COMMISSION STAFF WORKING PAPER EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT
Date: 2011-11-30
Institutions: European Commission
Subjects: audit, auditing, confidentiality, conflict of interest, financial control, legal status, management audit, market supervision, professional secret, quality label

EUROPEAN COMMISSION 

Brussels, 30.11.2011 
SEC(2011) 1385 final 

COMMISSION STAFF WORKING PAPER 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the document 

Proposal for 

a Directive of the European Parliament and of the Council amending Directive 
2006/43/EC on statutory audits of annual accounts and consolidated accounts 

and a 

Proposal for 

a Regulation of the European Parliament and of the Council on specific requirements 
regarding statutory audit of public-interest entities 

{COM(2011) 779 final} 
{SEC(2011) 1384 final} 

 
 
 
 
  
 
 
 
 
 
COMMISSION STAFF WORKING PAPER 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the document 

Proposal for 

a Directive of the European Parliament and of the Council amending Directive 
2006/43/EC on statutory audits of annual accounts and consolidated accounts 

and a 

Proposal for 

a Regulation of the European Parliament and of the Council on specific requirements 
regarding statutory audit of public-interest entities 

1. 

INTRODUCTION 

Audit, alongside supervision and corporate governance, should be one of the key contributors 
to  financial  stability  as  it  provides  assurance  on  the  veracity  of  the  financial  statements  of 
companies. Robust audit is key to re-establishing trust and market confidence. 

The  Commission  took  the  lead  in  examining  the  audit  market  when  it  launched  its  Green 
Paper  in  October  2010,  a  consultation  that  elicited  700  responses  from  a  wide  group  of 
stakeholders.  

In its report of 14 September 2011 on the Green Paper the European Parliament supported the 
Commission's holistic approach and its main proposals on reshaping the audit market. 

The  United  States  is  also  considering  important  changes  particularly  in  the  domain  of  the 
independence  of  auditors.  Serious  consideration  is  being  given  to  the  mandatory  rotation  of 
audit firms to address what are perceived as serious shortcomings. 

2. 

PROBLEM DEFINITION 

The audit of companies' financial statements is a service provided in the public interest. Audit 
contributes to the credibility as well as reliability of financial statements. This service is the 
result of a statutory entrustment to a select group of qualified specialists on the one hand and 
is  a  statutory  obligation  for  all  companies  on  the  other.  Although  not  identical,  certain 
elements of the audit market for large companies are similar to the market of Credit Rating 
Agencies (CRAs). While the former is dominated by "the Big Four" (PWC, KPMG, Ernst and 
Young  and  Deloitte),  the  latter  is  dominated  by  three  large  CRAs  (S&P,  Moody's,  Fitch). 
Moreover,  in  both  markets  there  is  an  inherent  conflict  of  interest  in  that  the  subject  of  the 
opinion is also the client. From a listed company perspective, the issuer of securities on whose 
accounts and on whose credit worthiness audit and rating opinions are being provided is also 

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the  party  that  pays  the  auditor  and  the  CRA.  Both  auditors  and  CRAs  derive  their  business 
from a legal requirement: companies must have their financial statements audited and many 
legal provisions require credit ratings. 

It is important to acknowledge the need for appropriate calibration. Given the greater societal 
implications  of  large  listed  companies  and  financial  institutions  it  is  important  to  devise  a 
more demanding and rigorous framework when auditing their financial statements. Therefore, 
certain concerns are more acute for entities that affect a very large number of stakeholders e.g. 
listed companies and those entities that carry out certain activities, especially in the financial 
services sector (referred to in our rules as Public Interest Entities (PIEs), are: 

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The  expectation  gap  between  what  stakeholders  expect  of  an  audit  and  what 
auditors  actually  do.  Many  have  asked  the  question  of  how  banks  could  fail  only 
months  after  they  had  been  given  clean  audit  reports.  Moreover,  there  is  a  distinct 
lack  of  communication  between  auditors  and  supervisors  regarding  apparent 
weaknesses in the financial solidity of audited entities, in particular in the financial 
sector. 

