The European Commission has proposed a draft law that could split up the largest auditing firms and force them to use a separate entity and name for their advisory and non-audit practices.

The draft law was introduced in the European Union’s Brussels headquarters by Internal Markets and Services Commissioner Michel Barnier.

The proposals adopted Wednesday by the European Commission aim to clarify the role of auditors in response to problems found during the financial crisis and during inspections of auditing firms by national regulators. The proposals would introduce more stringent rules for the audit sector to strengthen the independence of auditors and introduce greater diversity into the highly concentrated audit market, which is dominated by the Big Four. The commission noted that concerns around conflicts of interest have been expressed about the potential for an accumulation of systemic risk, as the market is effectively dominated by the Big Four.

“Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary,” said Barnier. “We need to restore confidence in the financial statements of companies. Today’s 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.”

Auditing firms would be prohibited from providing non-audit services to their audit clients under the European proposals. In addition, large auditing firms would be obliged to separate audit activities from non-audit activities in order to avoid all risks of conflict of interest.

The European Commission is also proposing to create a single market for statutory audit services by allowing auditors to exercise their profession freely across Europe, once they are licensed in one member state. There are also proposals for a strengthened and more coordinated approach to the supervision of auditors in the European Union.

All the measures are supposed to enhance the quality of statutory audits in the EU and restore confidence in audited financial statements, particularly those of banks, insurers and large publicly listed companies.

The proposals regarding the statutory audit of public-interest entities, such as banks, insurance companies and listed companies, envisage measures to enhance auditor independence and to make the statutory audit market more dynamic.

The key measures include mandatory rotation of audit firms. Under the proposals, public companies would be required to rotate their auditing firms after a maximum engagement period of six years, with some exceptions. A cooling-off period of four years would be required before the audit firm could be engaged again by the same client. The period before which rotation is obligatory would be extended to nine years if joint audits were performed, specifically if the entity being audited appointed more than one audit firm to carry out its audit, thus potentially improving the quality of the audit performed.

Joint audits would not be made obligatory but would be encouraged.

Under the proposals, public-interest entities would be obliged to have an open and transparent tender procedure when selecting a new auditor. The audit committee of the audited entity would need to be closely involved in the selection procedure.

In addition, given the global context of the audit profession, the European Commission has proposed that the coordination of auditor supervision activities be placed within the framework of the European Markets and Securities Authority to provide greater oversight at the EU level as well as internationally.

The commission has proposed the creation of a single market for statutory audits by introducing a “European passport” for the audit profession. To this end, the commission proposals would 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.

The proposal would also allow for a proportionate application of the standards in the case of small and midsized companies.

The European Parliament has not yet voted on the proposals, and they are likely to undergo considerable changes before a vote, which could take up to 18 months.

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