Position on the Rotation of Statutory Auditors

1 UKNF Position on the rotation of statutory auditors

2 This document presents the position of the KNF Office regarding the rotation of statutory auditors examining the financial statements of public interest entities. The document presents the legal basis for the rotation obligation, as well as the position of the Financial Supervision Authority Office regarding:

1. unification of rotation requirements for all public interest entities,
2. the effective date of the rotation requirement for the entity authorized to audit financial statements in insurance undertakings.
   Furthermore, the document contains conclusions from the analysis of audited financial statements of entities supervised by the KNF for the years 2004-2008.

3 I. LEGAL BASIS
Issues concerning rotation in the audit of financial statements are regulated by the provisions of the following acts:

1. the Act of May 22, 2003, on insurance activity (Journal of Laws of 2003, No. 124, item 1151, as amended), hereinafter referred to as the Act on insurance activity;
2. the Act of May 7, 2009, on statutory auditors and their self-government, entities authorized to audit financial statements, and public oversight (Journal of Laws of 2009, No. 77, item 629), hereinafter referred to as the Act on statutory auditors.
   The topic of rotation was also addressed in:
3. the code of professional ethics for statutory auditors (text according to the appendix to Resolution No. 2 of the Extraordinary National Congress of Statutory Auditors of June 30, 2002, on the principles of professional ethics for statutory auditors), hereinafter referred to as the code of professional ethics,
4. Good Practices of Companies Listed on the WSE (text according to the appendix to Resolution No. 12/1170/2007 of the Stock Exchange Council of July 4, 2007, effective from January 1, 2008).
   II. UKNF POSITION
   II.1. UNIFICATION OF ROTATION REQUIREMENTS FOR ALL PUBLIC INTEREST ENTITIES The UKNF is of the opinion that the discrepancies in the rotation requirement resulting from Article 89(1) of the Act on statutory auditors and Article 170(1) of the Act on insurance activity require the unification of legal regulations in the Polish legal system currently in force on this matter. In view of the above, the UKNF postulates the unification of legal regulations on the analyzed subject by appropriately extending the obligation of rotation of the entity authorized to audit financial statements (and not the key statutory auditor) specified in Article 170(1) of the Act on insurance activity, currently applicable to insurance undertakings, main branches of insurance undertakings, and reinsurance undertakings, also to all other public interest entities currently covered, in accordance with Article 89(1) of the Act on statutory auditors, by the obligation of rotation of the key statutory auditor. The UKNF is of the opinion that changing the entity authorized to audit financial statements – and not merely the person of the key statutory auditor – will significantly reduce the risk of error by the statutory auditor resulting from a routine approach to auditing the entity, which will simultaneously positively affect the quality of audited financial statements. Furthermore, it should be noted that changing the authorized entity will force the entity authorized to audit financial statements for the first time to apply different audit procedures, which directly results from the regulations of Standard No. 1 for performing the profession of statutory auditor. In the opinion of the UKNF, only the adoption of such a solution (rotation of the entity authorized to audit financial statements and not merely the key statutory auditor as provided for in Article 89(1)

4 of the Act on statutory auditors) will ensure, at the highest possible level, the quality of services provided by statutory auditors, and in particular their audit of financial statements.
II.2. EFFECTIVE DATE OF THE ROTATION REQUIREMENT FOR THE ENTITY AUTHORIZED TO AUDIT FINANCIAL STATEMENTS IN INSURANCE UNDERTAKINGS According to the UKNF, the maximum 5-year period during which the same entity authorized to audit financial statements may audit one insurance undertaking should be counted from January 1, 2004. It should be noted here that the amendment to the Act on activity in the scope of Article 170(1) of the Act on insurance activity only streamlined the terminology used, replacing the term "statutory auditor" with "entity authorized to audit financial statements," while the rotation principle itself, resulting from Article 170(1) of the Act on insurance activity, invariably refers to the entity authorized to audit financial statements. The above is consistent with the requirements of the Accounting Act, whose provision from January 1, 2002, specifies that the competent authority selects the entity authorized to audit financial statements. The supervisory authority also wishes to point out that Article 170(1) of the Act on insurance activity, in force since 2004, introduced the requirement that the entity authorized to audit financial statements could be selected by an insurance undertaking for a maximum period of 5 years. The 5-year period is counted from the financial statement for 2004, which means that the specified maximum 5-year period ended with the audit of the financial statement for 2008. Therefore, the provision of the Act on insurance activity will de facto apply for the first time to the audit of financial statements for 2009. Data held by the supervisory authority indicates that 33 insurance undertakings will have to change the entity authorized to audit financial statements in 2009.