Independence  is  neither  assured  nor  demonstrable  in  a  paradigm  where  audit  has 
effectively become one of a plethora of commercial services provided by auditors to 
their clients. The lack of regular tendering of audit services and periodic rotation of 
audit  firms  has  deprived  audit  of  its  key  ethos:  professional  scepticism.  We  find 
ourselves in a landscape where a large number of audited companies have effectively 
become  comfortable  with  their  auditor;  this  is  a  refutation  of  the  very  essence  of 
independence. 

Market  concentration  and  lack  of  choice:  The  market  is  so  polarised  that  rare  is 
the  occasion  when  the  auditor  of  a  PIE  is  not  a  'Big  Four'  firm.  In  the  majority  of 
Member  States,  the  Big  Four  audit  more  than  85%  of  large  listed  companies 
(FTSE 350  equivalent).  The  'comfort'  factor  amongst  audited  companies  with  their 
auditors  combined  with  the  perceptions  in  the  market  place  have  entrenched  the 
predominance  of  the  Big  Four.  There  is  reticence  with  regard  to  engaging  non  Big 
Four auditors even in the relatively rare occurrence of a tender for audit.  

The  combination  of  the  above  problems  implies  that  investors  and  other  stakeholders  are 
unable  to  unreservedly  trust  the  complete  independence,  and  therefore  quality,  of  the  audit 
opinion.  Inspections  of  auditors  carried  out  by  national  audit  supervisors  in  Member  States 
(and also in the US) found too often that audit independence is lacking. 

Although no stakeholder should rely solely on the audit report to form a view on the financial 
solidity of a company, it is nevertheless critical that a stakeholder should be able to trust the 
reasonableness  of  the  financial  statements  that  have  been  given  a  clean  audit  report. 
Stakeholders should particularly be able to rely on the ability of the audited entity to continue 
as  a  'going  concern'  i.e.  be  in  a  position  to  meet  its  obligations  to  its  creditors  in  the 
foreseeable future.  

There are other concerns related to the audit market, which are not just confined to PIEs but 
relate to the sphere of all entities requiring audits. These are quite specific to the Union and 
need to be addressed to improve the efficiency of the internal market: 

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• 

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Today, auditors need to be 'approved' in all Member States in which they want to 
carry out statutory audits. For natural persons, approval requires passing an aptitude 
test  in  each  Member  State  in  which  they  want  to  perform  audits  and  thus  entails 
bureaucracy as well as costs. 

Neither audit practice standards nor auditor oversight is harmonised in the Union nor 
is the latter indisputably independent from the audit profession in all Member States; 
the independence of oversight is compromised by the presence of practising auditors 
in  the  inspections  of  audit  firms.  In  addition,  the  big  divergence  in  the  resources 
available at the national level lead to a patchwork of non-homogenous supervision 
and  weak  cooperation  at  the  European  level.  Furthermore,  applicable  auditing 
standards  are  not  adapted  to  the  size  of  entities,  in  particular  medium-sized 
companies.  

There is currently a restriction on the ownership of audit firms which prevents wide 
ownership by non-auditors and restricts the capacity of mid-size audit firms to grow. 

3. 

SUBSIDIARITY AND PROPORTIONALITY 

Current EU rules leave considerable discretion to Member States even after the adoption of 
the  Statutory  Audit  Directive  in  2006.  This  has  resulted  in  important  differences  within  the 
Union. 

The  considerable  margin  of  discretion  allowed  to  Member  States  in  the  domain  of 
qualifications  for  statutory  auditors  alongside 
the  supervisory 
arrangements across Member States call for concerted intervention at the level of the Union. 

the  heterogeneity 

in 

Moreover, the question of risks emanating from the current market configuration and the need 
for  more  firms  at  the  upper  end  of  the  market  have  not  been  addressed  in  the  current  legal 
framework.  

By  its  very  nature,  statutory  audit  is  a  requirement  under  EU  law  and  to  this  extent  any 
changes  to  address  the  main  problems  will  have  to  be  accomplished  by  means  of  legal 
instruments in the Union. 

4. 

OBJECTIVES AND POLICY OPTIONS 

Initiatives in the domain of audit would complement advances in other domains of financial 
regulation, such as: corporate governance, accounting and credit ratings.  

General Objective of the changes in audit: Contribute to the efficient functioning of financial 
and non-financial markets by strengthening the market role of the audit profession to provide 
relevant  economic  agents  and  the  market  with  more  reliable,  transparent  and  meaningful 
information, at an acceptable cost, about the veracity of financial statements of companies. 

