Jeremy Newman’s CEO Insights

The last posting

Jeremy Newman — Thu, 15 Sep 2011 07:30:00 +0100

Well this is it – my last blog posting as CEO of BDO International Limited. Although I don’t actually stand down from this role until the end of the month I am now (just about) ‘winding down’ and have agreed that my successor should take over the CEO blog next week. I am particularly pleased that Martin van Roekel has decided to continue to have a CEO blog and look forward, along with many others, to reading his thoughts over the next few years.

It is fitting that I am typing this posting in China – on my last major business trip (albeit I am going to BDO Canada’s AGM next week and to a meeting with IFIAR in Bangkok the following week – did I say I was ‘winding down’?!). I have in fact spent time this week in China and Japan - both of which countries have seen significant growth for BDO and each of which demonstrates the significant development in BDO over the past several years.

China is clearly an emerging and growing economy with a fast growing professional services sector and where BDO has demonstrated a preparedness to invest and an ability to grow a significant business that can match (or beat) any of our competitors. I believe that BDO’s growth in China over the past few years is easily the fastest of all the major accounting firms and has been achieved without compromising our commitment to quality in every aspect of our business. Indeed, I am confident that our business in China today has higher quality standards as well as much greater resources and capability than ever before.

Japan is of course a mature economy and one that has faced significant challenges in recent years – and particularly this year following the earthquake, tsunami and damage to some of its nuclear power plants. Growing our business in mature economies is more challenging, particularly those that are dominated by the four largest firms – and their dominance in Japan is extreme. However, the growing attractiveness of the BDO brand has enabled us to substantially increase our audit business and I am confident that my successor will soon announce a substantial increase in our tax business in Japan.

Asia Pacific has been BDO’s fastest growing region in each of the past several years and I am confident this will continue to be the case although we are also enjoying significant growth in Africa and elsewhere.

In addition to the significant amount of time I have spent in China and elsewhere helping develop and grow the BDO network, the other matter I have spent much time on has been in the area of competition or choice – or more accurately the lack of competition and choice in certain parts of the audit market. I am increasingly optimistic that legislators and regulators will now address this issue and look forward to developments later this year in the EU as well as in the UK and possibly also the USA. I continue to regard it as disappointing that we need regulatory and/or legislative intervention to address this long standing concern and that the profession has been not been able to find a ‘voluntary solution’ to the challenge; indeed it is even more disappointing that many in the audit profession still seem to think there is no issue and have failed to properly engage with this debate and perhaps worse that some deny the prevailing facts about the dominant position of the largest firms and the distorting effect this has on the market. BDO’s success in both China and Japan has demonstrated that the market place on both emerging and mature countries wants more choice and we are fortunate that the circumstances have enabled us to provide it in these markets. I hope that the circumstances will change in other countries to enable to do likewise. BDO (and I am sure others as well) knows it will need to make further investments but is ready and willing to do so if there is a suitable opportunity.

It has been a privilege to lead BDO for the past three years and I wish every success to all my colleagues and to my successor, Martin van Roekel.

Finally, my thanks to those of you who have read and responded to my blog – including via email and in person; please continue to do so with Martin. BDO, and the profession, benefit from your engagement.

Cross border expansion - a perspective on China

Jeremy Newman — Fri, 22 Jul 2011 12:45:00 +0100

The Economist, a leading weekly magazine, recently published an analysis of Chinese consumer habits, focussing on market growth and the emerging middle class in China, noting ‘small wonder that Western firms are piling in.’ The article entitled ‘The mystery of the Chinese consumer’ focused initially on demand for consumer goods, before concluding with insights on expansion into China.

The article notes several factors that are essential for cross border growth into China, many of which support findings from the BDO Ambition Survey: Global Ambition. The author, correctly in my view, highlighted the importance of establishing an ‘efficient distribution network early on’. This reflects a key discovery from the BDO Ambition Survey that finding trustworthy local partners and suppliers is vital to expansion.

The significance of understanding the local market was also raised. The author drew upon the experiences of a US DIY chain that is downsizing its Chinese operation, as few people undertake home renovations. This is a lesson that is applicable across all industries and our survey too noted that researching and understanding the Chinese market is crucial for cross border growth.

