Spanish Banking Association 7 th December 2010 AEB C/ Velazquez, Madrid Spain. Interest Representative Register ID:

Transcription

1 Spanish Banking Association 7 th December 2010 AEB C/ Velazquez, Madrid Spain Interest Representative Register ID: Consultation on Green Paper on Audit: Audit Policy lessons from the crisis December

2 EUROPEAN COMMISSION GREEN PAPER AUDIT POLICY: LESSONS FROM THE CRISIS (1) Do you have general remarks on the approach and purposes of this Green Paper? The Green Paper issued by the EC is a broad consultation on the audit function, and opened the debate on the role of the auditor, the audit market structure and other fundamental principles of the auditing function. We share many of the goals outlined in the Green Paper which would strengthen the role of the audit, the role of audit committees and promote financial stability and quality of audits. However, in general terms, we consider that the proposal fails to achieve these goals due to a lack of depth in the analysis of the potential improvement of the audit process in certain respects it raises. Several issues in the Green Paper proposals are of vital importance for members of audit committees and other related parties to corporate governance of companies, both European and non European. Some of the proposals go beyond the European space because some companies operate in a global market; therefore these proposals will have a global impact that should be considered before their adoption. It is also worth of mention that some of the issues raised may incur a disproportionate cost for companies having a negative impact on audit quality and may change in a very significant way some aspects of the corporate government and specifically the way companies manage their relationship with auditors. If some of these proposals are approved, certain strategic decisions 2

3 inherent to control and management of the companies would not be adopted by the competent governing bodies. Therefore, we believe that any change that might reduces the responsibility and the significance of audit committees, as representatives of shareholders in the government of entities, should not be adopted. Although specific responsibilities vary in each jurisdiction, audit committees are mainly responsible for the appointment of the auditor and their fee negotiation on behalf of the shareholders of the company. The topics that we believe would fundamentally change the role of the audit committee, undermining the quality of the audit function and generating an increase in costs, are: Potential conflicts related to the appointment of external auditor (questions 16 and 17). Mandatory rotation (questions 18 and 29). Prohibition of non-audit services (question 19). Compulsory joint audits (question 28). (16) Is there a conflict in the auditor being appointed and remunerated by the audited entity? What alternative arrangements would you recommend in this context? We do not see a conflict, provided there are adequate safeguards to address potential threats. In recent years, steps have been taken at international level to mitigate these potential threats: Standards of independence assumed and implemented by all audit firms globally have been issued. 3

4 Auditing is a profession subject to a high level of regulation, including various codes of ethics. The compliance of these standards is enhanced by the oversight by regulators on the audit profession and strict enforcement of the rules that apply to auditors. In addition, the audit committee plays a vital role in this process, acting as agent for shareholders in the prevention of conflicts of interest between the company and its auditors. Although specific responsibilities vary in each jurisdiction, in general, audit committees are responsible for the appointment of the auditor, the negotiation of audit fees on behalf of the shareholders and for overseeing the provision of services to the entity, other than auditing. In this regard, we support the strengthening of the audit committee s role (and in particular of independent members) for the appointment and determination of the remuneration of the auditor, being the final decision on appointment of the auditor an essential faculty of the General Shareholder s Meeting as owners of the company and as first user of audited financial statements. (17) Would the appointment by a third party be justified in certain cases? No, in any case. The appointment of an auditor by a regulator can create conflicts in their relationship, both between the regulator and the audited entity and between the regulator and the audit firm. On the other hand, if the auditor is appointed by a third party, other than the regulator, this third party will not have, in general, sufficient knowledge of the entity to choose the audit firm that best fits their profile. In any case, the appointment of the auditor by a third party would deprive the shareholders, the true owners of the company and first users of the audited financial statements, of a non-delegable competence. 4

5 With the controls set in the previous question, we believe that the decision to appoint an auditor should remain in the audit committee, as is the body that best knows the needs of the audited company and therefore is better able to select the auditing firm to provide the best services to the company. (18) Should the continuous engagement of audit firms be limited in time? If so, what should be the maximum length of an audit firm engagement? We do not believe that the appointment of audit firms should be limited in time, as there is no evidence to support that this improves the quality of the audit. Mandatory rotation is a concept designed primarily to cover potential problems of auditor independence. However, many countries (including the U.S. and most EU countries) have decided not to adopt, or have left even the mandatory rotation, as it has an adverse effect on the quality of the audit function. There are better mechanisms to promote the independence of the auditor, as the rotation of a member of the audit firm, which provides a new perspective on the audit while preserving the global knowledge of the risks of the audited company. Auditors are appointed by the Shareholders at varying time periods in different EU Member States and we believe that the General Shareholder s Meeting should maintain this right, including the possibility to re-appoint the same auditor. The professional and independence standards issued in recent years, establishing, among other requirements, partner rotation of audit firms at least every seven years, eliminating all risk of familiarity -which aims to correct the rotation mandatory-. In addition, the natural rotation of key personnel of the audited entities also mitigates this potential risk. Moreover, supervision by regulators on auditors and the supervision made by the Audit Committee on the independence of the auditor provide additional protection against any risk of familiarity. 5

