Michael Andrew, the chairman of KPMG International, sees a variety of audit risks arising in the global financial markets.
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Part of the firm’s job is to fend off those risks and help clients deal with them. He has been expanding the firm’s presence in emerging markets like Asia, and has set up his offices in Hong Kong, a first for the chairman of a Big Four accounting firm network. Australian-born Andrew was elected last May to take over the chairmanship from Timothy Flynn and became chairman in October. Andrew talked with Accounting Today last week from Asia by phone about the challenges the firm is seeing in areas like sustainability, auditing, tax, accounting standards and the changing regulatory environment.
Could you tell me about how KPMG deals with managing the firm internationally and coping with changing international accounting standards and regulations?
On my executive team I have a head of risk management and quality. Within that there are several work streams that look at global accounting standards and make sure that we’re up to date with every market development that happens around the world. We share that with our professionals through him. Equally, from an audit quality perspective, they monitor changes in regulation, policy and accounting standards, and promulgate that around the world. What we actually do is we break this down into about 12 regions in the world, and we pick a very senior professional practice or audit partner who really oversees the audit quality and independent risk issues in each of those markets and handles reporting to a head of quality and risk in New York. So if there’s a new India corporations bill coming in, they would be working with the senior partner who looks after the subcontinent and making sure that around the world we’re conscious of what the new regulations will be saying. He’s also responsible for really supervising conformance with our quality and technical standards around the world, so we have a quality review program. The guy who heads up this section, Larry Leva, is also on the International Forum of Independent Audit Regulators committee. He’s meeting regularly with regulators to swap and exchange issues of concern, which we then disseminate among the network. He meets regularly with them to exchange views, explain our position, and equally understand their position, and be able to inform their practices.
How do you feel about IFRS and the move toward a global set of accounting standards, and where the U.S. stands with that right now? There’s a lot of uncertainty about what the SEC is going to do. They’ve been giving mixed signals about that.
Haven’t they? I think it is essential in the medium to long term that the world move to one consistent set of global accounting standards. I think the global financial crisis has really highlighted the need for complete transparency across global markets to give confidence to investors. The question you have to ask yourself is why hasn’t this occurred? It’s fair to say, historically, while national accounting standards have been a significant advancement, they have at times been a little academic and a little subject to political interference, say, in Europe. I think those days are well past now and the concerns that the U.S. initially had quite rightly are now disappearing. There is much more of a business focus and much more of an investor focus in the formulation of accounting standards now. It is in my view inevitable that the U.S. participate and contribute toward the development of these standards and start to converge U.S. GAAP. Otherwise it’s going to find that the whole world will have changed except the U.S. These days, when capital is mobile and looking for different stock markets, it’s incredibly important to the U.S. capital markets that international investors are able to look at and compare alternative companies operating in the same sector.
What about international taxation? It seems like in the U.S. and other countries, there is increasing pressure to reform the corporate tax system and ensure tax compliance for both individuals and businesses with foreign profits and holdings. How does KPMG deal with things like transfer pricing without running afoul of tax authorities while also helping clients with tax compliance?
Basically, with transfer pricing you are applying standards that are set by the OECD, which really is a global standard as to how you allocate profits in different sectors across the world. What you’re really doing is you’re applying a set of economic principles to what is the real return on investments, how you attribute the global company’s profit to the intellectual property, to the services that it performs, and you benchmark those, to comparable organizations. It’s fair to say historically the U.S., the IRS, has been almost a thought leader and a stimulator to a lot of the OECD’s work, but I think over the past 10 years there’s been much more activity from all of the OECD countries to try to get a common standard in this area. While gaps remain, it’s relatively consistent now across the world, at least in the major countries, on what are the appropriate principles that you apply to international profit allocation. Then the second question is how you actually tax those profits, and that’s where you see a bit of tax competition, some of which is fair and some of which is unfair. You are now seeing this backlash in the United States and in Europe regarding the use of tax havens and tax incentives and concessions by some countries as really being an unfair trade or foreign investment activity and you’re seeing significant pushback. Some of the pressure that the U.S. is bringing to bear on a number of the old Swiss banks about secrecy and confidentiality is really starting to up the pressure on those countries who don’t conform with international tax principles.
Changes in the auditing profession have also become important with the proposals in Europe for splitting up the Big Four auditing firms so that there’s a separation between the audit and advisory functions, and other proposals for doing joint audits between different firms. And in both Europe and the U.S. there have been proposals for mandatory rotation of auditing firms. What do you think of those types of proposals?
This is probably my largest concern: that we’re seeing some very superficial political solutions imposed upon our profession, which don’t fully understand the nature of the issue. As you point out, the green paper released in Europe really is in two parts. First of all, there are a number of things in the green paper we support around European mobility of the audit profession and removing some of the competitive barriers that would prevent second- or third-tier firms from competing. All of those are good measures.
The issues that we take issue with are basically three. What he [Michel Barnier] is really trying to do—what he sees is market concentration. He’s saying that the Big Four firms dominate the European audit markets. Interestingly, the European Competition Commissioner came out yesterday and said there is no evidence—in fact, the evidence is quite to the contrary—that is the case. Mr. Barnier, who is doing this, is actually the banking regulator. He’s not the competition regulator. Therefore, he’s trying to, I suppose, address these as addressing audit quality. But the fact is none of these measures are addressing audit quality. They actually reduce audit quality. He’s really missed an opportunity to make some real reforms in this area. He is proposing audit rotation, which we have also seen proposed by the PCAOB in the U.S, but there is a huge resistance to this in the business community because they realize this is unnecessary, it’s expensive and it actually significantly increases the risk of audit failure. He’s proposing to make audit-only firms if your market share is more than 40 percent in the European market. What he’s really targeting isn’t audit quality; he’s targeting market concentration. But in doing so, he’s actually affecting and undermining audit quality. Because a firm like us won’t be able to hire or recruit actuarial specialists, treasury specialists, evaluation experts, tax experts, all the things that are pretty critical if you’re actually auditing a major global multinational company. So the proposal hasn’t of course been approved.