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AFM largely positive on European plans for strengthening financial audits

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Today, the Netherlands Authority for the Financial Markets (AFM) has offered its analysis of the proposals from the European Commission to the minister of Finance. On balance, the AFM assesses the proposals from the European Commission as positive. The AFM expects these proposals to contribute to an improvement in the quality of statutory audits, the recovery of confidence in auditors, and to strengthen the financial markets. Obviously, some comments may be placed regarding the proposals, which will be negotiated in the Council of Ministers and the European Parliament in the coming months. According to the AFM, the forced separation of large audit firms and the obligatory participation of ‘small’ audit firms in audits are not in order.

Gerben Everts, AFM director responsible for supervision of audit firms in the Netherlands: ‘Auditors have a long way to go to recover the breach of trust after the financial crisis. Legal safeguards must be dusted off. Improper commercial incentives confined. A change of mentality stimulated. In order to reach this, as regulator we prefer to cooperate with the audit firms. The AFM gladly applauds the plans from Brussels, which promote the quality, independence, and transparency of the work of auditors and strengthen external supervision. In order to regain the originally intended role for auditors to safeguard the public interest. We believe that this is the main task for auditors. We will supervise this constructively, independently and critically.’

On 30 November 2011, the European Commission presented its proposals for the reform of the audit market. The proposals concern a draft Regulation concerning specific requirements for the statutory audit of public-interest entities (PIEs) and a draft Directive concerning an amendment to the current Statutory Audit Directive.

The AFM has studied the proposals from the European Commission and assessed the changes to the current situation in the Netherlands that the proposals entail. The conclusions in our analysis are based on a policy-based analysis and expressly also on the AFM’s experiences as a regulator for audit firms.

The AFM particularly calls for attention the following main points:

Independence

The most important problem with regard to the independence of auditors and audit firms identified by the European Commission is that this independence is neither assured nor demonstrable. The statutory audit has effectively become one of a range of (commercial) services. A lack of independence is leading to a lack of an attitude of professional skepticism on the part of the auditor. The AFM has certain comments regarding the following points.

Limitation of fees from audit-related services and non-audit services
The AFM recommends that the services provided by audit firms be separated into two main categories:

  • services designed to provide assurance regarding the information provided by the audit client for external users of this information, and
  • services for the audit client itself.

Services from the first main category that are performed at the same time as the statutory audit are usually related to the audit and seldom form a threat to independence. The AFM therefore does not see a need for the measure proposed by the European Commission regarding a limitation of the fees from these audit-related services to a maximum of 10 percent of the total fees from the statutory audit.

On the other hand, services falling into the second main category do often constitute a threat to independence. These services increase the risk of self-review, self-interest, conflicts of interest, familiarity and/or intimidation. The AFM therefore supports the proposal by the European Commission in principle to entirely forbid the provision of these services in addition to the conduct of the statutory audit. This doesn’t alter the fact that services from the second main category could be offered to companies other that the audit client.

Mandatory tendering and rotation of audit firms
The AFM supports a regular, transparent, and realistic tendering procedure for statutory audits of PIEs. The audit committee of the PIE concerned is responsible for the selection and appointment of the audit firm. Such a tendering procedure creates a natural moment of reflection on the adequacy and quality of the auditor, as well as the scope and design of the audit. A periodic evaluation of the quality of the audit and a realistic consideration of possible alternatives can form an important incentive for quality. The AFM is not at this point convinced of the need to rotate the audit firm after six years in all cases. This choice should be left to the general meeting of shareholders.

Joint audits
The AFM does not support (compulsory) joint audits. The AFM sees potential risks with regard to quality if none of the engaged audit firms has a complete overview of the statutory audit, whereby full responsibility cannot be univocally allocated to one external auditor.

Provision of information

The European Commission’s proposals will increase transparency with regard to audit firms, the quality of these firms and the statutory audits they conduct, and with regard to the supervision that is exercised. The AFM is of the opinion that the information asymmetry can be reduced as a result of these measures.

European harmonisation and supervision

The AFM endorses the harmonisation aimed for in the proposals of the European Commission through the simplification of cross-border activities by auditors, the obligation to make the application of the International Standards on Auditing (ISAs) compulsory, and the strengthening of supervision. The AFM is also a proponent of closer cooperation between European regulators where this is necessary and effective.

The measures that the European Commission proposes to constrain the sizeable market share held by the ‘Big Four’ audit firms (including mandatory splitting up of large audit firms, joint audits, compulsory inclusion of ‘small’ audit firms in the tendering procedure), are in the AFM’s opinion too far-reaching and arbitrary.

The AFM is committed to promoting fair and transparent financial markets.

As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.

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