Thirdly, the feature noted challenges associated with the recruitment and retention of talented staff. This again, mirrors our global survey with identifying the right people on the ground recognised as the single biggest challenge for successful international expansion.

Due to China’s vast economic growth, many organisations are rightly thinking about expanding into this market. Whilst, expansion provides its own unique challenges across myriad business functions, none should be considered insurmountable. Indeed, from our own experience and drawing upon insights from the BDO Ambition Survey: Global Ambition, it is clear that thorough research, cultural understanding of China, trusted local networks and identifying the right people is the key to expanding successfully into China. I have been pleased to see an increasing number of BDO’s clients seeking to take advantage of the opportunities presented by China but rightly ensuring that they follow this advice.

I look forward to this year’s survey with interest.

Moving on

Jeremy Newman — Fri, 8 Jul 2011 14:00:00 +0200

BDO has today issued a Press Release confirming that after three years in my role as CEO of BDO International, and over 33 years in total with BDO UK and BDO International, I will be stepping down on 30 September 2011.

I have had a fantastic career and have been privileged to lead BDO UK for 7 years and BDO International for the last 3 years. I have had some great colleagues, worked with some brilliant people and, in my earlier career, been involved with some terrific clients. There have been many highlights during the last 3 years when I served as CEO of our international network. We can all feel proud of the growth and development of the network, particularly in China and the emerging markets, enabling BDO to be an increasingly important global accounting network. This is a reflection of the commitment and efforts of my many colleagues from across the globe who work so tirelessly and expertly every day to deliver for our clients and our people. I also take great satisfaction from the important contribution BDO has made to the ongoing debate about the future of the audit profession, in particular in discussions prompted by the European Commission’s Green Paper. I do believe that after many years of talking we are actually going to see some action.

I am grateful to all our BDO Member Firms, and specifically all their partners and staff, for giving me the opportunity to lead our network and to give BDO stronger central leadership and a more coordinated approach to the development of its business, whilst retaining our heritage and our respect for national culture.

I wish my successor, Martin van Roekel, formerly Managing Partner of BDO in the Netherlands and currently a member of my Global Leadership Team, every success. He has been closely involved in all the significant changes in BDO over recent years and is well placed to continue to lead the network’s growth and development when he becomes CEO on 1 October 2011.

As for me, it is time for a change. I don’t know what I will do but after 33 years in this business, I am looking forward to seeking new opportunities outside the accounting profession.

Of course, I will be here until the end of September – and will continue blogging until then!

China and Big 4 only clauses

Jeremy Newman — Mon, 4 Jul 2011 15:00:00 +0100

I have recently had an email exchange with Paul Gillis, Visiting Professor of Accounting at Guanghua School of Management, part of Beijing University about a thesis he is writing about the Big Four in China. Professor Gillis is a former Big Four partner and, unsurprisingly, he has a very positive view on the role of the Big Four.

I am therefore very grateful to Professor Gillis for a recent posting on his blog http://www.chinaaccountingblog.com/weblog/big-four-clauses.html which draws attention to the use of Big Four only clauses in China, something that surely the Chinese Ministry of Finance will not approve.

As Professor Gillis states in his blog:

“I have been reviewing the SEC filings for Harbin Electric’s (NASDAQ: HRBN) going private proposal... HRBN’s CEO has proposed to take the company private with $400 million of funding provided by China Development Bank (CDB). CDB is a state owned bank directly under the supervision of the State Council. It has been described as the engine that powers the national government’s economic policies. Certainly CDB would follow State Council policies for the accounting profession and not use Big Four clauses?

Think again. In CDB's loan commitment to HRBN this general undertaking is required:

No Group Member may replace the Auditors, unless the new auditor to be appointed is any of Deloitte & Touche, PricewaterhouseCoopers, Ernst & Young and KPMG.

So, CDB is precluding HRBN from hiring any of China’s top local accounting firms, including the affiliates of BDO, RSM and Crowe Horwath who rank in the top 10 in China and globally. But HRBN can keep its existing auditor – California based Frazer Frost. Frazer Frost is currently serving out a suspension from taking on new clients that the SEC imposed because of shoddy accounting work in China.

