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Big Four must spin off consulting in EU.

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Brussels: Europe's biggest professional services firms face upheaval following formal announcement of a reform package by the EU Commission yesterday.

Th eplans have been condemned by the Big Four and they will continue to lobby to get them overturned.

The proposals mean that all auditors will be prohibited from providing non-audit services to audit clients. The provision of non-audit services to non-audit clients will be allowed.

But the Big Four face a real threat to their business model. Large audit firms will be required to separate their audit activities into Pure Audit firms.

Claire Bury, from the Commission's Internal Market directorate, who unveiled the proposals, said that the Pure Audit stipulation means a complete ban on the provision of non-audit services by the large firms, who will be obliged to spin their consulting operations off into separate legal entities.

She did imply that there would be some discretion over which advisory services could be retained. "It depends on the degree of conflict of interest." Tax and risk management advice would be banned, for example, whilst IT design and HR services might be authorised.

The Big Four firms argue that the proposals will do nothing to improve audit quality, and will increase costs.

Rolf Nonnenmacher, Head of KPMG's EMA region, said: "KPMG believes that the proposals miss the opportunity to put in place a meaningful framework for change, and would have no bearing on audit outcomes.

"They are also in marked contrast to the views of the majority of stakeholders, including financial institutions, investors, MEPs, business and academics.

"Audit quality is best provided by multi-disciplinary firms. The capability of firms to provide quality audits will be diminished if auditors are separated from wide ranging advisory expertise including, crucially, risk management in the financial sector."

Ian Powell, Chairman of PwC UK and head of the PwC region that covers the European Union, said: "Adding cost and complexity to business will not help European capital markets, investors and business. The Commission's focus should instead be directed to measures which reinforce trust in audited information by focusing on audit quality."

The Commission reiterated its view that the banking crisis fatally undermined public confidence in the audit process and the big auditors who monopolise audit provision to financial institutions in Europe.

The Commission said, "The 2008 financial crisis highlighted considerable shortcomings in the European audit system. Audits of some large financial institutions just before, during and since the crisis resulted in 'clean' audit reports despite the serious intrinsic weaknesses in the financial health of the institutions concerned. Recent inspection reports by national supervisors have also criticised the quality of audits.

"Under the proposals adopted by the European Commission, this situation is to change by clarifying the role of the auditors and introducing more stringent rules for the audit sector aimed in particular at strengthening the independence of auditors as well as greater diversity into the current highly-concentrated audit market. Furthermore, the Commission is also proposing to create a Single Market for statutory audit services allowing auditors to exercise their profession freely and easily across Europe, once licensed in one Member State. There are also proposals for a strengthened and more coordinated approach to the supervision of auditors in the EU. Taken together, all the measures should enhance the quality of statutory audits in the EU and restore confidence in audited financial statements, in particular those of banks, insurers and large listed companies."

Internal Market and Services Commissioner Michel Barnier said: "Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary: we need to restore confidence in the financial statements of companies. (The Commissions) proposals address the current weaknesses in the EU audit market, by eliminating conflicts of interest, ensuring independence and robust supervision and by facilitating more diversity in what is an overly concentrated market, especially at the top-end."

Key elements of the Audit Reform package:

The proposals relate to the statutory audit of public-interest entities, such as banks, insurance companies and listed companies are:

Mandatory rotation of audit firms: Audit firms will be required to rotate after a maximum engagement period of 6 years (with some exceptions). A cooling off period of 4 years is applicable before the audit firm can be engaged again by the same client. The period before which rotation is obligatory can be extended to 9 years if joint audits are performed, i.e. if the entity being audited appoints more than one audit firm to carry out its audit, thus potentially improving the quality of the audit performed by applying the "four-eyes principle". Joint audits are not made obligatory but are thus encouraged.

Mandatory tendering: Public-interest entities will be obliged to have an open and transparent tender procedure when selecting a new auditor. The audit committee (of the audited entity) should be closely involved in the selection procedure.

Non-audit services: Audit firms will be prohibited from providing non-audit services to their audit clients. In addition, large audit firms will be obliged to separate audit activities from non-audit activities in order to avoid all risks of conflict of interest.

European supervision of the audit sector: In addition, given the global context of audit, it is important that coordination of and cooperation on the oversight of audit networks is ensured both at EU level as well as internationally. Therefore, the Commission proposes that the coordination of the auditor supervision activities is ensured within the framework of the European Markets and Securities Authority (ESMA).

Enabling auditors to exercise their profession across Europe: The Commission proposes the creation of a Single Market for statutory audits by introducing a European passport for the audit profession. To this end, the Commission proposals will allow audit firms to provide services across the EU and to require all statutory auditors and audit firms to comply with international auditing standards when carrying out statutory audits.

Full details of the proposals can be found here.

The Commission answers FAQs on its reforms here.

You can watch the Commission's press conference here.

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