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The Economic Times |
Milind Kothari, Managing Partner |

03 May 2016

But these numbers face a formidable challenge in the form of a set of regulations that will radically change the manner in which audit companies function in India. According to the Companies Act 2013, businesses will have to change their auditors after two terms of five years each from April 1, 2017 (see What The Act Says). The government believes the move will enhance audit independence and audit quality that will further lead to more transparency and increased investor confidence.

Given that businesses rarely change their auditors — some of the relationships go back to decades — the new rules mean audit companies stand to lose several high-profile clients. In Deloitte's case, the firm will lose a big chunk of clients, including crown jewels such as TCS, Mahindra & Mahindra, Tata Motors, HDFC, and Tata Steel.

For Deloitte, preparing for the upcoming audit rotation has been an all-consuming affair for nearly two years. Venkatram though is confident of meeting the challenge. "We have lived and breathed auditor rotation over the past few years. We believe that we are well positioned to win our fair share when the mandated change happens," he says.

A few ki lometres away f rom Venkatram's office, sitting in a conference room on the 14th floor in Ruby Mills, Dadar is the boss of one of Deloitte's principal competitors — Rajiv Memani of Ernst & Young. EY is the biggest of the Big Four audit firms — PwC and KPMG are the other two — but it ranks second in the audit business. EY believes there is no better time than when the audit rotation kicks in to launch a bid for the top position in the audit business. Under Memani's watch, the audit practice in EY network has grown at the fastest clip in the firm's history,"The Indian member firm of EY Global which provides audit services has seen considerably strong growth over the last few years and hopes to further strengthen itself on all aspects," says Memani, who is chairman - EY India Region and a member of EY's global board.

A little further, seven kilometres south, Deepak Kapoor, Chairman of PwC India network, calmly sips tea in the swank PwC office in Bandra, cracking his trademark one-liners. The man who steered PwC back to health after the Satyam fiasco says his firm has treaded cautiously during the last few years but is now ready to rumble.

"We were preparing our network firms even before the Act was announced. We will make the most of the opportunity," says Kapoor. Evidently, the mandated audit rotation is on top of the mind for the bosses of the Big Four audit firms.

Preparing for a distinctly new system doesn't mean simply revamping the organisation. It also means auditors will have to brace for a spirited battle with competitors for thousands of statutory audit clients.

The audit rotation exercise in India is billed as the biggest of its kind in the world that will ultimately impact thousands of companies, including some of India's blue-chip companies. The Big Four would not scramble after every one of these businesses — they are simply interested in the accounts of the Who's Who of India Inc.

Each of the Big Four operates through a web of affiliate audit firms (see Ranking by No. of Audits...) and have leveraged their scale and expertise to corner the most lucrative end of the audit market comprising large conglomerates, blue-chip Indian companies and A-list MNCs, billing up to Rs 2,200 crore a year in auditing fees between them.

There's more at stake than just money. In the professional services world, the new era of auditing will be a test of market leader Deloitte's resilience, challenger EY's market might, old warhorse PwC's brand strength, and youngest player KPMG's aggressiveness.

The churn of clients seeking audits will be unprecedented. In the very first year, an estimated 750-800 company audits will rotate between the four firms and by 2020, the number will spike up to 2,500, according to experts.

The Face-off For the Big Four firms, the fight will open up on two fronts. One, they will have to face off between themselves and two, also slug it out with a pack of smaller Indian firms. These small firms are no slouches in terms of competition; they command a significant share of the audit market.

In the BSE 500, 62% of companies are still audited by non-Big Four firms and that includes some of India Inc's biggest companies. For example, Chaturvedi and Shah have been auditors of Reliance Industries, India's biggest private enterprise, for nearly four decades, Sharp and Tannan have audited Larsen & Toubro for over three decades, and Singhi & Co has reviewed Hindalco's books for over five decades.



Of course, the bright side for the Big Four owing to the new rules is that scores of companies are up for grabs.

So how will the battle pan out? The consensus among the larger firms is that the Indian market will follow the developed markets behaviour. Globally, the Big Four dominate the audit business — 99% of companies in FTSE are audited by the four big firms as are 86% of companies listed in New York Exchange (NYSE). "If you look at the experiences in Europe, the larger companies have mainly rotated among the Big Four. In India, given the increasing complex regulatory environment and deepening capital markets, we can expect a similar movement," says Russell Parera, Partner and Assurance Leader, Price Waterhouse Chartered Accountants LLP.