I doubt that CDB made a conscious decision to insert the Big Four clause in HRBN’s loan commitment. I suspect it was boilerplate inserted by White & Case, CDB’s U.S. legal counsel, which itself is evidence that these Big Four clauses are more widespread than the Big Four would like you to think. (the fact that the firms are not in alphabetical order, but in the order of size in the U.S. market, not in China, lends further support to that argument). There is a lesson in here for CDB, however – it is important to read the agreements and when adopting western practices to make sure they actually are the best practices for China's development.”

The suggestion that Big Four only clauses are “boilerplate” has been denied by many but it seems the evidence that this is the case is increasingly apparent. More worrying is the spread of these clauses, particularly to China. The longer it takes Governments and Regulators to ban Big Four only clauses the more damage they will do.

Cross border expansion

Jeremy Newman — Mon, 27 Jun 2011 16:15:00 +0100

Regular readers of this blog will be aware of my ongoing interest in China – and the success that BDO has enjoyed in that country where we now have over 6,000 people. I was thus very interested in a recent article in Harvard Business Review entitled ‘What the West Doesn’t Get About China’, by George Stalk and David Michael, both senior staff members at Boston Consulting Group, a management consultancy. The article offered data and insightful commentary on the country’s acceleration towards a consumer-driven economy and the need to understand the special challenges of doing business in China.

The article referred to the need for organizations to invest in both capital and human resource to cope with ‘extraordinary growth in demand’. However, the article only alludes to the significance of staffing. In my view this understates the importance of people as demonstrated by the BDO Ambition Survey: Global Ambition which found that identifying the right people on the ground is of paramount importance and the single biggest factor for successful expansion into China.

Stalk and Michael advised companies looking to capitalise on expansion opportunities in China to be equipped to do business in hundreds of locations, rather than a handful of large cities. They also recognised the huge impact equipping businesses for such an operational shift would have on organisational structure, distribution infrastructure and choice of business partners, as well as capital. This mirrors another finding from the BDO Ambition Survey: Global Ambition, which emphasised how imperative it is to establish local suppliers and efficient distribution networks when expanding into China.

Business leaders are right to think of China when expanding internationally, due to its economic growth rate, increasing consumer demand and expanding market size. However, it is becoming clear that understanding the local market from an operational perspective to ensure recruitment of talented staff and robust distribution networks are key to successful cross border expansion into China. This is reflected in BDO’s experience in China.

Twitter

Jeremy Newman — Wed, 25 May 2011 06:30:00 +0100

I have never understood Twitter but, along with many in the UK and other countries, I was curious to know if the rumours I had heard of the name of the UK footballer who had a super injunction was correct (it was) and, as every news broadcast told us, this information was available on Twitter. Whilst there, and given a comment I read in a magazine recently that you should do a ‘Google search’ on yourself every few months just to see what others will find out when they do such a search on you, I did a ‘Twitter search’ on myself – not expecting to find anything. Imagine my surprise therefore when I found many references to my recent blog posting about the recent announcement by the UK’s Office of Fair Trading (OFT).

Most seemed to just link back to my blog but one went to a website with an article that started:

“Perpetual fusspot and BDO Global CEO Jeremy Newman has not been shy about how unfair he thinks the dominance of the Big 4 is. The majority of his blog posts are tagged ‘Global Accounting’ and several consist of bellyaching about Big 4 this and the Big 4 that. Of course, since the mainstream media has finally picked up on the idea that the concentration of auditors could be a bit of a problem,...” http://goingconcern.com/2011/05/jeremy-newman-would-prefer-if-the-big-4-would-just-allow-real-competition-but-regulatory-action-will-do-just-fine-thank-you/

Now call me sensitive, but I do not see myself as a “perpetual fusspot” or “bellyaching”- just someone raising a valid concern and one that has now been recognised by others, including the OFT but also the European Commission, MEPs, the UK’s House of Lords and many others, as being a potential issue. I also don’t think the dominance of the Big 4 is “unfair” – I think it is a risk and not in the public interest. And again this view is shared by others – including those who represent the public interest.

So, my apologies to anyone who thinks I come across as a “fusspot” or “bellyaching” – it is not my intention to do so; but rather to raise valid concerns that need a full and open discussion and require appropriate action to be taken.

