Commission Consultation on the Adoption of International Standards on Auditing

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1 Hermes Equity Ownership Services Limited 1 Portsoken Street London E1 8HZ United Kingdom Tel: +44 (0) Fax: +44 (0) Auditing Unit-F4 DG Internal Market and Services European Commission By markt-consultation-isa@ec.europa.eu 15 September 2009 Dear Sir/Madam Commission Consultation on the Adoption of International Standards on Auditing We welcome the opportunity to comment on the proposed adoption of ISAs within the EU. This is an important topic which goes to the heart of investor confidence in the accounts on which they rely for their investment decision-making. By way of background, Hermes is one of the largest pension fund managers in the City of London and is wholly owned by the BT Pension Scheme. As part of our Equity Ownership Service, we also respond to consultations on behalf of many other clients from around Europe and the world, including the BBC Pension Trust, the National Pension Reserve Fund of Ireland, PNO Media Stichting Pensioenfonds of the Netherlands, Canada s Public Sector Pensions Investment Board and VicSuper of Australia (only those clients which have expressly given their support to this response are listed here). Hermes EOS has assets under advice of over 46 billion (as at 31 st March 2009). We are generally supportive of the adoption of International Standards for Auditing in the EU. We feel that the prospect of ISA adoption in the EU has had a very positive effect on the governance of the IAASB and on the quality of ISAs themselves including with regard to the IAASB s general (though not universal) attentiveness to comments received. We believe that more can be done in these areas, however, and in particular: 1. We believe that the IAASB can and should be made more independent still from the profession and more fully accountable to public interest bodies as well as the markets as a whole. We would welcome moves along these lines over the next few years, perhaps aligned with the process for public accountability of the IASB. 2. We believe that the ISAs themselves could be enhanced. While the IAASB did respond to many comments received, we believe that there are still aspects where the Board could have been more responsive and could have improved the ISAs further. Our view is that there does not need to be maximum harmonisation in this area. Rather, raising standards to a baseline level is helpful but allowing flexibility for member states to raise auditing standards would set the best context for investor confidence in the auditing process and in EU accounts. We would note that in some cases standards will be enhanced by apparent carve-outs just as much as they may be enhanced by add-ons. Hermes Equity Ownership Services Limited: Registered office: Lloyds Chambers, 1 Portsoken Street, London E1 8HZ. Registered in England No

2 In particular, we would draw attention to ISA 700 on the auditor report. We believe that this is a weak standard and it betrays the IAASB s origins as a profession-led organisation. The ISA is defensively drafted and requires the publication of a good deal of boilerplate indicating more what the auditor does not do than reporting on the conclusions from the work that the auditor has done. We strongly believe that this would generate reports which are unhelpful to users of accounts. We are therefore supportive of the UK and Ireland s new ISA 700, which focuses much more on the auditor s conclusions and makes these much more readily accessible and user-friendly. We commend this approach to the EU, and would note our view that it is extremely important for the EU to empower member states to make full use of paragraph 43 of ISA 700 which allows different formats for auditor reports when required under local law or regulation. While noting these caveats and in anticipation of the EU allowing full flexibility under paragraph 43 of ISA 700 and continuing to press for improvements to the governance of the IAASB and to the ISAs themselves we are of the view that ISAs should be adopted in the EU. We would welcome further discussion of any of the comments included here if that would be helpful to you. Yours sincerely PAUL LEE Director

