Patrick Gorry delves into the findings of the European Commission’s Market Monitoring Report and revisits the broader context and impact of EU audit reform
On 5 March 2024, the European Commission published its triennial Market Monitoring Report, analysing Public Interest Entity (PIE) audit data from 2019 to 2021 across 27 Member States as well as Norway.
A decade after the enactment of European Union (EU) audit reform legislation, the report underscores the persistent market dominance of the main firms in PIE audits, resulting in limited choices for auditors.
Background and objectives of EU audit reform
The introduction of EU audit reform stemmed from several key drivers and broader contextual factors.
Amidst the global financial crisis of 2008, weaknesses in financial reporting and corporate governance practices were exposed, prompting the EU to prioritise enhancing the integrity and transparency of audit processes.
In 2014, the EU adopted two legislative instruments: Directive 2014/56/EU, which amended Directive 2006/43/EC on the statutory audits of annual accounts and consolidated accounts (the Audit Directive), and Regulation No. 537/2014 on specific requirements regarding the statutory audit of PIEs (the Audit Regulation).
The legislation was led by several key EU institutions, including the EU Commission, EU Parliament, EU Council, European Securities and Marketing Authority (ESMA) and national regulatory authorities in EU Member States.
While the overarching goal was to increase the quality of statutory audits, the four primary objectives set out for the reform were to:
- Reinforce auditor independence;
- Promote market competition;
- Enhance transparency for investors; and
- Strengthen pan-European supervision.
Measurement of success
To evaluate the legislation’s effectiveness, we must examine each objective.
Reinforcing auditor independence
The legislation mandates the rotation of audit firms for PIEs after a specified period to help address familiarity and independence issues, promote fresh perspectives and improve audit objectivity.
It also restricts audit firms from providing certain non-audit services to their audit clients and imposed limits on fees for such services.
These measures aim to promote independence, prevent conflicts of interest and uphold audit integrity.
The legislation has strengthened auditor independence by enforcing mandatory rotation for auditors of PIEs. This has reduced conflicts of interest and enhanced audit objectivity.
Stricter rules regarding non-audit service provision have further bolstered auditor independence, ensuring a focus on high-quality audit services.
Mandatory rotation has, however, faced criticism for potential unintended consequences, such as increased costs for companies and concerns about the disruption of longstanding audit relationships.
The Market Monitoring Report revealed limited choice in tenders within the EU audit sector: 16 percent of the tenders had just one bid and 59 percent left PIEs with a limited choice of two to three bids.
In the same report, 51 percent of surveyed audit committees that had undergone auditor changes indicated that it was too early to evaluate the impact of auditor rotation or that no assessment had been made at the time the Commission issued the questionnaire.
Furthermore, 22 percent of audit committees rated the impact of auditor rotation as ‘neutral’, while 12 percent rated it ‘positive’.
Promoting market competition
The legislation aims to promote market competition and diversity in the audit sector by encouraging smaller audit firms to participate in PIE audits. It is meant to drive innovation, enhance audit quality and offer clients a broader selection of service providers.
To achieve this, the legislation mandates regular rotation or tendering of audit engagements to stimulate competition.
It also promotes joint audits to facilitate smaller firms’ involvement and enhance market competition.
Additionally, the legislation aims to increase transparency in the audit market by publishing data on audit firm market share and concentration.
Despite these efforts, market concentration remains a challenge. Larger firms continue to dominate, limiting the entry of smaller firms and hindering diversity among service providers.
While the largest firms’ dominance in the number of PIE audits has fallen slightly, they still control a significant portion of the market from a fee perspective.
Interestingly, a growing demand for joint audits indicates a potential shift in the market landscape toward increased diversity.
The Market Monitoring Report highlighted the continuing imbalance:
- In terms of total turnover among audit firms, the largest four firms collectively accounted for approximately 80 percent of the market, consistent with previous reports from the European Commission. Despite a decline in their share of PIE audits, these firms still hold a dominant position, capturing 86 percent of revenue from this source.
- Joint audits now account for 16 percent of the PIE market, up from nine percent in 2018. This trend is evident across an increasing number of Member States, with five additional countries adopting joint audits since 2018, bringing the total to 13. Among the six Member States with the most diversified PIE audit markets, joint audits are prevalent in five: France, Romania, Bulgaria, Poland and Greece.
The findings relating to European market concentration are replicated in the Irish market. The Irish Auditing and Accounting Supervisory Authority’s most recently published Annual Audit Programme and Activity Report put the market share of the four largest firms at 87 percent.
Enhancing transparency for investors
The legislation mandates increased audit reporting transparency, requiring additional information disclosure.
This increased transparency aims to improve communication between auditors, clients and stakeholders, providing a more comprehensive view of the audit process.
The new rules have significantly improved the informational value of audit reports, which is a key success of the legislation.
The mandates have improved communication between auditors, clients and stakeholders, ensuring investors can access relevant information to make informed decisions.
However, challenges remain in effectively communicating audit findings to investors. Discussions are ongoing concerning further enhancements to meet the investors’ evolving needs.
Strengthening pan-European supervision
The reform introduced measures to enhance governance and oversight of audit firms, including establishing regulatory bodies and oversight mechanisms to monitor compliance with audit standards.
The objective was to improve the consistency and effectiveness of audit supervision across Europe. The legislation has undoubtedly increased cross-border cooperation and information sharing among national competent authorities.
Harmonising audit standards and practices across Member States has aligned regulatory requirements, fostering a unified framework for audit supervision while improving quality and consistency at the European level.
However, one of the main challenges of strengthening pan-European supervision is the divergence in implementation of the audit regulation and oversight practices across Member States.
Future audit reform
EU audit reform represents progress, but there’s still work ahead. While successes are evident, challenges persist, notably the dominance of major audit firms.
The 2022 EU Commission study on the impact of the audit reform highlights improvements in harmonising national frameworks. However, it underscores lingering disparities in the transposition, implementation and enforcement of EU audit legislation across countries.
The legislation has profoundly impacted audit firms and the profession by reshaping regulatory requirements and enhancing independence, quality standards and transparency within the EU.
Yet, ongoing evaluation is necessary to ensure continued progress in the improvement audit quality, transparency and governance.
Recent high-profile accounting scandals, such as the Wirecard bankruptcy in Germany, underscore the need for further reform, especially amid increasing demand for sustainability reporting and digital audits.
With a new EU Commission and Parliament taking office imminently, however, further legislative developments are unlikely in the near term.
On the other hand, the Market Monitoring Report identifies potential challenges, including inflationary pressures, rising interest rates, geopolitical instability and the growing use of data analysis tools and artificial intelligence, which will require attention sooner or later.
One thing appears certain – what audit will look like in another 10 years will dramatically differ from what it looks like today. Whether an EU Audit Reform 2.0 is one of key change drivers remains to be seen.
Patrick Gorry is a Partner in the Audit and Assurance Financial Services Group of Mazars Ireland
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