I hate it when people say “I told you so” but…

Jeremy Newman — Fri, 20 May 2011 08:50:33 +0100

.. it is very tempting to do so in the wake of the announcement by the UK’s Office of Fair Trading (OFT) earlier this week.

Under the headline “Antitrust watchdog urges reform to break audit grip of Big Four” the FT states:

“Regulatory action may be required to break the dominant grip of the Big Four accounting firms on UK audits of leading companies…”

The only word I would challenge is “may” – it should say “will”.

The OFT said it had “… reached the provisional view that there are reasonable grounds for suspecting there are features of the market that restrict, distort or prevent competition in the UK” – to which I would add in many/most other countries as well.

According to Accountancy Age, the Chief Executive of the Financial Reporting Council, Stephen Haddrill, said:

“…that the OFT's expertise and power made it well-placed to deal with opening up the audit marketplace.”

"Having explored ideas for addressing these issues through our Market Participants' Group, it has become clear to us that the competition authorities are better placed than audit regulators to tackle competition concerns," said Haddrill.

At long last it seems that something might now be done to open up the audit market. It is a shame it has taken so long and that it will require regulatory intervention – though it is not too late for my colleagues in the Big Four, and others, to act on a voluntary basis to create the environment necessary to allow real competition.

Brazil and why the apparent justification for domination

Jeremy Newman — Thu, 19 May 2011 07:30:00 +0100

It is no secret that I have, for many years, been concerned about the domination of the four largest accountancy networks. Recent events in Brazil – where the Grant Thornton firm (Terco) was acquired by Ernst & Young and our own firm was acquired by KPMG – only serve to increase that concern. The dominance of the market in Brazil by the four largest firms is now almost total and although we now have an exceptional new firm in Brazil, more than capable of handling the necessary work for our clients, it is perhaps only 20% the size of our previous firm. Accordingly, we have lodged an objection with the various competition authorities in Brazil to register our concern at the acquisition of the former BDO firm by KPMG.

I believe that this is the first time that such an objection has been made – and I suspect our objection was unexpected by others as we have typically all accepted that the continued dominance of the Big 4 is unstoppable. And whilst our objection may or may not be successful, I think is important that we ‘stand up and be counted’ and make clear why we object to the acquisition which, in my view, has been prompted by KPMG's desire to significantly reduce competition and increase its market share in Brazil.

Of course, KPMG have had to explain to the Brazilian authorities why they think their acquisition should be approved and I must admit that this has brought a wry smile to my face. Now, whilst I object to the dominance of the Big 4 I have a great degree of respect for them and there is much they do that I admire, and some things I wish we could emulate. In particular they are usually very good at ensuring consistency in their global messaging particularly around matters of public policy and regulation – and certainly about the supposed importance of the need to have massive technical resources (thereby supposedly justifying their size). So there were two aspects of KPMG’s submission that have amused me.

First, their comment on the need – or otherwise – for technical capability. According to KPMG’s submission to the Brazilian authorities:

“The audit, tax consultancy and general consultancy markets have low barriers to entry. There are many certified professionals in the market that can provide these types of services. As an example, in 2009, there were over 220,000 accountants with a college degree in Brazil which were registered in the Regional Accountancy Councils. The initial necessary investment is relatively low (primarily in terms of facilities and human capital) and the regulatory barriers can be easily overcome, as the registration in the professional supervision boards is accessible to anyone that has the necessary qualifications.”

ie all you need is a college degree, certification and a modest investment!

Not quite consistent with their usual assertion that they need to be the size they are to enable them to afford the necessary investment in technical and other skills. As KPMG said in their submission to the UK FRC Market Participants Group that was looking at competition and choice in the UK audit market in March 2007:

"To undertake high quality audits in the context of current and evolving business practices and accounting standards, it is particularly important that audit firms have available (and under their control and subject to their quality control processes) a sufficiently broad range of technical skills"

The second is their comment on compulsory audit rotation, which is currently one of the proposals being promoted by the EC Green Paper as a possible was of creating a more dynamic audit market. In KPMG’s submission to the EC, with which sentiment I wholly agree, they state:

“…there is a danger that mandatory rotation and tendering will achieve precisely the opposite effect from the one intended by the Commission. As the representative of BDO LLP recently said in evidence to the UK House of Lords … “there is a study … that says that mandatory rotation compounds the concentration issue because, while audits are put out to tender, those that are put out to tender by the non-Big Four firms are generally sucked up by the Big Four and it is very difficult for the non-Big Four to win them back"

However, they have suggested to the Brazilian authorities:

“…it should be noted that the existence of a mandatory rotation of auditors … contributes to the dynamic operation of the independent audit market."

