State of play: An MAFR update

STATE OF PLAY: MAFR

UPDATE

With less than two years to go until mandatory audit firm rotation comes into effect in South Africa, audit firms, IRBA and CFOs share their insights into the process so far. By Tamara Oberholster

In 2017, the Independent Regulatory Board for Auditors (IRBA) issued the rule that public interest businesses must change audit companies every 10 years, thus introducing mandatory audit firm rotation (MAFR). The regulation comes into full effect in April 2023. Ahead of this, many organisations have already adopted the practice – 43 percent of JSE-listed companies, according to Imre Nagy, acting CEO of IRBA. Several of these rotations have happened during the Covid-19 lockdown. This posed new challenges, with audits needing to happen largely virtually. "Not only did we have to cope with an audit and reporting season during lockdown, but we also had a change of auditors, compounding the challenge as they don’t know your environment, and both the teams didn’t really know each other,” says Dorette Neethling, CFO at Adcock Ingram. “Our planning also had to include reporting to our controlling shareholder for 11 months of the year, adding another dimension to the workload. I am very proud of my team as they fairly easily adapted to all these changes and challenges.” Hardy Maritz, acting executive director of finance at UCT, explains that the university's entire council changes every four years per its statute, which fell at the end of June 2020. “Given it is our equivalent of a corporate board, we had no option but to make sure we met our original deadlines,” he says. “Given council appoints our audit committee, we also ran the risk of an entirely new audit committee coming into a very complex business. We had this situation four years ago, with no continuity at all from our previous audit committee, and were left with new members wondering what may have caused this. What helped with the audit was that our entire finance team, as well as senior members of our external audit team from EY, were already used to working remotely and online due to us learning to work away from the office during #FeesMustFall.”

How painful is the process?

Sean Capazorio is CFO at Aspen Pharmacare. The multinational pharmaceutical group has been using a joint audit model for seven years, with the audit in each

region split between a Big Four firm (selected globally) and an emerging firm (selected locally). The group has recently rotated firms through a tender process. “It is obviously a very disruptive process because you do get a strong working relationship with the existing audit firms,” he says. “You have to invest a lot of time in educating the new audit team and it probably takes two or three years to really get up to speed.” Sean adds that the process was also stressful because people in other regions, who aren’t subject to the same regulatory requirements (such as those in Aspen’s South American operations), don’t necessarily understand why rotation is required. However, he says there have been benefits, such as thinking about better ways of working, re-evaluating costs, and getting a fresh perspective. It’s been stressful for the audit firms too, Dion Shango, CEO of PwC Africa, admits. “What we’ve seen is that our people are quite set in their ways – in being specialists in delivering a service to a client, and when you take somebody out of their comfort zone, and ask them to start competing against their peers in the market, that’s a daunting and challenging experience,” he says. “But the transformation has been positive, to our culture as an organisation. It's certainly added to the repertoire of skills and capabilities that we have. Everybody has learnt and everybody has developed.” PwC made its objections to MAFR known during the initial consultation process. “We found ourselves not being 100 percent in agreement with the reasons that were being put forward,” Dion says. PwC believed that rotation would be costly – both for audit firms and for clients – and that it would not necessarily result in a reduction of market concentration – a secondary aim of MAFR.

The cost concerns have proven valid. Dion says PwC underestimated the investment in terms of both time and resources that MAFR would present. This has meant the firm has had to be more intentional in deciding which opportunities it will invest in pursuing to avoid overextension.

Dion Shango Sean Capazorio

And market concentration has proven tricky too. “We as a firm are always in support of any and all measures that promote audit quality in its entirety on the market concentration issue. What we have seen thus far is that whilst MAFR has indeed allowed other firms, particularly mid-tier sized firms, to gain entry into the market or listed entities in particular, there has also been a significant shuffling of the deck chairs as it were, with some of these audits changing between the large firms. That's an interesting trend to observe. And it will be interesting to see how long it continues.”

Is MAFR achieving its aim?

Imre explains that the role of IRBA is to protect the financial interests of the public by ensuring that only suitable qualified individuals are admitted to the auditing profession, but more importantly to ensure that registered auditors deliver services of the highest quality and adhere to the highest ethical standards. “The primary role of MAFR is to help to ensure independence, which IRBA regards as the bedrock of the auditing profession. There is a real need for auditor ethics to be strengthened,” he says. He cites several instances over the last few years where a change in auditors has resulted in material restatements of financial reports. These often result in an investigation of the previous auditor, as the question becomes why they missed the issues at hand. “This in itself shows that there are benefits to having a fresh pair of eyes,” says Imre – when a firm has audited a company uninterrupted for decades, it’s hard not to maintain complete independence, free from bias. Imre says that IRBA is seeing an improvement in audit quality, although not yet directly attributable to MAFR. However, as more rotations take place, he says more data will become available, which will hopefully further substantiate the value of the rule.

Aside from protecting auditor independence, a secondary aim of MAFR was to open up the market to non Big Four firms. Victor Sekese, CEO at SNG Grant Thornton, says that to date, it has helped to ensure second-tier firms are invited to the table, but that it has not yet translated into lessening the Big Four’s market dominance. “However, when you look at net movement, second-tier firms have gained about 12 percent of new appointments,” he says. “It's still early days. My expectation is that in the second round of rotations, we're expecting to see the net gain increasing more, especially as the second-tier firms gain more reputation and more experience.”

Victor Sekese Dorette Neethling

Additional reform measures required

Victor believes additional instruments are necessary to augment MAFR’s role in addressing market concentration. Having recently completed his dissertation on audit regulation, Victor has some recommendations to offer on this front. The first is that key executives in public interest organisations need to be subject to a set of professional requirements. “They should be members of a well-recognised professional body, but over and above that, we need to provide those professional bodies with the power to be able to sanction their members,” he says. “Secondly, we should look into professionalising directors. Theoretically, there's no requirement for one to be a director of a corporate entity.” Insisting on minimum requirements for directors of public interest entities would help to ensure sufficient management controls are in place, long before auditors come into the process. Victor also believes that there is value in the joint audit model, where emerging firms are partnered with established firms to ensure capacity building takes place. This, he says, is what the UK regulators are implementing, and South Africa should take heed. Victor says this model was successfully proven in South Africa in the public sector in the 1990s, and that if we are serious about addressing market concentration, we should consider a return to it.

Imre says that IRBA agrees that MAFR is no silver bullet and needs to be viewed in the context of the wider financial reporting and governance ecosystem. “There are a lot of gaps in the system and even in the profession itself,” he says. “From a regulatory perspective, we've adopted a refocused strategy focusing on three areas.” These are: sustainability and relevance; audit quality; and comprehensive stakeholder engagement. Imre homes in on broadening the stakeholder focus to the wider financial reporting and governance ecosystem, pointing out that auditors are only able to perform their function with the information they are supplied, and gaps may creep in before their involvement. “I think the entire line of defence needs to be improved,” Imre says. IRBA is working with stakeholders to find common ground and find a platform to develop solutions together to improve the system in its entirety. “There's a lot of work to do and we as a regulator can't do it alone. We need all the role players to come together and we need to look in the same direction, to find solutions for the profession. There are a lot of solutions in the public domain. We need to sit and look at all of them.” l