III. CONCLUSIONS FROM THE ANALYSIS OF AUDITED FINANCIAL STATEMENTS OF ENTITIES SUPERVISED BY THE KNF FOR THE YEARS 2004-2008.
The UKNF analyzed the audit of financial statements of entities supervised by the KNF. The thematic scope of the research area was limited to entities under prudential supervision, excluding cooperative banks.

1. Supervised entities, in terms of auditing financial statements, use the services of the largest audit firms, including in particular 3 firms: KPMG, Ernst & Young, PricewaterhouseCoopers (in 2007, 68% of supervised entities were audited by these 3 firms; in 2008, 65%).
2. KPMG has the largest share in auditing financial statements (in 2007, 30% of supervised entities used its services; in 2008, 27%), Ernst & Young (in 2007, 22%; in 2008, 23%), PricewaterhouseCoopers (in 2007, 16%; in 2008, 15%).
   KPMG is a leader among audit firms auditing financial statements of insurance undertakings (in 2007 and 2008, 32% of the market), commercial banks (in 2007, 38% of the market; in 2008, 35% of the market), and brokerage houses (in 2007, 27% of the market; in 2008, 22% of the market). 5 Ernst & Young is a leader among audit firms auditing financial statements of PTE and OFE (in 2007, 43% of the market; in 2008, 36% of the market) and TFI (in 2007, 31% of the market; in 2008, 26% of the market).
3. Among audit firms auditing financial statements of supervised entities, BDO (in 2007, 9% of the market; in 2008, 7% of the market) and Deloitte (in 2007, 6% of the market; in 2008, 8% of the market) also have a significant market share.
   It should be noted that Deloitte has a relatively small share, compared to the other 3 firms belonging to the so-called "Big Four," in auditing financial statements of supervised entities. In the case of this audit firm, specialization in auditing commercial banks and brokerage houses is visible (in 2007, 71% of all financial statements of supervised entities audited by this firm; in 2008, 65%).
4. The highest concentration of audit firms concerns PTE and OFE (in 2007, 4 audit firms for 28 entities; in 2008, 5 audit firms for 28 entities) and commercial banks (in 2007 and 2008, 6 audit firms for 47 and 48 commercial banks respectively - in addition to the aforementioned 5, also Mazars & Guerard Audyt Sp. z o.o.).
   The greatest fragmentation concerns TFI (in 2007, 13 audit firms for 33 TFI; in 2008, 14 audit firms for 39 TFI) and brokerage houses (in 2007, 18 audit firms for 41 brokerage houses; in 2008, 20 audit firms for 45 brokerage houses).
5. 50% of insurance undertakings and PTE and OFE operating in 2008 used the services of the same audit firm continuously for 5 years (concerning the audit of financial statements for the years 2004-2008). In the case of commercial banks, the same audit firm audited the financial statements of 53% of banks.
6. In the years 2004-2008, most often 1 audit firm was represented by 2 or 3 key statutory auditors.

6 Chart 1. Share of the largest audit firms in the market for audit services provided to supervised entities in 2007.
Market share of the largest audit firms in 2007 KPMG 30% PwC E&Y 16% 22% Deloitte 6% BDO 9% Others 17% Chart 2. Share of the largest audit firms in the market for audit services provided to supervised entities in 2008. Market share of the largest audit firms in 2008 KPMG 27% PwC 15% E&Y 23% Deloitte 8% BDO 7% Others 20%

7 Chart 3. Structure of supervised entities by audit firms auditing financial statements in 2007.
Number of supervised entities audited by audit firms in 2007 64 35 47 14 19 37 0 10 20 30 40 50 60 70 KPMG PwC E&Y Deloitte BDO Others Chart 4. Structure of supervised entities by audit firms auditing financial statements in 2008. Number of supervised entities audited by audit firms in 2008 61 34 52 17 16 46 0 10 20 30 40 50 60 70 KPMG PwC E&Y Deloitte BDO Others
IV. SUMMARY
The UKNF is of the opinion that the appropriate solution for unifying legal regulations concerning rotation is to adopt the principles of rotation of the entity authorized to audit financial statements, and not merely the rotation of the key statutory auditor. In view of the above, in the opinion of the UKNF, the provisions of the Act on statutory auditors should be amended to introduce the obligation of rotation of the entity authorized to audit financial statements for all public interest entities.