Effect of the EU's 8th directive - Interview in The Hindu Business Line on 3 Dec 2009

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 7,000-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 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 36 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 is involved. 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 which 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.

The above interview appeared in the 3 December 2009 edition of The Hindu Business Line, a link to which is available here.

Rahul Roy (1963-2009)

Today, I have lost a great boss, colleague, mentor, counsellor and superior.  Rahul Roy was all of that to me.  But above all, he was a great friend.  Tomorrow’s newspapers will most likely carry memoirs about Rahul, the professional accountant.  But this is about Rahul the person.

In the last couple of years that I’ve worked and interacted closely with him, I’ve come to learn a lot, not just about work and technical aspects, but what it means to be “well read”.  His interests varied from accounting and auditing, to science fiction; from contemporary thriller fiction to poetry of the English Romantics; from debating to the latest Bollywood blockbuster movies; from linguistics and literature to diverse culinary and epicurean experiences.  And any conversation with this great man meant that one would hear no less than three of these topics mentioned.

A self-confessed slave to perfection, Rahul would never employ short-cuts; yet, he was the kind of man who used to write instant SMS poetry on his way to office.  His laconic, pithy one-line emails, almost always cynical yet comic, always stood out amidst the plethora of verbal diarrhoea one got to read otherwise.

In the last few months, he realised that he was behind in the digital age, and so activated a Facebook profile and two blogs – one professional (www.proandanti.blogspot.com) and one personal, which he meant to use as a forum to express his tangential streak but sadly, never ever got down to doing so.  As his “Boswell”, it wasn’t uncommon for me to receive requests to update his professional blog at strange times of the day.

In many ways, Rahul was an anachronism.  The right man caught in a wrong age.  If his thoughts and words seemed esoteric, it was only because the rest of the world was still too young to understand.  It was a privilege to learn just about anything from Rahul, that tremendous storehouse and font of all relevant and sometimes obscure knowledge!

I’m told that many years back, in response to a question on why he wanted to become President of the Institute of Chartered Accountants of India, he is said to have remarked in his typical fashion, “As the youngest president, the law of nature decrees that I would be the longest surviving past president”.  That, in a line, was Rahul Roy.

If only he could have read this tribute, I know exactly what he would have said: “We are not amused”.  Majestic plural in true Queen Victoria style!

R.I.P, Rahul.