So now you know; the acquisition of the former BDO firm in Brazil can only be justified by changing your mind on technical skills and audit rotation!

EC Green Paper – the next instalment

Jeremy Newman — Fri, 13 May 2011 07:30:00 +0100

The European Parliament’s Committee on Economic and Monetary Affairs (ECON) has released their opinion on the EC Green Paper and it makes encouraging reading.

For example,

“…the high market concentration of the "big four" audit firms may cause an excessive build up of risk, smaller firms are diverse and their growth and expertise should be encouraged through increased opportunities to compete…”

“…following the financial crisis, auditors have been identified as being able to play a key role in strengthening the risk management oversight of financial institutions, in particular…”

“…review audit committee practices with regard to tendering processes with a particular view on aspects of transparency and administrative burdens associated with a formal tendering process; whilst ensuring that the quality of auditing services is not affected; considers that, in order to guarantee the independence of audits, companies should consider an open tendering process for statutory appointments of external auditors every eight years…”

“…investigate the use of restrictive covenants by banks and other financial institutions on loans and other financial products to companies, which may be limiting auditor choice…”

All good stuff and a few more useful suggestions as well.

The paper also calls for “…the Commission (DG Comp) to hold a detailed investigation into the audit market…” So a potential competition enquiry by the EC as well as the one currently under consideration in the UK. A mixed blessing if it actually happens as these enquiries can take a long time and may delay the implementation of other changes – but recognition there is an issue that needs to be addressed.

We now await the report from the Committee on Legal Affairs (JURI) to see how many of ECON’s proposals it takes on board – and what else it proposes.

My thanks to the various MEPs who were involved for all their efforts – I am sure we are not the only ones who are grateful – including ECON’s rapporteur Kay Swinburne and others including Sharon Bowles, Sylvie Goulard, Wolf Klinz, Olle Schmidt and Corien Wortmann-Kool.

Human resilience

Jeremy Newman — Mon, 9 May 2011 08:19:57 +0100

I have often commented that one of the privileges of my job is that it gives me the opportunity to deal with people from many different cultures and backgrounds.

I have always been struck by the consistency of the BDO partners and people in every country I have visited and their commitment to the development of exceptional people who are committed to delivering an extraordinary level of client service built on strong relationships.

I am typing this on a plane leaving Australia having spent a few days there at a joint meeting of the partners of the BDO Member Firms in Australia and New Zealand. I saw this BDO spirit there as I have seen everywhere else but what struck me at this meeting was the human spirit I see everywhere and the resilience of people.

The meeting was held at the Gold Coast, just outside Brisbane – and thus very near the area most badly affected by the Queensland flooding last year. There were a number of partners from our Brisbane office at the meeting. There were also a number of partners from our office in Christchurch, New Zealand – which was badly affected by the tragic earthquake. In recent weeks I have also been in Tokyo (I have previously commented on this) and in Beirut for our Middle East Regional Meeting; this meeting being attended by partners from offices in other countries in the Middle East that have had to close for some time during the current unrest in the region.

In all these places people have borne unimaginable challenges – arising both from natural disasters and human actions – yet none of them have let this overwhelm them. Indeed, the camaraderie I saw between the Australians and New Zealanders was uplifting – each seeking to help the other and all committed to ‘business as usual’. I am only sorry I could only spend a few days with them.

Are businesses feeling more confident?

Jeremy Newman — Tue, 26 Apr 2011 14:45:00 +0100

I am often asked on my travels what I think about the global economy and the level of business confidence. I always make it clear that, in my view, it is difficult to give a single answer that is correct in all regions and countries; there is no doubt that some countries have coped far better than others and many countries – particularly in the Asia Pacific region – continue to grow strongly whilst others (mainly in Europe but also the USA) still face significant challenges.

