NFRA: Oversight over larger audit firms a must, says Vishesh C Chandiok

National Financial Reporting Authority: Making the new regulator work

The Cabinet last week approved constitution of the National Financial Reporting Authority (NFRA) to oversee auditors of listed entities and large unlisted companies. The jurisdiction of the existing self-regulatory body, the Institute of Chartered Accounts of India (ICAI), will continue over its members and over those firms that are below the threshold to be announced by the government. 

Independence is not a science. It’s what others perceive, not what you feel. Independence is, therefore, about being seen to be independent. Post major frauds at the turn of the millennium, the audit profession, globally, no longer appeared independent. The profession had been ‘self- regulated’ by member-controlled bodies -- American Institute of Certified Public Accountants (AIPCA) in the US, Institute of Chartered Accountants (CAs) in England & Wales (ICAEW) in the UK, and others. 

India remains the only major economy where CAs are still effectively self-regulated. The alternative to ‘independent regulation’ is for the audit profession to continue to field disproportionate blame in the event of fraud -- as if auditors were the only people ‘sleeping at the wheel’, as auditors have ‘other auditors as cops’, and therefore the natural perception that there is little consequence of getting it wrong. 

India today has a quasi-independent regulator called the Quality Review Board (QRB). The QRB is a ‘joint venture’ between the government and the ICAI. The need for the NFRA would have never emerged had the profession understood the direction of the wind and ceded control of oversight to the QRB. 

Learning from that experience, the ICAI and the NFRA need to collaborate towards a common objective -- enhancing audit quality. This will, in turn, lead to better financial reporting, which is essential for efficient capital markets. In the end, the NFRA will lead to enhancing the reputation of the audit profession and the value from an audit. So if the ICAI and its members are interested, they would unequivocally promote the NFRA. 

Overall, the NFRA should focus its efforts not on standard setting (where it should rely entirely on the ICAI as standards are now aligned to global standards) but on oversight over larger audit firms that audit public interest entities (PIEs). 

The Supreme Court’s recent order on MAFs (multinational accounting firms) along with the NFRA provides a brilliant opportunity to the government to help the Indian audit profession catch up. The key issue is defining what is not an MAF; according to the said order, as many as 171 firms are MAFs. These 171 firms collectively represent pretty much the entire PIE audit profession in India!  It’s high time the regulation of these 171 PIE audit firms moves out from the ICAI to the NFRA. The ICAI can continue to regulate all individual CA members and firms that perform services other than PIE audits.

The alternative is PIE audit continuing to lose its value, and that is an undesirable consequence for all -- auditors, CAs, regulators, companies, and the society at large.