31 May 2012

GO: Audit - EU Pension Fund position paper for the European Parliament

Governance for Owners published its EU Pension Fund position paper for the EP, prepared by Universities Superannuation Scheme Ltd in cooperation with significant institutional investors in EU equity markets. In their position paper they analyse the quality of the audit and proposed EC Directive.

They believe there are a number of worrying features of the audit market. At a very fundamental level, they are concerned about auditor independence and professional scepticism. Potential conflicts of interest have always been present in the system of auditing, so the challenge is how these are managed. They believe the current system is not delivering, as evidenced by:

• the failure of auditors to provide adequate warningsprior to the collapse of a number of banks and insurers in the financial crisis;
• too few large auditorsproviding audit services to the largest listed companies;
• the lack of rotation;
• the high levels of non-audit workconducted by the auditor for the same company;
• the apparently heavy dependence of the regulators and standardsetterson the large audit firms for professional and financial support.

They set out their thoughts and specific proposals below in response to the proposed EC Directive and Regulation on audit.

Mandatory rotation

Proposal: Audit Committees are required to set a maximum tenure period for auditors to suit their company’s complexity and size, and outline their reasoning to shareholders. An upper bound of 15 years should be set to safeguard shareholders' long-term interests. It is expected that Audit Committees will undertake at least one competitive tender including the incumbent, and then again at the end of the full term, excluding the incumbent. There should be a ‘clear water’ period of at least five years before an auditor can be re-appointed.

Appointment & tendering

Proposal: They would like to see a system of mandatory tendering every five-seven years, combined with mandatory rotation after no more than 15 years. The tender should involve at least two candidates (other than the incumbent) to ensure genuine competition and to open the market to new entrants. They do not feel the EC should go as far as requiring that a smaller auditor is involved in the process. The selection and appointment process needs to be transparent for shareholders.

Non-audit services

Proposal: Auditors should be permitted to undertake audit related work, but they favour restrictions on non-audit work for audit clients combined with a requirement that where the value of non-audit work rises above 50 per cent of the audit work, the Audit Committee must select a new audit firm at the next tender.

Audit reports

Proposal: They would like to see a fuller audit report that draws attention to key areas of judgement, estimates, any weaknesses in the financial system, assumptions underlying fair value estimates, any disagreements with management, etc. They would support more formal adoption of the “Audit Committee Reports – Global Disclosure Guidelines” published by the Enhanced Disclosure project.

Audit committees

Proposal: They support having two members with some auditing/accounting expertise on Audit Committees at large cap firms.

EU-wide ISAs

Proposal: Rather than extending the coverage of ISAs, the EC should investigate as a matter of some urgency whether IFRS is delivering accounts that provide a “true and fair” view as required under the 4th and 7th Accounting Directives, and therefore can ensure prudent long-term stewardship by management and shareholders.

Full paper

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