New audit regulation won't improve independence - auditors

Cape Town – The majority of stakeholders in the financial auditing sector told MPs on Friday that they are opposed to the intended implementation of the Mandatory Audit Firm Rotation (MAFR). 

In October 2016, the Independent Regulatory Board for Auditors (IRBA) published a consultation paper about the proposed new framework, which will change the way in which companies appoint auditors. 

In terms of the new measure (MAFR), an audit firm wont’ be allowed to serve as the registered auditor of a listed company for more than 10 consecutive financial years. Furthermore, the same audit firm can only be reappointed after the expiry of at least five financial years. MAFR will be effective for the financial years on or after 1 April 2023.

On Friday, stakeholders in the auditing industry, including two of the “big four” auditing firms, as well as independent auditing bodies and IRBA made submissions to Parliament’s standing committee on finance. 

READ: Naspers objects to new auditing framework

Representatives from Ernst & Young Africa (E&Y) and PricewaterhouseCoopers (PwC) both said they don’t believe MAFR will be feasible in South Africa. On the contrary, it will further constrict an over-regulated market and concentrate the auditing industry even further.

'No audit failures' 

Ajen Sita, CEO of E&Y Africa, said the company is not aware of any audit failure in the past 20 years that can be attributed to a failure of independence. 

In fact, the World Economic Forum (WEF) assessed South Africa’s audit standard and capital markets and rated it as being number one in the world for seven consecutive years, Sita said. 

“I appeal to you to not rush into an experimental solution (such as MAFR) and humbly request that more work be done to understand the impact and consequences of MAFR in South Africa,” Sita said.  

Dion Shango, CEO of PwC, said in his submission that his company has always support measures to improve audit quality and work with all stakeholders in this regard. 

READ: Call for overhaul of auditing in South Africa 

“We at PwC have tried to find research showing audit failures in our country which can be attributed to a lack of independence and we’ve come up with a 2% failure rate,” Shango said. 

He warned that South Africa should be wary of the unintended consequences of MAFR. “In other parts of the world where it was introduced it has actually led to an increase in the market share of listed companies being audited by the ‘big four’ (Deloitte, PwC, E&Y and KPMG).” 

Shango explained that there is an increased business cost associated with audit firm rotation. “Many smaller companies say they don’t have the resources to do proposals for winning audits for large companies. We must be careful that the status quo is not perpetuated.” 

MAFR doesn't lead to auditor independence

Gugu Ncube, president of the Association for the Advancement of Black Accountants of South Africa (ABASA), said in her submission that there is a genuine need to address auditor independence, but that it stems more from “perceived threats” to independence versus “actual threats”. 

She also noted that potential threats in the South African context are the market concentration of firms serving listed companies. 

“Global companies that are large, complex and often specialised are audited primarily by one of the ‘big four’. The potential collapse of one of these firms could therefore possibly disrupt stability in the financial market and damage investor confidence,” she said.  

Ncube cited a number of investigations – one of which showed that MAFR has not proven to improve auditor independence to enhance quality and would therefore not be the ideal vehicle to achieve this objective. 

She continued, saying that a review of 26 reports by regulators or other representative bodies from around the world reveals that 22 conclude MAFR is not beneficial, while four are in favour of it. 

READ: Transformation at the heart of mandatory audit firm rotation

She did however point out that ABASA strongly advocates for the transformation of the auditing profession across the board to better reflect the demographics of South Africa. 

“This includes the introduction of new players in the market, which will allow smaller and medium-sized players to service large clients and transformation of the demographics of the ‘big four’ firms. 

Simon Mantell, a qualified chartered accountant and owner of Mantelli Biscuits, said although there may be an increase in costs involved with the implementation of MAFR and a “loss of institutional memory because of rotation,” the new framework will definitely improve quality and independence. 

“Audit independence is not nearly as good as anyone believes,” Mantell said. “It’s vital that MAFR is implemented.” 

'Where's the evidence?'

Michael Harber, a lecturer at the University of Cape Town’s (UCT) college of accounting, told MPs that IRBA has not provided compelling evidence that audit independence is at risk and neither does academic research support this notion. 

Neil Maree, acting deputy head of banking supervision at the South African Reserve Bank (SARB), said “further detail” is needed before implementing MAFR. “Some countries have adopted it and others retracted from it. The benefits versus costs and the unintended consequences of the framework need to be taken into account,” he said. 

READ: Strong objection to new audit regulation proposals 

Concluding the submissions during Friday’s second round of public hearings, IRBA’s Bernard Agulhas told MPs one of MAFR’s major objectives is to protect the ordinary public from “material adverse events” that could have been avoided. 

He added that the auditing profession has failed in overseeing the categories of leadership responsibilities, ethical requirements, engagement performance and monitoring. 

According to him, the declining quality in auditing standards is evident from the amount of inspections and consent orders (which are basically admissions of guilt) that have emerged lately. 

“Auditors have signed 57 admissions of guilt in 2016,” Agulhas said, maintaining there is enough evidence available to show that independence and quality are declining. “Auditors miss risks and businesses fail, which mainly affect pensioners and the public which invest in them.”