Michael Andrew, the chairman of KPMG International, sees a variety of audit risks arising in the global financial markets.

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.

The final proposal he’s looking at is the issue around limiting non-audit services, restricting the amount of services an auditor can do. So I think all we want is a consistent approach by regulators across the world. One set of rules, because for example in the U.S., we’ve lived with the SEC rules for a long period of time and they’ve been very effective. At least you know exactly where the rules are drawn, and you rely very much on your audit committees to administer them. The issue in Europe is that it’s very vague where the boundaries are. The European Union proposal would almost eliminate the service, rather than actually draw the boundaries. I think it’s one of these phases that people go through. It’s populist. But what frustrates us is that the Big Four firms, in fact the Big Six firms, have put up a series of very positive reform measures that really aren’t being debated or discussed by the politicians. The regulators quite like the policy measures we’re introducing, but the politicians aren’t mentioning them. A good example would be: where people feel the systemic risk is, it’s in the financial services sector. There need to be measures to enable auditors and prudential regulators to have a discussion and sharing of information around risks in the financial services sector. This is compulsory in Germany, but nowhere else in the world. Secondly, there is a series of critical investigative information that currently is not subject to any auditing or opinion. I think the real question to ask the capital markets is what is the information that investors need to make sure their investments are secure, safe and relevant? And there’s no work being done in this area.

Third, we are saying that there are a number of measures that need to be strengthened in global corporate governance, especially the role of audit committees and giving them greater authority and greater prominence to be able to actually appoint, dismiss, and review the performance of their auditors. And while there are many countries around the world that have audit committees, there are many countries where it’s just a process rather than real substance. Finally, I think we need to say more about what we do and be prepared to make many more comments on forward-looking information, make comments about the business operating model at companies, talk about emerging risks, talk about the scope of work we’ve done, what have the auditors looked at, what have they reviewed, rather than just saying the accounts are true and fair. You know, actually tell the market that we’ve specifically examined certain issues. So this is where the debate should be headed, but unfortunately it’s not where the debate is going at the moment.

I saw your presentation on sustainability at KPMG’s conference in New York, and I was wondering if you could tell me how accounting firms like yours are advising their clients on sustainability? Is this an expanding niche for firms like yours?

Very much, because the trend that’s happening is that major global companies are now reporting on their sustainability performance to independent stakeholders, particularly not-for-profit organizations, to governments, and even some companies who require their suppliers and customers to conform in these areas, so they want independent assurance. They want advice about how to set up systems and how to basically make sure their internal controls have proper auditing standards to make sure the information in the marketplace is accurate. This is a very significant piece of work for us, to operate with companies, to advise them how to set in place systems, to put up sustainability programs, and then to make sure there is proper relevant reporting, which again is audited. So we’re now auditing some of the major global companies in the world for carbon reduction practices, their safety measures, their sustainability performance, and helping them put together their reports so the market can fully understand the progress they are making in these important areas.

How about litigation risks? Does KPMG need to be especially careful now to avoid litigation over audits, with things like shareholder lawsuits or overtime lawsuits becoming so prevalent now?

First of all, I think the greatest risk we face in the world at the moment is regulatory risk. It’s not losing your license in a particular jurisdiction because you offend the regulators. It’s not just civil litigation. In fact, our experience is that the civil litigation environment has improved in recent times. We’re not seeing the same level of claims or incidents reported through to us. The thing that is interesting is that more of these claims tend to be coming from the emerging countries, so we are seeing more claims, for example, in countries like Africa and Brazil, where foreign investors are becoming more involved in countries where the corporate governance is less robust. As a Big Four auditor, we really have to be very careful with the clients we get involved with and to really strengthen our risk management procedures in some of these countries. For example, we rely very much on bank confirmations. Well, the way of doing a bank confirmation as an audit technique in an emerging country is very different from doing a bank confirmation technique in New York or London. You really have to make sure that you’re dealing with the right person and the information you’re getting is accurate and reliable. It’s almost a given in the major markets around the world, but when you come to these countries, you have to do it in a particular way just to give you a level of confidence that the person you’re talking to has sufficient authority and knowledge to independently verify those assets.

Are you seeing any trend toward other types of lawsuits, like overtime and wage and hour lawsuits in the U.S.?

I think there are probably more claims of that type, but they’re relatively minor compared to the overall kinds of things. We’re competing for talent, so we tend to pay pretty well by global standards. Whether it’s overtime, or whether it’s promotion allowance, or mobility costs, we generally rank pretty well on those issues, so frankly it’s not really a significant issue for us across the world. We generally are regarded pretty much, I think we were voted the world’s number 2 favorite employer. Because of the effort we put into training, technology, career development and university programs, it’s very unusual to see any significant claims from employees. It’s just not our cultural environment.

Has the competition for talent gotten easier or harder?

It’s probably not harder at the moment, because I think the global financial crisis has put a lot of pressure on a lot of our traditional recruiting or talent competitors, particularly investment banks, stockbrokers and financial institutions. They tend to be downsizing their workforce, and equally because we’re a global organization it’s much easier for us to relocate people from Western Europe into the fast-growing markets we have in Asia, in South America, in Africa. We actually tend to find that while we still have a need for talent, we find the market is quite favorable at the moment.

How about technology? Is that a challenge to keep up with technologies such as mobility while also protecting security?

It is, but it also tends to be our core business, so the very fact that the rapid pace of change in technology is occurring means that organizations tend to be coming to us to help them with a strategy on digitalization, help with a strategy on social media, to look at installing large new ERP systems across the world, and be the sort of independent advisor on those matters. We are ourselves investing hugely in technology centers in India and in the U.S. Really we are probably at the leading edge of the thinking here. In a sense, it’s more a business opportunity for us than it is a problem or an issue. The issue for us is more communication, where employees through social media are able to share information on a 24/7 basis. I’m often asked by reporters such as yourself on issues which I really don’t know about, but which have come onto the global radar screen through the use of social media.

What trends do you see in the auditing profession in the next year?

I think we will be very influenced by the outcome of the regulatory discussion. This could be very, very significant reform if governments appear to adopt some of the more radical principles that have been suggested, so that’s the first issue. Secondly, I think the huge changes that are taking place in the emerging markets and the need to understand accounting standards and how they’re applied in China, India and Africa. I think the increasing compliance responsibilities from bribery and corruption legislation, from tax legislation. The other is there is a huge amount of work for us in the banking and insurance sector to comply with the new capitalization requirements, and the Dodd-Frank Act. There is significant regulatory imposition on that sector, which means there will be a lot of work for the Big Four accounting firms in helping the financial services sector transform into these areas.

How does the economic environment appear to you?

We all understand that the economic environment is going to be very challenging in the next [12] months. There are a lot of uncertainties out there at the moment, so it is a critical time for audit quality. We’re dealing with issues about how to deal with the sovereign debt crisis in the Eurozone and we’re facing issues about investments into new and emerging markets and economies, and we’re looking increasingly at technology risk around the world. The challenge is to make sure that our auditing and advisory capability is up to those [challenges]. It requires some very substantial investment from us at the moment. There is no shortage of things to invest in, but some of the returns in some of these markets are very challenging.

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