Impact of EU Directive on Indian auditors

To a company, what can be worse than having a qualified audit report? Perhaps, the non-acceptance of the financial statements, despite an opinion from the accounting professional, as in a likely situation that is set to impact corporates with a European financial footprint.

“In just a few more months, these companies run the risk of their financial statements not being accepted by the European Union (EU) member states where their instruments are listed,” says Aniruddh Sankaran, a senior professional in a member firm of Ernst & Young Global, during the course of a recent interaction with Business Line.

Sankaran cites as examples the Aditya Birla group, Tatas, GAIL, Axis Bank, HDFC Bank, Infosys, Reliance, UB, and Wipro, which have equity/debt listed on European stock exchanges.

He explains that the risk of non-acceptance of financial statements emerges from recent changes to the EU’s Company Law Directive (widely known as the 8th directive), designed to restore investor confidence in European capital markets.

“These new changes, the focus of which seems to be the creation of a new and globally-recognisable commercial, regulatory and accountability framework, require that auditors of entities having equity or debt listed on any European stock exchange should, in effect, be ‘accredited’ by the relevant member state where that stock exchange is situated.”

Excerpts from the interview, carried out over the phone and through email.

First, what is the scale of the problem that we have on hand, in terms of the number of Indian companies that would be impacted by the Directive?

At present, of the 7000-plus entities listed across various capital markets in the European Union (EU), nearly 300 are Indian issuers. This includes listing of debt and equity instruments. These issuers are audited by around 90+ different Indian auditors and/or audit firms. By virtue of the amended Directive, auditors of these issuers will now need to be registered with the relevant member state(s) of the EU.

Is there a history behind the 8th Directive? Are there similar such regulations in other countries that Indian corporates should be aware of?

The 8th directive, or more formally, the EU’s Company Law Directive, was initially adopted in April 1984. However, in its original form, it did not specifically address quality assurance by external regulators. The recent amendments attempt to rectify that position and clarify matters such as duties, ethics, independence, etc, of auditors. The focus seems to be the creation of a new and globally-recognisable commercial, regulatory and accountability framework. There is also an attempt to improve coordination between regulators in the EU and those outside the EU, such as the Public Company Accounting Oversight Board (PCAOB) in the US.

At present, the UK, Germany, Ireland, the Netherlands, Norway and Denmark have registration requirements for auditors, under the 8th directive. Other jurisdictions within the EU are expected to join soon. The PCAOB in the US also has oversight requirements for its registrants and, in some cases, affiliates of such registrants as well.

What is the process for an Indian audit firm to be registered with the EU member states? Also, what are the costs?

The European Group of Auditors’ Oversight Bodies (EGAOB) have worked together to develop model application forms and guidance material. There are two types of scenarios currently envisaged – full registration and transitional relief.

In general, full registration will require information that includes particulars of the audit firm or auditor, status of existing registrations, a list of relevant audit clients, Transparency Report, confirmation of good repute, to list a few, that need to be filed with the regulator.

For auditors and audit firms that are not able to comply with the requirements for full registration, a transitional relief is available. This provides the option to auditors to file minimal documentation, and yet continue to be registered. Transitional relief is not available to auditors of all countries, but only to those in a specified list of thirty-six countries.

Registration requirements vary by country. Also, registration is not “passportable,” so registration is required for each country. However, registration as such requires filing of these specified documents, and a lot of time involvement to do so. Nevertheless, cash costs of registration itself are not expected to be significant.

India is one of the countries eligible for transitional relief. However, one must be aware that although there are some benefits of the relief, it is available only up to June 2010 (December 2010 in some cases). Also, in a couple of instances, the documentation to be filed for it is more than what is needed for full registration. Therefore, for obvious reasons, transitional relief may not be the best approach.

Can you describe the likely adverse effects of non-acceptance of audit reports in the EU states?

The changes to the 8th directive require that auditors of entities having equity or debt listed on any European stock exchange should, in effect, be “accredited” by the relevant member state where that stock exchange is situated. Simply put, not meeting the registration requirements means that the reports of those auditors will not be valid in the relevant jurisdiction.

For Indian auditors, in the immediate short-term, this means that audit reports issued by Indian auditors will cease to be valid in the relevant EU member state(s), unless they are registered. As mentioned earlier, there are some provisions for transitional relief up to 2010; however this does not solve the bigger problem.

Over the longer term, and contrary to the ICAI’s vision of increased marketability and growth for Indian CAs, current and future issuers may have to move away from Indian audit firms, to firms abroad who are registered with the relevant member state. Moreover, this will go against the fundamental grain of boosting investor confidence, to the extent this applies to auditors.

Do you see a conflict that Indian audit firms can run into within the country when complying with the EU Directive? (Owing to the ICAI’s regulations.)

Full registration under the 8th directive requires filing of a Transparency Report. This includes information relating to the internal quality control system and independence policies of the audit firm, quality assurance reviews performed on the firm, list of public interest companies for which audits were carried out.

From an Indian standpoint, much of this information is likely to be viewed by the ICAI to be in the nature of ‘advertisement.’ The ICAI’s regulations on advertisements and what constitutes advertising have traditionally been quite conservative. But this is not an ICAI issue alone. There may be restrictions or confidentiality prohibitions in the auditors’ home country, which protect or prohibit the disclosure of necessary information required for registration.

Hasn’t the ICAI been educating its members in this regard?

In early 2008, the ICAI met a delegation from the EU to discuss various accounting and auditing issues; presumably, the 8th directive was one of the issues discussed. The ICAI has effectively been charged with ensuring the credibility of Indian issuers, auditors and the economic and accounting environment at large.

So far, it has done a great job of aligning Indian accounting standards to the IFRS, upgrading auditing standards to reflect changes to the International Standards of Auditing, converging with the IFRS in general, and overall making the Indian accounting and auditing environment more contemporary.

But in the context of the 8th directive, the ICAI has a limited amount of time left to come to a decision on the matter.

Your views on what the immediate set of actions should be, within the accounting profession...

The next few months are extremely critical. The ICAI must act quickly, have detailed dialogues with the key stakeholders involved, including ministries, issuers and their auditors. A solution must be found, in order to retain India as reckoning force on the international capital markets map.

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Printable version | Oct 25, 2021 12:15:07 AM |

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