It was thus interesting to read a recent article by Eswar Prasad and Karim Foda, both esteemed thinkers within the world of economic theory. The Financial Times recently published a brief global economic analysis by the two of them entitled ‘Economic recovery picks up pace, but expect some turbulence ahead’ (this article is only accessible to Financial Times subscribers). The article was somewhat bullish, noting that the “global economic recovery is getting on to a firmer footing” in spite of recent shocks including revolution, war, natural disasters, rising food prices and debt crises.

Whilst the article fairly says that rising uncertainty will continue to keep financial markets on edge, there was some cause for cautious optimism, with a rise in business confidence noted over recent months. This mirrors findings published in October last year in the BDO Ambition Survey: Global Ambition, which also reported on a high level of confidence amongst businesses.

In addition, Prasad and Foda surmised that is was emerging markets, such as Brazil, China and India which carried the world economy on their shoulders during the past 12 months, expansion into which was another finding from the BDO Ambition Survey.

Indeed, our survey revealed organisations were feeling confident in terms of growth; with two-thirds of the most ambitious mid-caps having more aggressive expansion plans in 2010 than 2009 – and 95 per cent feeling confident about international cross-border growth.

Whilst people are right to exercise caution as we emerge from the global financial crisis, we must also recognise and applaud that there is an expansive, forward looking and ambitious business community seeking to grow internationally.

EC Green Paper (the latest instalment)

Jeremy Newman — Fri, 8 Apr 2011 10:07:26 +0100

This coming Monday sees the discussion by the Legal Affairs Committee of the European Parliament on amendments submitted to it’s draft report on the Green Paper prior to the scheduled vote in May. This is an important moment for the accountancy profession and another step along the legislative path towards important reform.

The phrase ‘oligopoly’ has been used to describe Big 4 dominance in Europe by Antonio Masip Hidalgo MEP, and the behaviour of these networks in emerging regions, such as Brazil, has highlighted this is not a problem limited to European markets. It’s an issue of global significance that we as a profession have historically been slow to acknowledge, but can now begin to address.

The Green Paper has been the catalyst for a great deal of discussion about the role of the auditor, and whilst its future direction is uncertain at this moment in time, the strength and variety of feeling around the issue is abundantly clear – with 120 amendments being submitted to the Legal Affairs committee's draft report on the Green Paper, a report only four pages long.

BDO has made the case to reform the present flawed market structure, without which other changes will be difficult to implement. Action is needed to address the bias in public sector procurement and the ongoing trend of the Big Four acquiring firms from competing networks (including BDO), particularly in emerging markets.

And, of course, we need to deal with restrictive covenants in financing agreements which prevent fair competition. I have been pressing for this for almost 8 years now and, at last, it seems everyone recognises the issue.

All of these important issues have been addressed by amendments to the Committee’s report on the Green Paper and I hope that MEPs will support these changes.

We seek equal opportunity, not preferential treatment. The level of systemic risk has now gone too far, but it can and must be mitigated against with reform.

EC Green Paper – more developments

Jeremy Newman — Mon, 28 Mar 2011 12:30:00 +0100

Last week Antonio Masip Hidalgo, Member of the European Parliament, issued the report and recommendations of his Committee on the European Commission’s Green Paper ‘Audit Policy: Lessons from the Crisis’.

As you would expect, I read the report with interest. MEP Hidalgo is correct to refer to the Big Four as an ‘oligopoly’ – with all the implications that has for competition; it is perhaps no surprise that market forces alone can not produce the necessary changes required to increase competition. I think even the Big Four now accept that the present market concentration within our profession is not healthy – the difference of view being the extent to which intervention is required to address the situation. Indeed, having for many years denied their existence the Big Four firms in the UK (albeit with differing degrees of enthusiasm) have recognised that something needs to be done about restrictive covenants (ie Big Four only clauses) in lending and other financing agreements.

