Over the last two years, considerable amounts of newsprint have been spent
discussing the amendments to three European directives related to corporate
governance and audit: the 4th, 7th and 8th directives. This guidance provides an
overview of the European legislative process and the current status of these
directives. download

4th and 7th directives

These directives contain the rules for the financial statements of companies (4th)
and groups of companies (7th). When they were first introduced, they changed
the formats of accounts, making them much more standardised.

The amendments proposed to the 4th and 7th directives in 2004 covered:

1. Establishing that board members are collectively responsible for financial statements and key non-financial information;
2. Unlisted companies’ transactions with related parties more transparent;
3. All companies to provide full information about off-balance sheet arrangements, including Special Purpose Vehicles, which may be located offshore; and
4. Making listed companies issue an annual “corporate governance statement”.

In December 2005 the European Parliament passed an amended version of the directives. It is currently waiting to be considered by the Council.

The Parliament amendments affected all four elements.

Parliament clarified the proposed principle of collective responsibility for financial statements, noting that responsibility and liability are separate, that they derive solely from national law and that the directive does not create any new law on liability.

They reduced the requirements on related party and off-balance sheet transactions so that the cost and burden of disclosure did not exceed its benefits.

They also amended the proposed content of the ‘corporate governance statement’ and stated that it would not form part of the financial statements.

Currently, therefore, the statement will include:

• Details of the code(s) of governance that the company applies;
• Explanations where it is not complying with the provisions of that code;
• A description of the main features of the company's internal control and risk management systems in relation to the financial reporting process;
• The operation of the shareholder meeting and its key powers, and a description of shareholder's rights; and
• The composition and operation of the administrative, management and supervisory bodies and their committees.

8th directive

This relates to oversight of external, or statutory, auditors. It covers the minimum requirements for people to qualify as external auditors, including an outline syllabus on which they must be tested. It also covers registration of external auditors and their ongoing regulation as well as ethical requirements such as independence and competence. It introduces the concept of a public interest entity, which is defined as listed companies, banks and insurance companies, although member states are free to add other entities to the list, if they wish.
As part of the supervision of external auditors, the Commission’s proposals of 2004 included a requirement (article 39) for public interest entities to have an audit committee, composed of non-executive members of the administrative body or members of the supervisory body of the audited entity with at least one independent member with competence in accounting and/or auditing.

The current status of the directive is that it has been approved by both the European Parliament, subject to certain amendments, and by the Council.

Therefore, the directive will be adopted as soon as the final amended text is available.

During the discussions of the proposed directives, one of the most fiercely contended provisions was the requirement for an audit committee.The current status of the directive is that it has been approved by both the
European Parliament, subject to certain amendments, and by the Council.
Therefore, the directive will be adopted as soon as the final amended text is
available.
During the discussions of the proposed directives, one of the most fiercely
contended provisions was the requirement for an audit committee. For UK and
Ireland listed companies, the requirements themselves would not be more
onerous than the current requirements of the Combined Code on Corporate
Governance. However, of course, if the requirements were enacted into statute,
the companies would not have the option of not complying with them. It is this
move from ‘comply and explain’ that has been fiercely resisted by many lobbying
groups.
Therefore, the most significant amendments relate to the requirement for an
audit committee. There is now more flexibility for member states to decide what
to enact about the need for an audit committee and about its composition and to
exempt companies from the requirements.

Therefore, the most significant amendments relate to the requirement for an audit committee. There is now more flexibility for member states to decide what to enact about the need for an audit committee and about its composition and to exempt companies from the requirements. However, the final version of the responsibilities of an audit committee continue to include to “monitor the effectiveness of the company’s internal control, internal audit where applicable, and risk management systems”.