ICAS responds to the EC Consultation on Corporate Reporting – improving its quality and enforcement
ICAS responds to the European Commission’s consultation on corporate reporting – improving its quality and enforcement
ICAS has responded to the European Commission (EC)’s consultation on ‘corporate reporting – improving its quality and enforcement’ and the related call for evidence. This is the first stage of the EU process as it considers what reforms are required to the corporate reporting ecosystem for public interest entities (PIEs). The key points from the ICAS response are set out below.
Overall
- ICAS welcomes that the EC is undertaking a holistic review of the corporate reporting ecosystem i.e., corporate governance, corporate reporting, audit, and their supervision. In order to improve the existing corporate reporting ecosystem, it is essential to examine each of these constituent parts to determine what reforms are necessary, as all have a key role to play. This approach recognises that external audit does not operate in a vacuum but rather forms part of the wider corporate governance and reporting framework that oversees large corporate entities. The desired outcome is of course a regulatory environment that not only protects the interests of investors and the wider public interest, but also ensures that businesses in the EU have a regulatory environment that is proportionate and respected. It is imperative that the final changes which are taken forward, post the consultation process, respect this need for holistic reform, and are delivered in a co-ordinated manner.
- The 2014 EU Audit Regulation was primarily designed to: increase auditor independence, enhance choice in the PIE audit market, improve audit quality and enhance supervision of audit firms. Evidence would suggest that these aims have only partially been met e.g., mandatory audit firm rotation has had minimal effect on the levels of choice and concentration in the PIE audit markets in member states.
- The extent of member state options in the Regulation would appear to have hindered the impact of the package of measures included in the EU Audit Regulation. This has resulted in undue complexity across the EU. Therefore, simplifying and harmonising the existing requirements on audit would be beneficial.
Corporate Governance
- Currently, the EU Framework for corporate governance is limited and thus not conducive to promoting a consistent approach across member states. Consequently, there is a range of corporate governance frameworks and practices across EU member states. Enhanced requirements at the EU level would likely improve the situation, subject to appropriate enforcement.
- Additionally, there is a need to better facilitate an understanding amongst stakeholders that the responsibility for running an entity and for preparing its financial statements rests with the directors of that entity, in particular, the executive directors. The inclusion of a broader responsibilities chart at the front of the annual report, and/or on a company website, may help to better convey to stakeholders the respective responsibilities of the key players, including the directors and auditors.
- Furthermore, requiring directors to report on the effectiveness of an entity’s internal controls over financial reporting would better promote the respective responsibilities of directors and auditors. When analysing recent corporate failures, it is clear that there have been weaknesses in such controls.
Corporate reporting, audit, and supervisory quality indicators
- There is considerable merit in establishing recognised quality indicators for corporate reporting, statutory audit, and supervision. In order to promote their acceptance and use, their development would need to involve all key stakeholders. Consideration might also be given to the development of quality indicators in relation to corporate governance or performance of audit committees.
- Various sets of audit quality indicators (AQIs) have been developed by different bodies across the globe, but none are seen as generally accepted. Used appropriately and in the proper context, AQIs could be an effective mechanism to improve audit quality but they need to be specific to the needs of users, and the user group will of course vary; from the firms themselves, audit committees, users of financial statements and regulators. The true value of AQIs goes beyond the quantitative measurements and therefore such measures should not be solely based on inputs or outputs. There is a need to understand what the deeper underlying insights are. Therefore, interpretation of AQIs also has to take account of various other factors such as the nature of the organisation and its operating environment, the audit approach, and communication between the auditor and management/the audit committee during the audit.
Sustainability
- COP26 has reiterated the need for immediate action in relation to sustainability. ICAS is therefore fully supportive of the EU’s European Green Deal ambitions. Corporate reporting has to embrace sustainability and not just on climate change. This is what investors and other stakeholders are demanding in order that the true impact of an entity’s business model and operations can be assessed
Global Alignment
- There is a need to ensure that alignment is maintained with the global standards issued by the International Auditing and Assurance Standards Board (IAASB) and International Ethics Standards Board for Accountants (IESBA) as in many cases PIEs operate in various jurisdictions.
- A number of significant revisions to these standards (not yet applicable) have taken place in the last 15 months including on quality management, group audits and tighter restrictions on the ability of audit firms to provide non-assurance services to PIE audit clients.
Non-audit services
- Auditors should be allowed to provide non-audit services where such services do not impair, either the real or perceived independence of the auditor. This would include services that are required by law or regulation; and other services where the auditor is best placed to provide the said service and there is little threat to the independence of the auditor e.g., reviews of interim financial information.
Competition and choice
- There is limited number of audit firms in the PIE audit market. Therefore, there is a need to determine the best mechanism to help reduce the level of concentration in the PIE audit market and an acceptance that any policy introduced will only have a substantive impact over a longer-term period. This will allow firms to better plan and invest to ensure that they have appropriate resources at their disposal to take on the audits of a number of such entities. On their own, legislative measures would not be sufficient.
- There is also a need for audit firms to want to operate in this market. Therefore, consideration also has to be given to matters such as the regulatory burden, and auditor liability regime.
Supervision
- There is considerable variation across the EU in terms of the mechanisms used for, and quality of, supervision by public authorities of auditors, in particular, with respect to the methodologies applied on inspections, the transparency of reports thereon, and methods of investigations and sanctioning.
- The role of the Committee of European Auditing Oversight Bodies (CEOAB) and its relationship and interactions with national oversight authorities needs revisiting with a view to strengthening the current framework to help facilitate more effective and efficient supervision across the EU.
- In relation to the supervision of corporate reporting, the European Securities and Markets Authority (ESMA) plays a key role, but this could be further enhanced by strengthening its authority over national competent authorities to improve the consistency and quality of supervision.
- There is also merit in creating a regulatory environment that is designed such that regulators aim to work constructively with PIEs and their auditors to raise the overall standard of corporate governance, reporting and audit quality.
- Audit regulators need to consider whether a compliance-based inspection model remains suitable for audit. Unlike many aspects of prudential and financial services, audit is not just about processes and procedures but also about management and auditor judgements. Therefore, supervisors should not only check auditors’ compliance with standards and legislation, but they should properly consider the use of professional scepticism and judgement. Additionally, to allow for timely rectification of any weaknesses identified, the time period between an inspection being undertaken and the auditor being informed of inspection result should be subject to an appropriate maximum limit.
Investors
- There is a need to promote greater involvement of the investment community as they also have a key role to play in holding companies to account.