Europe Joins India In Audit Reform

The European legislator’s recently reached agreement in principle to reform the law as it applies to large companies and their auditors. Much of the reform will be familiar to followers of developments under the Indian Companies Act 2013, and provides further evidence that issues in capital markets are rarely national in nature.

The agreement, as a package, will substantially address investor concerns about sparse communication from the auditor, long tenure of the auditor, and excessive volume of non- audit services provided to a company by its auditor.

The main proposals as they apply to large companies are:

– Rotation of the company’s auditor every ten years, which may be extended by a further 10 years after public tender, or 14 years if using joint audit transitional provision of 6 years to change your auditor if it has already been in place for more than 20 years, 9 years if in place for 11-20 years. (In India, the new Companies Act proposes rotation at end of 10 years and provides a 3 year transition period, roughly half the duration of the proposed EU norms.)

– Cap on volume of non-audit fees at 70% of the group audit fee, averaged over 3 years. (Under current ICAI norms, in India this stands at 100% of the annual audit fee.)

– Ban on the company’s auditor providing it with certain non-audit services, including certain tax, corporate finance and risk services. (The new Act also enhances similar restrictions in India)

– Improved communication by the audit committee, the auditor, and between the auditor and the company’s regulator. (Other than relating to fraud, no changes on these matters in India).

– Contractual clauses restricting choice of auditor are “null and void”. Therefore private equity firm term sheets and the like that often direct choice towards a certain group of firms are now barred, certainly opening up choice in theory to a larger group of firms. (Again, a significant omission in India, and something one can expect the ICAI and MCA to pick up and consider in India post this legislation in the EU).

The draft law was originally published in November 2011. Since then there has been fierce lobbying in Brussels, with complaints that the volume of lobbying was excessive and negative. This had led to delay, and even though we now have agreement in principle, the EU processes mean that the law will not be effective until 2016 – 8 years after the financial crisis that prompted the reform.

Grant Thornton welcomes the agreement in principle as helpful to European investors, and we anticipate the package of measures will have meaningful impact. Our own experience is that the discussions in Brussels, in the UK, in India and elsewhere have raised the profile of investor concerns. They worry that the audit contract is rarely subject to challenge, or where there is a rare tender that too often there is competition primarily on price.

Opponents of reform also tried to assert that changing auditor will harm audit quality. They have sought to confuse the debate using arguments applicable to changing auditor every few years and applying those to changing auditor at all. Opponents of reform have sought to say such curbs will restrict companies’ choice and bring additional cost on the company. Even if those concerns were justified, investors have deemed it a cost worth paying. They will be pleased that it is no longer acceptable for the auditor to provide non audit services by default and unchallenged.

Both in the EU and in India, some companies have been proactive and not waited for the law to be finalised- they have put their audit out to tender or changed auditor. Others have taken steps to reduce the amount of non-audit services that they allot to their auditor. This is evidence that some companies are hearing investor concerns. It is also evidence that audit committee chairs increasingly want to use a wider range of accounting firms.

Addressing these concerns in the law ensures that isolated improvements will become change across the market. And it ensures that a reaction to the current debate is sustained into permanent reform. A diverse accounting market fostering innovation and competition based primarily on quality will better serve investors.

These reforms deal with investor perceptions and seek to safeguard audit quality. The accounting profession needs to get back to what it does best – providing high quality services in the interests of investors.

By: Vishesh Chandiok, National Managing Partner, Grant Thornton India LLP

The article was published in the firm.moneycontrol.com on 02 January 2014