Recent announcements from Brussels give us reason to be cautiously optimistic. The Commissioner for Internal Market and Services, Michel Barnier, speaking at the European Commission’s conference on the future of auditing confirmed that “things will not stay stagnant” and that “no change is not an option”.
I have no doubt that Hidalgo’s report, amendments and subsequent decisions will become an important contributor to the development of the audit profession and will impact greatly upon its future direction. It would be deplorable for the status quo to remain when there is such an opportunity for greater transparency, choice and competition.

We, and others, seek equal opportunity, not preferential treatment. By removing barriers we hope to help create a more dynamic, equitable and stronger profession. The challenge we must all face up to is ensuring that new regulation creates an environment for this framework to flourish, not one that reinforces the present, failing model – we must all work towards a credible alternative. This requires everyone in the profession, including the Big Four, to positively engage in the debate and to positively embrace change. I hope that all my colleagues will respond positively.

I have just returned from a few days in Tokyo…

Jeremy Newman — Mon, 28 Mar 2011 09:30:35 +0100

… which was a slightly surreal experience. From a business perspective it was a good trip. The newly established BDO Japan is developing well – early days (it was only established on 1 January) but making good progress and building on the success of its two constituents, BDO Sanyu and BDO Toyo. The deal in Japan has been well received by clients and staff of both firms and has been positively received by others, including the JICPA, with whom I met whilst in Tokyo.

Tokyo itself was much quieter than usual. On arrival I was the only person in the ‘foreign passports’ queue (I had flown in from Malaysia not the UK) although the bus from the airport to the hotel was busier than usual (I subsequently discovered that the train from the airport wasn’t running – which is presumably why only two people on the bus were actually staying at the hotel). The hotel was quiet but it was very much ‘business as usual’. The Japanese themselves are quite remarkable – the joint disasters of earthquake, tsunami and problems arising from the damage to their nuclear power generators would be a challenge for most people yet, outwardly at least, that Japanese are taking it all in their stride. They are doing lots of small things to save power – for example, many escalators and hot air hand dryers are switched off; lighting levels are lower; heating is turned down or switched off; kettles in the hotel room are switched off with a polite notice asking guests to switch them off again after use. All little things and no real inconvenience – but I am sure they make a difference.

There continue to be tremors/after shocks; the first one (I was on the 15^th floor of a building when it started to shake) caught me by surprise and left me feeling like I was suffering from motion sickness but as soon as I realised what was happening I was fine. My hosts were unaffected – just commenting that this meant the elevators would not be running for about 15 minutes and that the underground/subway trains would also stop for a similar time.

In fact the only real inconvenience was British Airways who, for unspecified ‘operational reasons’, cancelled their direct flight from Tokyo to London so that I had to fly via Seoul, adding over 4 hours to my journey home. I bet if the airline was run by the Japanese it would have been ‘business as usual’.

Good news

Jeremy Newman — Thu, 24 Mar 2011 05:43:24 +0100

The UK Government issued its' 'Plan for Growth' yesterday which included the following:

“The Government is calling on the OFT to investigate whether clauses in lending agreements made by the banks are unfairly restricting competition in the audit market. The OECD have suggested that banks sometimes make loans to business contingent on their audits being undertaken by the top tier audit firms. The Government is calling on the OFT to investigate claims that such clauses exist, that they unfairly and inappropriately restrict competition and that their removal would mean that the next tier of audit firms would be better placed to compete for larger audits and lead to a more vibrant market for audit services.”

The OFT is the Office of Fair Trading, a UK body that investigates issues relating to competition.

This is really good news and I hope that the OFT looks widely at the issue of restrictive covenants including those that are ‘Big 4 only’ clauses disguised as ‘experience requirements’ which only a Big 4 firm could meet.

This is long overdue but a step forward.

Big 4 bias – can we ever overcome it?

Jeremy Newman — Mon, 14 Mar 2011 09:00:00 +0200

Reuters have recently reported that some Chinese companies that list shares on the U.S. stock exchanges are "dumping smaller auditors and hiring Big Four firms to convince investors their bookkeeping can be trusted." This is due to a rise in the "scrutiny of their accounting and a spike in shareholder lawsuits that allege securities fraud. Their auditors have been accused of missing fabricated contracts and inflated profits that triggered stock drops when they were revealed."

