Mandatory Audit Firm Rotation is a good thing, says Nkonki's Mitesh Patel

“It is simply staggering that of the 353 audit partners who sign off on the financial statements of all JSE-listed companies, only nine are Black African – that’s just 2.5%,” says Mitesh Patel, Managing Director of Nkonki, a 100% black-owned audit and advisory firm. “Given the transformation imperative within the broader South African corporate context and our profession as a whole, there can be no doubt that Mandatory Audit Firm Rotation (MAFR) will assist in driving the transformation agenda.”

Patel is talking to the recent announcement by the Independent Regulatory Board for Auditors (IRBA) that it will begin a process to implement MAFR in South Africa in an effort to strengthen auditor independence - an announcement which was met with much resistance from various stakeholders, including auditing firms.

Whereas uncertainty remains about the exact tenure to be imposed on audit firms locally, Nkonki is of the view that MAFR in South Africa will bring tangible benefits for most parties involved. More importantly, it will improve transformation within the auditing profession.

"While MAFR is non-existent within the listed sector, it is indirectly implemented, in some respects, within the public sector as most large State Owned Entities go out on tender every five years, with a standard clause that the auditor's appointment is subject to the annual approval of shareholders."

For context, South Africa is not the only country to be faced with MAFR - over 30 countries worldwide have some form of MAFR in place already. Moreover, in 2014, the European Parliament approved the new EU Audit Regulation and Directive, which will require European-listed companies, banks and financial institutions to appoint a new auditor every ten years. Steps have also been taken in the UK, as well as in some of the BRICS countries, to focus on the independence of auditors. Meanwhile, in the US, the Public Company Accountancy Oversight Board (PCAOB) is taking a lead on the issue.

Patel adds that there is also the matter of the dominance of the JSE by a handful of audit firms in the country to consider, with over 90% of JSE-listed companies audited by a few firms, most notably the so-called "Big Four". "MAFR will help to level the playing field, allowing other audit firms access to listed entities, which will in turn drive skills transfer in the profession and bring about true, broader-based empowerment."

Nkonki believes that the arguments against the introduction of MAFR - namely the loss to a company of industry and knowledge of the business built up by a long-term auditor, and that taking on new auditors requires huge input by the company's management and thus holds a hidden cost for shareholders - are invalid. "The reason for this is that, in general, firms take on an investment cost when they take over an audit. A recent case is Sasol Limited, which changed its auditors from KMPG to PwC. The audit fee as per the 2013 Annual Financial Statements, the last year of audit for KPMG, was R84 million. In 2014, when PwC took over, the audit fee went up marginally to R86 million, an increase of just 2%, which could be attributed to inflation. In 2015 the fee remained unchanged at R86 million. It is clear that in this case, the company didn't pay a premium as a result of changing auditors," Patel explains.

As a proponent of MAFR, Nkonki opines that because of long-standing relationships with their clients, auditors may become overly familiar with the company's management and risk, losing the professional scepticism needed to remain objective.

"In some cases cited by Bernard Agulhas, the CEO of the IRBA, during his recent announcement at our sixth Annual Audit Committee Conference for Listed Companies, South African companies have had the same audit firm in place for over 40 years. In one extreme, the relationship had endured for over 90 years."

Nkonki also supports the argument that commercial pressure to maintain a long-term economic relationship with a particular company may undermine an audit firm's commitment to the rigour and independence of the audit process. "There is no doubt that a new audit firm will bring fresh eyes to the audit process and is hence more likely to bring a fresh approach," says Patel.

As for the argument that transitioning firms can be a risky process, Patel concludes that this is simply not the case, as has been demonstrated by Vodacom Limited, Bidvest Limited, Famous Brands Limited, Sasol Limited and ABSA Limited, all of which recently changed audit firms.