Leaders of mid-sized and smaller firms disagree. Vishesh Chandiok, the National Managing Partner of Grant Thornton India LLP (GT), the closest competitor to Big Four firms, says it's an open fight. "There are a lot of companies who want a service focussed proposition over a size focussed one." Milind Kothari, Managing Partner, BDO, says there is a big opportunity in the mid-market for alternative firms.

Already, signs of consolidation in the smaller Indian firms are beginning to emerge. Baker Tilly DHC, the Indian affiliate of the Baker Tilly network, has merged five smaller firms across India to match the Big Four's coverage. "There isn't an iota of fear of losing clients to the larger firms," says Dilip Desai, Chairman, Baker Tilly DHC.

But if global trends are anything to go by, the big firms may have an edge. In the Netherlands, the first European Union country to pass a bill requiring mandatory rotation of auditors, the larger companies rotated amongst the Big Four, the mid-sized companies upgraded and smaller companies went to smaller firms. But the fact also remains that in a supply constrained market like audit, they can't win all.

Solving the Jigsaw Given that there are so many businesses seeking a new auditor, one could see the competition as a scramble for market share. But it is not as simple as that. While robust demand for quality services would compensate for lost clients, the firms will have to work on two tracks simultaneously to balance their service portfolios. Expect to see relationships with old audit clients to get milked — to obtain non-audit work such as consulting, valuations and accounting services. This kind of work was previously taboo to auditors. Not anymore.

"We may be losing an audit, but not a client," says Venkatram. "Audit rotation is not just about changing auditors. For clients, it is equally about changing their advisors." Deloitte, which has traditionally been focused on audit, has hired more than 700 people in non-audit services. Today, the firm's non-audit staff outnumber audit professionals.

Firms in which non-audit services dominate face a different kind of problem — recalibrating their portfolio. A large number of clients buy advisory, tax, transaction related services from them and taking on audit work from such clients would mean dropping higher billing services due to emanating compliance conditions. "It's imperative for the firms to ensure that audit separation is done in a congenial way," says Sanjeev Krishan, Deals Advisory Partner at PwC.

As it happens, preparing for epochal change is not easy. Leaders of the Big Four have held countless meetings to understand and prepare for the impact of audit rotation on the overall business, personnel and profitability. Senior partners are in constant talks with influential audit committee members and their promoter networks. Influential alumni groups have been activated and partners from other service lines embedded in most large companies are pulling their weights behind their audit brethren.

Things have gotten dirty in some cases. When a firm's client review sheet found its way on a social media site, some competitors went to town telling companies how low they were in the rival's priorities. Now murmurs abound about a firm being involved in another Satyam-like situation. Calls are already being made to teams of large accounts to shift over once the client shifts.

As the D-Day approaches, things are hotting up. "Some companies are saying if audit partners are rotating out in 2016-17, why not change the firm too. Other companies are changing internal auditors as per their policies, so they are thinking change both external and internal auditor now," says Jamil Khatri, partner, KPMG.

When the Ball Rolls Then there is the matter of getting the house in order. In the world of professional services firms, auditing is considered a stable annuity business with minimal changes. The new rule will mark nothing short of a disruption in a quaint world.

How will the firms handle that kind of transition? "It is a challenge when a large number of clients move out and another set of new clients come in. Such a large scale transition involves extensive planning by the firm," says Sudhir Soni, National Leader of SR Batliboi, the Indian member firm of EY Global. Deloitte even had an active change management program running with focus on strategic selling, talent retention and leadership development. PwC ran a transformation program covering people, processes and technology for the last 24 months in preparation for rotation.

Despite competition heating up, a price war hasn't started yet. "Though price is important, this is not the primary criteria in selecting an audit firm," says Soni of SR Batliboi.

The audit rotation will also test the financial strength of the firms. Firms lose money for the first 2-3 years of a new audit. Bigger the audit, bigger the loss. The audit fees in India are amongst the lowest in the world —statutory audit fee for a global company like Infosys is mere Rs 2 crore. But auditors are not paid the lowest in the world. Far from it. So the audit rotation has the potential to erode or even wipe out all the profits of the audit practice in the Big Four firms for the next 2-3 years, according to experts.