctions shall be proportionate
as well as effective and dissuasive and the list of factors to be taken into account
when determining appropriate sanctions, as set out in Article 63, we do have
concerns that some of the potential sanctions set out in Article 62 are potentially
very severe and do not distinguish between different Articles which may have been
breached.