On December 31, 2024, the Financial Services Commission (the “FSC”) announced its “plan to defer the periodic designation requirement for companies with excellent accounting and audit governance.” This plan has been established as part of the financial regulators’ “key improvement plans for the current accounting system” (the “Accounting Improvement Plans”) as explained in our previous newsletter dated June 2023 (Link).
When announcing the Accounting Improvement Plans, the financial regulators pointed out that the excessively high ratio (up to 50%) of listed companies having designated external auditors gave rise to adverse effects such as undermined competition among auditors to provide high-quality audits, and designated auditors’ abuse of power by demanding an excessively high amount of remuneration for audits. In order to ensure that the designation ratio is maintained at an appropriate level, the financial regulators unveiled their plans to revise the requirement of periodic designation of external auditors (the “Designation Requirement”). More specifically, those plans would aim to abolish the current rules or drastically amend them to only impose administrative fines on companies that have committed minor violations associated with audit procedures or that are unlikely to have engaged in accounting fraud. However, due to the insufficiency of data necessary for analyzing policy effects, as the Designation Requirement has been in place only for three years since its introduction (in 2020), the financial regulators have decided to maintain the current requirement for the time being and re-examine the need for revising the Designation Requirement when sufficient data becomes available for an analysis of policy effects.
Accordingly, rules for granting a grace period (the “Grace Period Rules”) have been established in order to reduce the burden on companies to designate external auditors. Key details of the Grace Period Rules are summarized as follows:
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Evaluation and Selection of Companies with Excellent Governance
If a company applies for a review of eligibility for a grace period granted to companies with excellent accounting and audit governance, an evaluation committee consisting of experts from the private sector will review the application, and the Securities and Futures Commission (the “SFC”) will finally determine the company’s eligibility.
The evaluation criteria for companies with excellent governance consist of a total of 17 indicators in five areas related to accounting and audit (i.e., independence of the audit function, expertise of the audit organization, effectiveness of the audit support organization, transparency of the auditor appointment process, and internal efforts).
In accordance with the evaluation criteria quantified to the maximum extent, companies will be marked on an absolute scale. In principle, companies that score at least “800 points” out of the total of 1,000 points will be selected as being eligible for a grace period.
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Scope of Applicants
A listed company may apply for a grace period if it (i) has established an audit committee, (ii) has undergone an audit by a designated external auditor for at least one year since the enforcement date of the Act on External Audit of Stock Companies (the “External Audit Act”) which was wholly amended on October 31, 2017 and came into force on November 1, 2018, and (iii) has not been disqualified for the last three years.
The grounds for disqualification include (i) where the company or its officers/employees are sanctioned by an administrative agency, or convicted by a court, or indicted by the prosecution, for their embezzlement or breach of trust, or for their violations of the External Audit Act or the Financial Investment Services or Capital Markets Act (e.g., limited to unfair trade practices and violation of the disclosure obligation), and (ii) where the company lacks credibility in accounting, such as when it received an audit opinion pointing out that its financial statements are not fairly presented (e.g., qualified/adverse opinion or disclaimer of opinion), or when it restated its financial statements, or when an audit is in progress due to concerns about accounting fraud.
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Effect of Being Eligible for a Grace Period
Once a company is selected as being eligible for a grace period, it will be granted a three-year grace period during which the Designation Requirement will not be applied starting from the year the company is first subject to such requirement following its selection. Therefore, the company may voluntarily appoint auditors for an additional period of three years, which has the effect of extending the period of voluntary appointment of auditors from six years to nine years.
However, the company must comply with the requirements it satisfied at the time of selection until the expiration of the grace period. If the company is found to have failed to comply with the requirements (e.g., occurrence of reasons for disqualification), unless there are special circumstances, the grace period will immediately come to an end.
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Next Steps
An evaluation committee will be established by the first quarter of 2025. Applications for a grace period will be received in June or July 2025, and eligible applicants will be selected by the third quarter of 2025 based on the evaluation committee’s review and the SFC’s resolution.
At the time of announcing the Accounting Improvement Plans in 2023, the financial regulators stated that they would reexamine the Designation Requirement from the beginning after its scheduled operation until 2028, by which all listed companies would have been granted a grace period at least once. Accordingly, the Grace Period Rules will also be operated for three years (from 2025 to 2027) prior to the reexamination.
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In practice, listed companies are burdened with the execution of audits and the audit costs due to the periodic designation of external auditors. If the Grace Period Rules can ease the audit burden on companies, this will likely have a positive impact on corporate accounting and audit practices. In light of the foregoing, each company may consider conducting preliminary reviews to identify whether it satisfies applicable requirements and taking measures to correct deficiencies. Although there may be changes in the course of implementation, the FSC stated in its press release that the Grace Period Rules would employ an absolute evaluation method, implying that the ratio and the number of companies selected as being eligible for a grace period would not be limited.
[Korean Version]
