UK implements new EU audit framework
The new EU audit framework, including rules on mandatory rotation of auditors, retendering of audit engagement and changes to the rules on audit committees, is now in effect in the UK.
The Statutory Auditors and Third Country Auditors Regulations 2006 (SI 2016/649) took effect on 17 June 2016. They implement the Audit Regulation (Regulation (EU) 537/2014) and Audit Directive (Directive 2014/56/EU) in the UK. They make a number of changes to the Companies Act 2016 in relation to auditor appointments and appoint the FRC as competent authority for the public oversight of auditors.
In addition, a number of regulators have published changes to their rules to implement the new framework. In particular, the Financial Conduct Authority has amended the audit committee requirements in the Disclosure and Transparency Rules and the Financial Reporting Council has published updated versions of the UK Corporate Governance Code, its Guidance on Audit Committees, Auditing and Quality Control Standards and a consolidated Ethical Standard.
The main changes of interest to companies are:
Mandatory rotation and retendering of audit engagements
The Regulations amend the CA 2006 to limit the maximum duration of audit engagements for public interest entities that are required to appoint a statutory auditor. Public interest entities include entities with securities admitted to trading on a regulated market (but not AIM-listed companies), banks, building societies and insurers. The maximum duration of an audit engagement is 10 years, extendable to 20 years provided a tender process in accordance with the Audit Regulation is carried out at least every 10 years. Sections 487A and 491A of the CA 2016 set out the transitional arrangements for private and public companies, respectively. Limited liability partnerships are not covered by the Regulations but will be subject to further legislation.
Restriction of audit choice prohibited
Regulation 12 provides that any term in a contract which restricts an audited entity's choice of statutory auditor is void. This only applies where the audited entity is a non-public interest entity. Rules applicable to public interest entities take effect one year later on 17 June 2017. This rule does not affect provisions in contracts regarding appointment of auditors to determine a closing accounts adjustment or other dispute, only to statutory audits.
Changes to the rules on audit committees
The FCA has made changes to the audit committee rules in DTR 7.1 for financial years commencing on or after 17 June 2016. These set out a number of changes to composition requirements, including the following:
- a majority of the members of the audit committee must be independent;
- at least one member must have competence in accounting and/or auditing or both and the members as a whole must have competence relevant to the sector in which the issuer is operating;
- the chairman of the audit committee must be independent and must be appointed by the members of the audit committee.
There are also a number of changes to the responsibilities of the audit committee, including a requirement for the audit committee to inform the board of the outcome of the statutory audit and for the committee to review and monitor the appropriateness of the provision of non-audit services.
DTR 7.1 applies to issuers required to appoint a statutory auditor. Alternative Investment Funds and UCITs are exempt from the scope of the rule (see DTR 1B.1.3).
The FRC has also published updates to the UK Corporate Governance Code and its Guidance on Audit Committees which apply for financial years commencing on or after 17 June 2016:
- Provision C3.1 of the Code now requires the audit committee to have competence relative to the sector in which the company operates but there is no provision for at least one member must have competence in accounting and/or auditing as set out in the Audit Directive. Since this requirement is included in the amendments to DTR 7.1, the FRC has retained the formulation that at least one member of the audit committee must have "recent and relevant financial experience" as it considers this to be more flexible;
- Provision C3.8 requires the audit committee to include advance notice of any retendering plans in the section of the annual report describing the work of the audit committee.
The updated FRC Guidance on Audit Committees reflects changes arising from the new rules on audit committees and auditor appointments as well as developments and good practice since the previous guidance, especially in relation to risk management and internal audit. The Guidance also recommends that the audit committee should disclose the nature and extent of any interaction with the FRC's Corporate Reporting Review team and any significant findings by the FRC's Audit Quality Review team and the actions the auditors plan to take in response to those findings.
Changes to the provision of non-audit services
The FRC's new Ethical Standard prohibits the provision of certain types of non-audit service to public interest entities and subjects other non-audit services to a fee cap of no more than 70% of the average audit fees for three consecutive financial periods. The first financial period to be considered is the first one commencing on or after 17 June 2016. In addition, the FRC Guidance on Audit Committees now limits pre-approval of non-audit services to services which are clearly trivial. This is more restrictive than the previous guidance which permitted pre-approval routine services where the fee was not significant and certain audit-related services.
Issuers should review the terms of reference of their audit committee in view of the changes to the DTRs, UK CGC and FRC Guidance on audit committees. Audit committees should consider disclosures of any retendering plans under the amended UK Corporate Governance Code (the Competition & Markets Authority already requires disclosures as to the date of next audit tender in the fifth year in which there has been no competitive tender process).
Sources of rule changes and further information
The Statutory Auditors and Third Country Auditors Regulations 2006 can be found here.
The updated version of the UK Corporate Governance Code and the FRC Guidance on Audit Committees and the new Ethical Standard can be found here.
The changes to the DTRs are contained in the Disclosure Rules and Transparency Rules Sourcebook (Statutory Audit Amending Directive) Instrument 2016 and can be found here.
FAQs published by the European Commission on the new EU audit framework can be found here.