The  set  of  policy  options  on  substantive  requirements  presented  in  this  section  aims  at 
addressing the problems analysed above. The preferred options are highlighted in bold.  

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Specific objective 1: Clarify and define the role of the statutory auditors generally as well as 
with specific regard to PIEs 

1.1 Options to improve the awareness of business preparers/market about the scope of audit 
generally. 

0.  Baseline scenario. 
1.  Clarify  and  specify  the  scope  of  statutory  audit  in  the  EU  rules  (without  enlarging 

it). 

2.  Redefine the scope of statutory audit to fill the expectation gap: the auditors should carry 

out a rigorous examination of the "going concern" premise of an entity. 

1.2 Options to improve the information that the auditor provides to users and audited entities 
(PIEs). 
0.  Baseline scenario. 
1.  Improve and expand the audit report to provide more information to the public.  
2.  A  more  detailed  report  for  the  audited  entity  itself  (to  audit  committee  and 

management). 

3.  Improve communication between auditor and audit committee. 
4.  Combination of options 1 to 3. 

1.3  Options  to  improve  the  communication  channels  between  auditors  and  supervisors  of 
PIEs. 
0.  Baseline scenario: obligation to report breaches of rules in certain cases.  
1.  Recommending regular dialogue between auditors and supervisors of PIEs. 
2.  Requiring regular dialogue between auditors and supervisors of PIEs.  

Specific  objective  2:  Reinforce  the  independence  and  professional  scepticism  of  statutory 
auditors and audit firms in the provision of statutory audit to PIES 

2.1 Options to reduce and mitigate the risk of any conflict of interest due to the provision of 
non-audit services to PIEs. 

0.  Baseline scenario: general criteria on independence. 
1.  Prohibition of the provision of certain non-audit services to the audited entity. 
2.  Prohibition of the provision of any non-audit services to audited entities. 
3.  Pure audit firms: only allowed to conduct statutory audit and unconnected to firms 

providing non-audit services. 

2.2  Options  to  reduce  and  mitigate  the  risk  of  any  potential  conflict  of  interest  due  to  the 
existing system of "auditee selects and pays the auditor". 
0.  Baseline  scenario:  'light'  intervention  of  the  audit  committee  in  the  appointment  of 

auditors. 

1.  Stricter  rules  in  the  procedure  for  the  appointment  of  auditors  with  an  increased 
role  for  a  strengthened  Audit  Committee  (at  least  two  of  its  members  must  be 
independent and at least one should have knowledge about audit). 

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2.  Appointment of auditor by a third party (i.e. a regulator).  

2.3  Options  to  reduce  and  mitigate  the  risk  of  any  potential  conflict  of  interest  due  to 
"familiarity threat". 
0.  Baseline scenario: only key audit partner rotates. 
1.  Mandatory rotation of an audit firm after a certain period of engagement . 
2.  Strengthening  of  the  role  of  the  audit  committee  in  overseeing  the  work  of  the 

auditors. 

3.   Establishing additional requirements on the internal organisation and governance of 

audit firms. 

4.  Combination of options 1 to 3. 

Specific  objective  3:  Improve  market  conditions  for  the  audit  of  PIEs  with  a  view  to 
increasing audit quality 

3.1 Options to facilitate switching of an audit firm. 
0. 
1. 

Baseline scenario: no requirement to tender for or engage a new auditor. 
Regular  tendering.  Audited  entities  would  invite  a  minimum  number  of  firms  to 
participate in a tendering procedure, including a non-Big Four firm.  
2.  Mandatory rotation of an audit firm after a certain period of engagement. 
3.  Combination of options 1 and 2. 

1. 

3.2 Options to facilitate an objective choice of an audit provider. 
0. 

Baseline  scenario.  The  reputation  of  Big  Four  audit  firms  will  continue  to  deter  the 
consideration and selection of alternatives. 
Prohibit contractual clauses between the audited entity and a third party (such as 
a bank) limiting the choice of audit firm. 
Increase transparency on audit quality (publication of inspection reports) and on 
audit firms (e.g. disclosure by firms of their financial statements). 
Establish a pan-European audit quality certification for auditors or firms meeting 
certain  quality  requirements  that  endorse  their  ability  to  carry  out  high  quality 
statutory audits of PIEs. 
4.  Combination of options 1 to 3. 

