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Ban on use of "Big Four-only" clauses

With planned changes to EU regulations governing the audit market, contractual clauses limiting the selection of audit firms will have to be removed from credit agreements.

Agreement has been reached in Brussels on reform of the audit market. A new Art. 37(3) will be added to the Statutory Audit Directive (2006/43/EC) prohibiting the use of contractual provisions limiting the selection by the general meeting of shareholders of audit firms to conduct a statutory audit by indicating a list or category of auditors or audit firms.

In credit agreements, banks often include a clause under which the audit firm appointed by the borrower to examine the borrower’s annual financial statements must be one of the “Big Four”—Deloitte, Ernst & Young, KPMG and PwC. When the planned amendment goes into effect, clauses of this type will cease to be valid.

One of the goals behind the change is to break up the concentration of the audit market and remove barriers to market access by small and medium-sized firms. As found in the studies conducted for the purpose of the amendment, the audit market is strongly dominated by the Big Four. In most of the EU’s member states, the Big Four are responsible for auditing of the financial statements of over 80% of public companies. Even if the figure for unlisted companies is lower, significant market share remains divided among just a few international firms.

This raises the question of the treatment of clauses—also commonly encountered—which do not expressly limit the borrower’s choice of auditors to a specific list or category of firms but require prior approval of the selection by the lender. In practice, this may limit or exclude the borrower’s freedom to select the auditor of its choice and therefore effectively block access to the market by smaller audit firms. Given the reasoning behind the change in the directive, clauses which only indirectly limit the freedom to select auditors may also be questioned.

Depriving banks of the possibility of requiring that borrowers’ financial statements be audited by firms they trust is to be compensated for through provisions intended to raise the quality of services provided by audit firms and increase the independence of auditors, according to the planned reforms. Significantly from the perspective of international commerce, the new rules are to introduce a system making it easier to obtain recognition of an audit firm’s certification under the laws of one member state in other member states, and also achieve more effective oversight of the audit market by national regulators and greater cooperation among regulators at the EU level.

The proposed changes are expected to be voted on by the European Parliament and the Council of the EU during the first half of 2014. After adoption of the directive, the member states will have two years to transpose the provisions into national law. Until then, the existing clauses would remain in force.

Clauses limiting the selection of auditors to the Big Four or requiring the bank’s approval of the selection of auditors are also found in the credit documentation forms recommended by the Loan Market Association. If the ban enters into force, clauses of this type will have to be removed from credit agreements. However, the LMA will not make changes to its forms until the final wording of the reform is determined.

Łukasz Szegda and Marta Stachurska, Banking & Finance Practice, Wardyński & Partners