Auditing needs to become global

ACCOUNTANCY

European investors today regularly invest across national borders. In order to safeguard their interests, the European Commission (EC) is concerned about the regulation of non European Union (EU) audit firms and has proposed principles for such regulation in EU's 2006, Directives on Statutory Audit.

Such measures require third-country audit firms to register in EU member states wherever and whenever their client securities are admitted for trading. There is provision for exemption from registration but EC would have to evaluate and decide on the equivalence of such third country audit oversight systems prior to granting such exemption.

On a number of issues relating to how third country audit firms can be regulated and evaluated, the EC has recently undertaken a public consultation exercise. At the outset the EC mapped the current "exposure" of EU member states to audit firms of 63 different countries and quite surprisingly India topped the global list! Out of a total of 220 audit firms in 63 countries to which European investors were exposed, India accounted for 54.

Obviously India has overnight leap-frogged to the attention of European regulators and the entire gamut of the audit profession and its regulation in India are under the scanner.

The Commission and all respondents to the survey have underlined that there has to be an assessment of the equivalence of the Public Oversight System over the audit profession in all these non-EU countries. It is being increasingly felt that EU as a whole should take an equivalence decision on a common framework rather than individual EU member states evaluate individual third-country regimes.

A majority of the respondents to the EU consultation exercise felt that focus must be accorded on countries based on a prioritisation of the criteria of "number of companies concerned", "advanced oversight structures in place" and "major world economies".

There have also been suggestions of adopting a risk based approach of focusing on those countries which would give rise to the greatest risk for investors, if their oversight regimes were not properly aligned to international standards. Under all the possible criteria, India would be categorised as a country that would be of the highest concern.

The oversight system in India has been largely driven by the Institute of Chartered Accountants of India (ICAI). Even today, after the constitution of an independent Quality Review Board by the Government (where ICAI has 50 per cent representation) Peer Review is an exclusive ICAI domain. For the last 57 years the disciplinary mechanism has been totally within ICAI.

It is only in the last few months that the Government has created an independent disciplinary structure, with again 50 per cent ICAI participation. While ICAI has been diligently discharging the onerous responsibilities it has been burdened with by the global standards. The regulatory regime in India in its present construct would perhaps fail the tests of the definition and expectation of "independent public oversight".

While in theory, auditors have unlimited liability, in practice there have been no significant instances of litigation against the audit profession in India or devolution of liability on auditors, in the history of the profession. This, along with the fact that the system of peer review has just been recently initiated and has yet to ensure significant coverage and also the absence of any other significant regulatory oversight may negatively impact an equivalence study as is being proposed.

The size of our country and the fragmentation of the profession would create significant challenges to convince an external audience about the profession's ability to deliver uniform audit quality. Delayed convergence with International Generally Accepted Auditing Standards (GAAS) and GAAP could definitely further undermine any equivalence study.

Corporate India is raring to go global. Cross border acquisitions, mergers, amalgamations, accessing capital markets in a world without boundaries, is what is spurring an economic rejuvenation of the country.

But one of the fundamentals underpinning of all of this is the reliability that developed markets can place on financial statements originating in India. That is what the EU would now be focusing on. The profession has no choice other than to immediately converge to global GAAS and GAAP; to open itself, fast, to public scrutiny.

The writer is director, Ernst & Young India Pvt Ltd. Views expressed are personal