2. 

3. 

Baseline scenario: Large PIEs remain restricted in their choice of audit firms. 

3.3 Options to increase the choice of audit providers for PIEs. 
0. 
1.1  Pure audit firms. PIE audits will be performed by firms that provide only audit services. 
Joint audits: Obligation for large PIEs to have more than one audit firm, at least one of 
1.2 
which is not among the largest ones. Both audit firms will have joint responsibility for 
the audit.  

1.3.  Mandatory joint audit applied only to large PIEs in the financial sector  
1.4  Mandatory joint audit to all large PIEs conducted by pure audit firms 
1.5  Mandatory joint audits applied to large PIEs in the financial sector conducted by pure 

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audit firms 

1.6.  Voluntary joint audit for  all PIEs: creates incentives for audit providers and audited entities  to 

use joint audit on a voluntary basis.  

1.7  Voluntary joint audit for  all PIEs by pure audit firms 
2. 

Lift  restriction  of  ownership  by  non-auditors  on  audit  firms,  while  maintaining 
safeguards of independence. 
Establish a ceiling of market shares (20%): regarding the statutory audit of large listed 
companies. 

3. 

4.  Combination of options 1 and 2. 

Specific objective 4: Avoid unnecessary additional compliance costs for both audited SMEs as 
well as for audit providers, especially in a cross-border context 

4.1 Options to facilitate the cross-border recognition of auditor competence. 
0.  Baseline  scenario:  auditors  and  audit  firms  should  be  approved  in  all  Member  States  in 

which they want to carry out statutory audit.  

1.  Mutual  recognition  by  all  Member  States  of  audit  firms  approved  in  a  Member 
State. The key audit partner leading the audit must be approved as an auditor in the 
concerned Member State. 

2  Mutual recognition of statutory auditors approved in a Member State (for the cross-

border provision of services). 

3.  An  adaptation  period  scheme  with  increased  convergence,  transparency  and 

predictability in the aptitude test (in case of establishment). 

4  Combination of options 1 to 3. 

4.2  Options  to  streamline  audit  standards  on  practice,  independence  and  internal  control  of 
audit firms across the EU. 
0.  Baseline scenario: auditing standards may differ according to Member States. 
1.  Introduction of International Standards on Auditing (ISAs) across the EU. National 

additions would be acceptable, where necessary. 

2.  Introduction of ISAs, allowing for Member States derogations. 

4.3 Options to ensure that statutory audit is adapted to SMEs needs. 
0.   Baseline scenario: auditing standards apply irrespective of the size of the audited entity. 
1.  Request  Member  States  to  ensure  that  a  proportionate  and  simplified  audit  for 

SMEs is possible. 

2.  Introduce limited reviews for SMEs instead of statutory audit. 

Specific objective 5: Improve the effectiveness, independence and EU-wide consistency of the 
regulation and supervision of auditors of PIEs 

5.1.  Options  to  ensure  independence  and  effectiveness  of  supervision  of  national  statutory 
auditors and audit firms. 
0.  Baseline scenario. Audit profession closely involved through their professional bodies in 

audit supervisory matters. 

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1.  Establishment of an independent EU oversight authority responsible for the supervision of 

audit firms auditing PIEs with a cross-border impact for stakeholders. 

2.  Strengthening  national  audit  supervisory  authorities.  The  mandate,  powers  and 
independence  requirements  for  audit  supervisors  established  at  the  EU  level,  but 
supervision carried out nationally. 

5.2  Options  to  set-up  an  effective  EU-wide  supervisory  cooperation  mechanism  that  would 
also ensure an efficient supervision of supranational audit firm structures. 
0.  Baseline  scenario.  Group  of  experts  (EGAOB)  composed  of  representatives  of  national 

public oversight authorities and led by the Commission. 

1.  Cooperation within a level-3 Lamfalussy-type committee. Independent legal status to the 
EGAOB which would decide on its own work, with the Commission as observer only. 
2.  EU-wide cooperation  on  auditor  supervision matters within ESMA  (in  cooperation 

with EBA and EIOPA). 

3.  New  European  Authority  of  audit  supervisors  specifically  devoted  to  the  supervision  of 

the audit market. 