6 The mandatory change would increase both, costs of companies (internal costs arising from the explanations of their activities and processes to the new audit team) and audit risk, reducing the quality of execution for the loss of knowledge by the outgoing audit firm on the business and systems of the audited entity. Research by Bocconi University, a leading business schools in Italy (Italy is one of the few countries that currently require rotation of audit firm of listed companies in nine years) has shown that rotation required: (i) reduces the quality of audits, (ii) increased costs for businesses, and (iii) increases the concentration in the audit market. The rotation reduces audit quality by eliminating the accumulation of knowledge which holds an auditing firm after several years auditing the same entity. The Bocconi University research showed that 80% of audit failure occurs in the first two years of audit relationship where the audit firm was still immersed in the expensive learning curve. Bocconi study also found that a change of auditor increases the overall cost of the audit, even if the incoming auditor accept a fee lower than its predecessor, concluding that this saving does not overweigh the extra time that the key personnel of the audited company would spend to explain its activities, the internal control and processes to the new auditor. In the U.S., a study by the U.S. Government Accountability Office (GAO) has also concluded against mandatory rotation. The GAO analysed this view in 2008 and found that regulatory changes occurred in recent years (including mandatory partner rotation of audit firm) have provided the benefits of mandatory rotation intended. Mandatory rotation of audit firms can also create significant practical problems in a global environment. For example, a global company with operations in many countries, including one or more that require mandatory rotation of audit firm, or have to change audit firms worldwide in every phase of rotation in each jurisdiction (to keep benefit of a single audit firm for its global operations) or 6

7 use different auditing firms in each of the jurisdictions that require rotation. Either approach can be costly and inefficient for global business and also increase audit risk (i.e., reduce audit quality.) In summary, we believe that any theoretical potential benefit of mandatory rotation is not worth the risks generated and also limits the rights of shareholders. (19) Should the provision of non-audit services by audit firms be prohibited? Should any such prohibition be applied to all firms and their clients or should this be the case for certain types of institutions, such as systemic financial institutions? No. There is currently legislation limiting enough, clearly, the type of services other than audit that can be performed by the auditing firm to preserve its independence. In addition, there are also mechanisms that control this risk for audits of public interest entities: (i) auditors should confirm annually their independence from the audited entity; (ii) report annually to the audit committee of the additional services rendered to the entity audited, and (iii) discuss the threats to their independence and the safeguards applied. Additionally, audit firms are subject to independent monitoring by the respective regulators. We believe that a general prohibition on audit firms to provide non-audit services is not necessary to preserve the independence and their negative impact would be clearly disproportionate to the objective pursued. Additionally, any ban would undermine the capacity of audit firms to recruit and retain top talent. For companies with complex global businesses, the range and depth of skills offered by multidisciplinary audit firms improve the quality and efficiency of audit services and therefore are best suited to your needs. Services other than auditing, but allowed under current rules, involve increasing awareness that 7

8 the audit firm has audited entity, its risks and processes, and contributes positively to a quality audit. (28) Do you believe that the mandatory formation of an audit firm consortium with the inclusion of at least one smaller, non systemic audit firm could act as a catalyst for dynamising the audit market and allowing small and medium-sized firms to participate more substantially in the segment of larger audits? We believe that audit committees and shareholders should be free to choose the audit firm that best meets their needs. We do not believe that mandatory joint audit is an effective measure to achieve the end proposed, and negatively affecting the quality of audits and could increase the costs for businesses. A joint audit makes it more difficult to obtain a comprehensive understanding of the business. Furthermore, the use of different methodologies by different audit firms audit can lead to inefficiencies and inconsistent approaches as well as duplicated work or not done. Additionally, if the idea is that the biggest audit firm performs the main part of the audit and the smaller firm a small part of the audit, it is unclear whether this would have a substantial impact on the access of smaller firms to market. An analysis of audit firms that audit French companies from CAC 40 (France is the EU's single country where joint audits are mandatory) shows that 70% of companies are audited by two Big 4. Moreover, mandatory rotation of audit engagement partner may also be a problem for the smaller firm because it has, of course, a smaller number of partners with expertise. Additionally, it introduces a new element of uncertainty as the potential expansion of responsibility for the acts or omissions of an audit firm to the other co-auditor. 8

9 Finally, joint audits may involve a potential threat to the independence, given the risk of "forum shop" between companies and two firms. (29) From the viewpoint of enhancing the structure of audit markets, do you agree to mandatory rotation and tendering after a fixed period? What should be the length of such a period? No. As mentioned above, in response to question 18, the mandatory rotation would increase costs and risks for companies by reducing the quality of audits, missing the knowledge accumulated by the outgoing audit firm. It seems to us appropriate to encourage companies to consider the various auditing firms in the market and eliminate contract clauses that require only work with one of the Big 4. But we reject any artificial intervention in the market, including allocation not based in market because the principles of free markets, free trade, free investment and free service have been crucial to the long history of growth and development in Europe. Audit Committees, representing the interests of shareholders, should be free to decide when and how to request an audit competition and should not be required by law. The mandatory rotation of partners of audit firms, together with external monitoring by the respective regulators, reduces the problems of independence without the company having to take the internal cost of a necessary process of request for competitive proposals. The obligation of inviting tenders recurrent produce the same disadvantages as the mandatory rotation increasing the costs of the companies involved in any process of applying for competitive bids when there is no need for it. 9