The Companies Act, 2013, which became effective from April 1, 2014, has brought significant changes in the areas of auditor independence, limits on the number of audits for an auditor and responsibility and also introduced the mandatory firm rotation (MFR) requirement in India. The Act requires all large and listed companies to change their audit firms if they have completed 10 consecutive years, as of April 1, 2017. This regulatory requirement has the potential to pave the way for substantial changes in the structure of the audit profession, with substantial consolidation of audit of public interest (listed or large) companies amongst a few firms. A survey by Grant Thornton and Prime Database on MFR found that 431 companies out of 1,480, that is, only 29 per cent of the companies listed on the National Stock Exchange, are audited by large firms with international presence. However, as a fallout of the auditor rotation requirements, 65 per cent of the respondents of the MFR survey stated that they would prefer to appoint large firms with international presence to comply with norms as opposed to large Indian firms as their future auditors.
This cannot be a bad thing, as India is unique with more than 1,000 audit firms who audit 1,480 public interest entities (PIE) currently - a number substantially higher than much larger and more mature economies (in the US 560 audit firms audit 3,700 companies; in the UK 41 audit firms audit 2,300 companies), unless we end up with only a handful of audit firms of any size. Those larger and more mature economies already have this opposite problem of too much concentration among a handful of firms. In fact, the European Union (EU) with its own recently introduced MFR requirements (20 years), along with several other supplementary measures, is trying to solve this problem.
The other interesting measures the EU has adopted include the need to mandatorily tender such audits every 10 years and the banning of "restrictive covenants". It is common knowledge that the audit marketplace has been plagued with an artificial barrier in favour of so-called "Big X" firms, something that has survived those firms themselves going out of business or consolidating from 12 to now just four, whilst not adding other firms to this "club". There are several "not so big firms", who currently audit and are at least equally capable of auditing all but very complex PIEs.
Indeed, often those firms are better placed to be auditors to such mid-sized local and global companies with audit quality indicators and inspection scores quite similar and sometimes better than these so called "Big X" firms. After all, in most other industries, "big" very often means mass market and generic, with true first-class advice often being offered from someone other than the "biggest". How many of us consciously ask to be booked into a "Big X" hotel or fly only a "Big Y" airline!
The other restriction that still impacts the ability of old Indian firms to compete relates to advertising, solicitation and displaying affiliation to "foreign networks". More than 100 top audit firms in India have an affiliation with an international accounting organisation. However, none of them is allowed to quote or display this affiliation in any manner on their firm collateral or firm brand. The "Big X" firms have an unfair advantage as they get the reference to them being part of the "club", a brand which is bigger than their own individual brands. If Indian firms were allowed to quote such affiliation, and adopt such "global" brands as part of their own, this would perhaps help potential users better understand and therefore, lead to more acceptance of such Indian firms.
The changing regulatory environment is another big barrier. The cost of carrying out audits of large listed companies has increased dramatically, stretching capacity thin. Given how expensive it is to comply with the new legal requirements including MFR, documentation of internal financial controls, financial reporting under Ind AS, and goods and services tax, and the significant downside from litigation/increased auditor's responsibilities exposing them to class action suits, this will impact the availability/pool of eligible and competent firms to take on the audits.
Indeed, the structure of the Indian audit profession is going to transform in the next five years. If we were to supplement the new MFR requirement with also banning restrictive covenants and at the same time allowing Indian firms to adopt global affiliations in their brand, we would set the ball rolling towards creating a more vibrant Indian audit profession with 50 audit firms of different sizes and competencies. India Inc needs this choice. It needs to learn from the trends of its western counterparts. If we don't, India may be left with 5-10 audit firms of any scale in five years, something that will not be in the interest of either vibrant capital markets or a vibrant Indian economy of the time.
Vishesh C Chandiok is national managing partner, and Yogesh Sharma is partner, Grant Thornton India LLP
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