5. 

ASSESSMENT OF IMPACTS 

Cumulative impact 

The preferred policy options, taken together, will contribute to financial stability by securing 
the  veracity  of  financial  information  through  robust  audits  and  meaningful  audit  reports. 
Complete independence, a key requirement for robust audits, will be delivered by a series of 
measures  such  as  mandatory  rotation  of  audit  firms,  the  prohibition  of  the  auditor  from 
providing  non-audit  services  to  the  audited  entity  (including  a  restructuring  of  auditors  into 
pure audit firms). . Moreover, such measures will create a healthier market with more firms 
gaining  exposure  and  building  reputation  in  the  audit  of  large  PIEs.  The  application  of 
internationally  recognised  auditing  standards  and  the  removal  of  barriers  to  cross-border 
provision  of  audit  services  should  lead  to  a  more  integrated  European  audit  market.  Any 
improvement  to  statutory  audit  would  have  to  be  accompanied  by  more  independent  and 
effective  supervision  across  the  Union  including  regular  dialogue  amongst  supervisors 
themselves as well as between supervisors and auditors.  

Economic impact 

Better audits and more informative audit reports will enhance confidence in the markets while 
also informing stakeholders of any problems with regards to any particular entity. The direct 
beneficiaries  of  such  confidence  will  not  only  include  investors  and  creditors  but  also  the 
company  itself  (as  well  as  its  employees).  There  would  also  be  more  differentiation  with 
regard  to  the  quality  and  reliability  of  the  financial  information  presented  by  the  audited 
entities.  This  would  have  an  impact  on  the  cost  of  doing  business  e.g.  working  capital 
requirements for companies: a creditor would be more willing to extend better terms to a more 
reliable entity. 

Costs and Benefits 

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Measures such as the strengthening of audit committees, more extensive audit reports and a 
formal internal report, the tendering of audit services and the rotation of audit firms will entail 
additional  costs  for  both,  audited  entities  and  audit  firms.  Even  if  it  is  difficult  to  present  a 
reliable  figure  of  total  costs,  the  impact  assessment  shows  that  the  incremental  costs  as  a 
percentage of overall costs are capable of being absorbed by audited entities and audit firms 
alike.  

In terms of benefits, also difficult to quantify, the proposals will enable higher quality audits 
and  more  confidence.  More  informative  audit  reports  could  lower  the  cost  of  capital.  Audit 
rates may also decrease as more players will emerge at the top end of the market.  

The restrictions on the provision of non audit services by auditors will create a level playing 
field  for  other  service  providers,  mostly  SMEs,  e.g.  lawyers,  consultants,  IT  providers,  tax 
advisors, etc. This more competitive environment should result in lower prices for companies 
buying such services.  

There  will  also  be  direct  recurring  net  benefits  for  the  EU  economy  as  a  whole  due  to  the 
introduction of common auditing standards at the level of the Union.  

Social and environmental Impacts 

Discussions  at  the  European  Economic  and  Social  Committee  have  highlighted  the 
importance of robust financial information with regard to the solidity of the entity from the 
perspective  of  employees.  Although  audits  do  not  have  a  direct  environmental  impact,  they 
are  extremely  useful  in  providing  assurance  that  any  liabilities  related  to  environmental 
remedial work or claims have been adequately identified as well as quantified.  

Administrative burden 

There  would  be  additional  costs  from  tendering,  rotation  and  joint  audits  both  for  audited 
entities as well as auditors. On the other hand, the removal of cross border obstacles and the 
introduction  of  common  standards  within  the  Union  will  reduce  the  current  administrative 
burdens for the provision of audit in other Member States. Administrative burden for SMEs 
will also be reduced, not least because Member States will have to ensure a proportionate and 
simplified audit for SMEs. 

Legal instruments, transposition and compliance aspects 

The  combination  of  a  directive  and  a  regulation  will  consolidate  the  improvements  to  the 
existing legislation and lay out a harmonised framework for critical changes.  

Monitoring and evaluation 

The monitoring and evaluation of the preferred policy options will be carried out in 3 steps: 
(1)  a  transposition/transitional  period;  (2)  monitoring  by  the  Commission,  the  national 
authorities and ESMA and (3) the evaluation of the policy, within a longer time horizon.  

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