3 Question 1: Is international acceptance of the ISAs sufficiently demonstrated? Yes, we believe that there is now sufficient international acceptance. While the EU will be an early adopter, it seems clear that others will follow that lead or move at around the same time. Question 2: What degree of importance do you attach to the fact that the Commission may amend the standards? On the whole, we believe that it is helpful for the Commission to retain the flexibility to amend standards, but we believe that it should only be exercised in the most unusual circumstances and following due process. In our view, that due process will need to involve support from investor representatives, not just from the profession. Question 3: To what extent are add-ons or carve outs by Member States acceptable? The consultation paper states that Reliance on auditor s reports could be enhanced if the investors know that a single set of auditing standards are being used in the European Union. We do not wholly agree. We believe that reliance will be enhanced most by European member states applying the highest standards in auditing. This will best be achieved by some states applying higher standards generating increased investor confidence provided that all reach a baseline set of standards. We are strongly of the view that we should seek to level up standards in auditing across the EU. We therefore see significant value in ISA adoption as a way of raising standards. However, we are not convinced that adoption needs to be on a maximum harmonisation basis. This risks lowering standards in some markets by removing additional standards which would increase the requirements of the auditors and so raise the service enjoyed by investors from their work and we would note that in some cases apparent carve-outs from ISA requirements may have the impact not of lowering standards for auditors but of increasing them (for example ISA580 sets inappropriate requirements not of the auditors but of management in paragraph 11, requiring the unrealistic representation that All transactions have been recorded [our emphasis]). We are not at all convinced by the profession s argument that the same standards globally are necessary for audit quality. We can see why this is in the profession s interest, and we certainly agree that raising standards in some markets will be a positive step, but we cannot agree that this requires identical auditing standards worldwide. We therefore believe that it is important for there to be flexibility in the way in which member states can implement the ISAs, and that they should be enabled to make add-ons and carve-outs provided that the changes which are made have the effect of increasing auditing standards and so delivering a higher quality audit for European markets. In particular we believe it is vital that member states are empowered to issue guidance as appropriate to assist in the application of the ISAs in their markets. Question 4: Do you have any comments on the overall cost/benefit analysis presented in the University of Duisburg/Essen study? We are surprised by the asserted conclusion that investors favour a single set of international auditing standards. We cannot identify any basis in the questions asked

4 nor in the results of the survey to justify this surprising assertion. Indeed, the investors' responses overwhelmingly suggest that users see no substantive difference between ISAs and US auditing standards, implying that there is no pressure from investors for convergence. Our clear view as investors and we believe that this view is generally shared is that our interests would be best served by a high minimum level of auditing standards but one which allowed individual countries the flexibility to set additional requirements which enhanced the service provided by auditors to investors. Question 5: Should the Application Material be part of the adoption process and be acknowledged as best practice? We strongly believe that flexibility should to be built into the European system so that application material can be tailored by each member state to their particular needs and to respond to developments. We do not believe that the IAASB process and the EU adoption process will be conducive to a speedy response to arising issues and therefore the EU needs to build in mechanisms to enable member states to respond more quickly. Question 6: Should ISQCI on internal quality controls be part of the adoption process? Yes, we believe that ISQC1 is a necessary adjunct to ISAs. Question 7: In case of adoption of the ISAs at EU level, would a common reference to ISAs as adopted in the EU in all auditors reports in the EU be sufficient? Or is further harmonisation of audit reports necessary? We do not believe that harmonising audit reports across the EU would be worthwhile. Indeed, we do not think that it would be practical in the context of the different legal requirements in member states; for example, aligning the lengthy French audit reports with those in other countries does not seem practical, even if it were advisable. To be clear, we do not believe that this would be advisable. As noted in our introductory comments, we strongly believe that ISA 700 is one of the weakest of the ISAs and its wholesale adoption in the EU would be a negative step. Rather, we believe that if the EU adopts ISA 700 it needs to do so with the clear intent that paragraph 43 will be openly available for use to enable member states to design audit reports which serve the needs of users more effectively than the current poor report outlined within the substance of ISA 700. Question 8: Do you support adoption of ISAs at EU level? Yes. Question 9: If yes which of the options do you support? If an audit is required, we believe that it needs to be done to a single standard. Only in this way will audited accounts provide the assurance expected by the users of those accounts. We are therefore of the view that if ISAs are adopted they need to be adopted for all audits, and thus support Option 3.

5 Question 10: Do you have comments on the timing in case of an adoption of the ISAs? If ISAs are to be adopted, we would welcome this being done promptly, and the effective date chosen to be as early as is practicable to allow the audit profession the time it needs to be trained in the new requirements. It may be that different effective dates could be chosen for listed and for other companies: giving the main benefit of adoption for free movement of capital as early as possible without it being hindered by the greater time likely to be needed for training at smaller audit firms.