India needs an independent audit regulator

Almost all major economies today have independent audit regulators, with the most prominent ones being set up between 2000 and 2005. The Public Company Accounting Oversight Board (PCAOB) in the US is one of the earliest regulators, set up as a result of the Sarbanes-Oxley Act of 2002. To share knowledge and experiences, the International Forum of Independent Audit Regulators (IFIAR) was set up in 2006. Today, IFIAR has 52 independent audit regulators worldwide.

These facts indicate the significance, need and acceptability of independent audit regulators. Given the overwhelming support that the concept has garnered around the world, it would seem that it is hard to find an argument against setting up such a body. But that has not been the case in India.

Indian scenario

In India, discussions on setting up an independent oversight body had commenced almost a decade ago, however it is only now that it is finally close to being implemented. The arguments against setting up such a body have always primarily centred around the fact that the Institute of Chartered Accountants of India (ICAI) has sufficient safeguards to ensure that the process does not result in self-regulation, particularly with the Quality Review Board coming into existence, and lack of awareness regarding the extent of responsibilities of an auditor among non-auditors.

It is difficult to demonstrate that a mechanism that is designed, managed and includes members of the professional body can ensure effective implementation of independent oversight, which is perhaps the reason why India is not yet a member of IFIAR. The inclusion of an independent audit regulator, National Financial Reporting Authority (NFRA), in the Companies Act, 2013 despite all the opposition, was in itself a significant step at the time. But it has stayed in limbo.

NFRA’s extensive powers in terms of its ability to investigate, impose penalty and banning operations of auditors and audit firms have been the mainstay of most conversations around the topic. However, this is not the only objective of setting up an independent audit regulator. The overarching objective is to enhance audit quality which, in turn, will enhance investor protection and public interest. The Government and those involved in the process of defining the role of NFRA need to provide enough and equal attention to the other objectives, such as setting standards, monitoring compliance and, most importantly, suggesting measures for improvement in quality of audits.

While we have witnessed penalisation of auditors (life time debarring) as well as audit firms (ban from undertaking specific work), we are yet to see any regulator in India prescribing remedial measures. The PCAOB inspections result in not only finding deficiencies but also enforcing remedial measures to help audit firms in addressing quality control issues. Given the ambitious target of setting up large audit firms with global standards, bringing in this approach of positive support from the regulator in addressing deficiencies will be key to the success of NFRA.

Global best practices

As with the rest of the Companies Act, 2013, the rules are critical in understanding the entire impact of the legislation. It is hoped that the draft rules have considered some of the primary principles of setting up an effective independent audit regulator, which are globally accepted, that address not just the procedures relating to the disciplinary mechanism but also the structural and operational mechanisms that ensure that a) the body remains operationally independent; b) its decisions are subject to scrutiny and are transparent; c) members maintain highest level of independence and prohibiting conflicts of interest; and d) clarity in the inter-se relationships with the professional bodies, clear distinction in the respective roles and responsibilities

Operationalisation of NFRA is a step in the right direction and will help in reinstating the confidence of stakeholders and regulators. Most independent audit regulators have been set up on the back of audit failures, inadequate reporting and recognising the inherent weaknesses in self-regulation. What works to our advantage is that there is enough experience and knowledge across countries in setting up such a body. Their best practices can be used by NFRA and that will be instrumental in ensuring a robust, world-class oversight mechanism.

Chandiok is National Managing Partner, Grant Thornton India. Ravi is a chartered accountant

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