European Union: Statutory Audit Directive – Impact On Investment Funds

Last Updated: 27 April 2016
Article by Kevin Murphy, Sarah Cunniff, Dara Harrington and Adrian Mulryan
Most Read Contributor in Ireland, October 2018

On 17 December 2013, the European Parliament and the Member States reached a preliminary agreement on the proposal for a Directive amending the Statutory Audit Directive (Directive 2006/43/EC) and the proposal for a regulation on specific requirements regarding statutory audit of public-interest entities (the "Regulation"). The publication of the amending Directive and the new Regulation on Statutory Audit in the Official Journal of the EU took place on 27 May 2014 (OJ L 158). The Regulation came into effect immediately although there is a two year delay in the application of most of its provisions. Transposition of the Directive into Irish law must take place by 17 June 2016.

OVERVIEW

Proposed amendments to the Statutory Audit Directive aimed at reforming the audit market within the EU may have implications for any EU domiciled investment funds and specialist debt instruments which are listed on a regulated market, such as the Irish Stock Exchange. The proposals feature a number of proposed changes including:

  • a requirement for the rotation of auditors after a period of ten years;
  • a limitation on audit firms providing non-audit services such as tax, consultancy or advisory to their listed clients;
  • a limitation on fees of auditors for non-audit services in specific circumstances.

WHY REFORM THE RULES GOVERNING STATUTORY AUDIT?

Statutory audits contribute to the orderly functioning of markets by improving the integrity and efficiency of financial statements. The new rules address a number of shortcomings observed on the audit market:

  • Deficiencies, and in some instances misstatements, have been observed in audit reports by Member States' competent authorities.
  • An excessive familiarity between the management of a company and its audit firm, risks of conflicts of interest, and threats to the independence of statutory auditors can challenge the ability of statutory auditors to exert thorough professional scepticism.
  • A lack of choice of audit firms emanating from high concentration levels in the top-end of the audit market leading to possible systemic risk as the audit market is effectively dominated at the top end by four networks.

IMPACTS ENTITIES CLASSIFIED AS PUBLIC INTEREST ENTITIES ("PIE") IN EU LEGISLATION

The Statutory Audit Directive targets the audit process for all public interest entities in the EU. These entities include:

  • All entities that are both governed by the law of a Member State and listed on a regulated market;
  • All credit institutions in the EU, irrespective of whether listed or not;
  • All insurance undertakings in the EU, regardless of whether they are listed or not and regardless of whether they are life, non-life, insurance or reinsurance undertakings; and
  • Entities designated by Member States as public-interest entities, for instance undertakings that are of significant public relevance because of the nature of their business, their size, or number of employees.

WHAT WILL CHANGE: KEY MEASURES

I. Enhanced information to investors

The primary objective of the reform is to increase the quality of statutory audit. This means both enhancing statutory auditors' independence and providing investors and shareholders of audited entities with better and more detailed information via the audit report.

For instance, in the case of a PIE audit, the Regulation introduces a requirement for statutory auditors auditing PIEs to report on key areas of risk of material misstatement of the annual or consolidated financial statements. In addition, statutory auditors will need to explain to what extent the statutory audit was considered capable of detecting irregularities, including fraud.

The reform aims to help reduce the 'expectation gap' that often exists between the perceptions of what auditors should be delivering and what they are bound to deliver.

II. Statutory audit of PIEs: Mandatory rotation of statutory auditors

There are obvious risks for PIEs in having the same statutory auditors or audit firms. A long professional relationship may undermine the statutory auditor's independence and negatively impact on its professional scepticism. Rotation of the key audit partner within an audit firm is insufficient because the main focus of the audit firm remains client retention. A new partner would be under pressure to retain a long-standing client of the firm.

Following the entry into force of the new rules, PIEs will be required to change their statutory auditors or their audit firms every 10 years as a maximum. The duration of the audit engagement shall be calculated as from the date of the first financial year covered in the audit engagement letter.

Member States, however, can establish shorter rotation periods (e.g. a maximum of seven or eight years). In addition, Member States can allow PIEs to extend the audit engagement: i) by an additional 10 years upon tender; or ii) by an additional 14 years in the case of joint audit.

III. Statutory audit of PIEs: Prohibition of certain non-audit services to audited PIEs

The objective of the reform is to ensure that statutory auditors and audit firms enjoy conditions of independence to perform their primary 'societal' role: statutory audit. When auditing PIEs, the provision of certain services other than audit (non-audit services) involve an inherent threat to their independence and may substantially increase the risks of conflicts of interest for statutory auditors and audit firms.

As a result, the Regulation introduces a list of non-audit services that statutory auditors and audit firms will not be able to provide to the audited entity, to its parent undertaking and to its controlled undertakings within the European Union (the so-called 'black list'), in order to avoid situations where the independence of statutory auditors or audit firms could be compromised.

Examples of services covered by the 'black list' include:

  • Specific tax, consultancy, and advisory services to the audited entity;
  • Services that involve playing any part in the management or decision-making of the audited entity; and
  • Services linked to the financing, capital structure and allocation, and investment strategy of the audited entity.

Member States can chose to derogate from the list of prohibited non-audit services to provide certain tax and valuation services when these services are immaterial or have no direct effect, separately or in aggregate, on the audited financial statements. Member States also have the possibility of prohibiting more non-audit services than those in the 'black list'.

Apart from the non-audit services listed in the Regulation, and where Member States have not adopted more stringent provisions, statutory auditors and audit firms can provide services other than audit to the PIEs they audit.

IV. Structure of fees received from PIEs

The Regulation establishes that when a statutory auditor or an audit firm has been providing non-audit services to the audited PIE for a period of three or more consecutive financial years, the total fees for such services shall be limited to a maximum of 70% of the average of the fees paid in the last three consecutive financial years for the statutory audit(s) of the audited entity and, where applicable, of its parent undertaking, of its controlled undertakings and of the consolidated financial statements of that group of undertakings.

All calculations for the cap need to be done at group level – i.e. they need to take into account not only the audited entity but also, where applicable, its parent undertaking, its controlled undertakings and the consolidated financial statements of that group of undertakings.

There is no fixed limit with regard to the amount of fees that a statutory auditor or an audit firm can receive from a given audited PIE. However, there is a percentage limit to prevent the statutory auditor or audit firm from becoming too dependent on a given audited PIE.

Thus, when the total fees received - both for audit and non-audit services - by a statutory auditor or an audit firm from a single PIE in each of the last three consecutive years exceed 15% of the total fee income received by that statutory auditor or audit firm, that fact should be disclosed to the PIE's audit committee. The audit committee should then consider submitting the audit engagement to a quality control review. If the fees received continue to exceed 15%, the audit committee should also consider whether the audit engagement should be kept; if so, the audit engagement can remain in place, but for a period no longer than 2 years.

CONCLUSION

The impact on listed Irish funds is considerable as they will have to consider not only audit rotation but also the extent of non-audit work which may be carried out by audit firms (e.g. tax advice). We expect final Irish rules to be issued imminently which will be applicable for accounting periods beginning on or after 17 June 2016 as per the timeline attached as Annex A.

To view the full article please click here.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions