The phased implementation of the EU Statutory Audit Directive in Ireland is on-going, with mandatory requirements in relation to audit committees for (re)insurance companies and others (subject to limited carve-outs) applying from 20 November. 

As highlighted in previous bulletins, the changes may necessitate early attention if changes to existing corporate governance structures are needed.

Background

While most of the legislation – the European Communities (Statutory Audits) (Directive 2006/43/EC) Regulations 2010 (the “Regulations”) – relates to the regulation of auditors and their functions, changes are included requiring the establishment of an audit committee where a company is a “public interest entity”.  There are a limited number of exceptions, but broadly insurance and reinsurance companies as well as other categories such as credit institutions and companies with listed securities must have an audit committee from 20 November.  The composition and business of the committee is also now prescribed.

Existing position

The Central Bank of Ireland’s guidelines already recognise the audit committee as “an essential element of an effective control environment” and stress areas in relation to its constitution such as the need for balance and independence.  This echoes the UK Corporate Governance Code (previously know as the Combined Code).  However, the new Regulations break new ground by putting the need for an audit committee on a statutory basis.  To the extent that a (re)insurance company already has an audit committee, there is still a need to revisit terms of reference and constitution to ensure these remain compliant.

Need for INEDs

The 20 November changes require that the membership of the audit committee must include at least two independent non-executive directors.  One of these must be competent in accounting or auditing. 

While the meaning given to the term “independent non-executive director” will be broadly similar to the INED provisions in the Central Bank of Ireland’s guidelines, there may be subtle differences.  For example, the Regulations require without any ability for derogation that to be “independent” a director must not have had, during the three years before appointment, any “material business relationship” or position of employment in the relevant entity.

It is also noteworthy that the requirement with regard to competence in accounting or auditing does not necessarily mean that the individual who fulfils this requirement has to be a qualified auditor or accountant and a competence based on experience or other professional qualifications can potentially satisfy the “competence” requirement.

Terms of reference

• (Re)insurance undertakings, and other relevant companies, already operating audit committees may still need to revisit existing terms of reference and constitution in light of the changes.  The Regulations specify mandatory areas of responsibility for an audit committee including the monitoring of:
• the financial reporting process; 
• the effectiveness of internal controls; and 
• the statutory audit of the annual and consolidated accounts; and 
• the review and monitoring of the independence of the statutory auditor and audit firm. 

Carve-outs

There are some exceptions to the need for an audit committee in given scenarios, but we expect these should only be availed of on taking proper advice.  The most likely exception will be where an appropriate parent company already operates an audit committee at that level.  The exact carve-out applies where a company is a “subsidiary undertaking” of a “parent undertaking” within the meaning in the EU Consolidated Accounts Directive (Directive 83/349/ EEC).  However, the inter-linking provisions are complex.  Of particular relevance to non-EU parent groups (e.g. Bermudian or US groups) is that the definition of a “parent undertaking” for the purposes of the exemption appears defined solely by reference to undertakings governed by the national law of a Member State.  This requires that the parent has:

• a majority of the shareholders’ voting rights in the other undertaking
• the right to appoint or remove a majority of the administrative, management or supervisory body of the other undertaking
• the right to exercise a dominant influence over the undertaking 

We expect (re)insurance undertakings will need to work with their legal or accounting advisors to establish if exemptions at subsidiary level can be availed of.  The position will require particular examination in relation to non-EU groups.

CP41

The implementing measures stemming from the Central Bank of Ireland’s recent corporate governance consultation process (CP41) which closed on 30 July 2010 are likely to mean further variations around the constitution of audit committees.  The changes are anticipated as we move towards the end of this year, although there is no specific date.  In the interim, (re)insurance companies and other affected undertakings such as credit institutions will still need to comply with the new audit committee provisions from 20 November.

Further information in relation to the European Communities (Statutory Audits)(Directive 2006/43/EC) Regulations 2010 is available from your usual William Fry contact, or any member of our dedicated Insurance Group.