According to Reuters: "More than 200 Chinese companies are listed on U.S. exchanges, and hundreds more trade on over-the-counter bulletin boards. In the last five months, at least 15 have upgraded to a Big Four auditor ... from a smaller firm, according to an analysis from Audit Analytics."

I understand the concern over what Reuters describes as "small, unknown firms [used] to save money" - but why is the answer that companies must use a Big 4 firm?

BDO China is a substantial business - almost 6,000 employees and widely regarded as the leading domestic firm in China. Indeed, our Shanghai firm was the first firm in China to convert to partnership status under the requirements of the Chinese Ministry of Finance and our firms in Beijing and Shanghai both received a prestigious 'H share licence from the Ministry of Finance (both firms are part of BDO China set up under a management company in a structure encouraged by the Ministry of Finance).

As Reuters fairly states: "An auditor's stamp of approval is key for investor confidence" but why do Reuters, and others, assume this must be a Big 4 firm? We have invested heavily to ensure we have the necessary capabilities - in China, the USA and internationally. BDO is ready, willing and able to handle this work.

Whither advisory services?

Jeremy Newman — Thu, 3 Mar 2011 07:53:41 +0100

The Financial Times Lex column last week referred to the Big Four’s plans to develop their consulting services in light of KPMG’s acquisition of EquaTerra, an outsourcing adviser, for an undisclosed sum and following PwC’s $378m purchase of Diamond Management and Technology and Deloitte’s acquisition of property advisers Drivers Jonas last year. According to Lex, “Further expansion plans are afoot. KPMG, whose advisory fees comprise an industry-leading 32 per cent of revenues, expects to double its global consulting business within four years. In the UK, E&Y wants to double advisory revenues within three.”

Lex raises “… the old question: will auditors sign-off on dodgy accounts to preserve the firm’s high-margin advisory fees? There are both legitimate and conflicted arguments from each side. Some academic studies have shown that client-unfriendly going-concern warnings on financial accounts are less likely where the client generates high non-audit fees, but others have shown no link.”

In my view this misses the point.

I think all accounting firms, and most others (including regulators and most investors), would agree that there is clear guidance on when auditors can provide non-audit services to clients and which such services can be provided. All good audit committees monitor and review this and I am not aware of any up-to-date evidence to support the concern that auditors will compromise their professional judgment merely to retain other lucrative assignments. Further, I think it is generally accepted that the attractiveness of the accounting profession to high quality people is enhanced by having multi-disciplinary firms and that certain non-audit skills and capabilities provide skills that are necessary to enable firms to deliver high quality audits. Indeed, in a letter to the FT earlier this week, in response to the Lex column, Alan Buckle, KPMG’s Global Chairman of Advisory Services, refers to the need to have “…advisory skills to help deliver audits…” which is “…essential when dealing with clients with complex risks, advanced technology and regulatory challenges. Without such skills, audit quality would be impossible to maintain.”

I agree. However, as noted above, I think this misses the point.

The issue is not whether audit firms should be able to provide non-audit services (you will appreciate I think they should) but the size and nature of those services and the extent to which these affect the ‘tone at the top’. I have a concern that where a firm derives too large a proportion of its revenues, and its profits, from consulting/advisory services then the firm becomes a ‘business’ rather than a ‘profession’ and the pursuit of profit becomes more important than the pursuit of quality and professionalism. The fact that many now refer to the ‘audit industry’ reflect this concern. A firm that is dominated by high margin consulting services will struggle to reconcile the aims and aspirations of the partners involved in that part of their business with the quality agenda that must be the absolute priority of the audit partners. Of course, we need to make a profit from our audit services, and all those other services which I think share a similar commitment to ‘professionalism’ (e.g. tax services) and where there needs to be a strong ethical framework – but the priority in such a business will not be profit at any cost. I accept that consulting services are ‘professional’ in the broadest sense but this is different to the professional and ethical framework of an audit business.

Consulting and other advisory services are important, and accounting firms should be able to develop them, but they must not be allowed to dominate the agenda and make the pursuit of profit the aim of our business. Profit should be the outcome of doing good work – and not the raison d’�tre of the firm.

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Financial Reporting and Auditing: A time for change?

Jeremy Newman — Tue, 22 Feb 2011 10:00:00 +0100

The European Commission’s conference on the future of auditing took place earlier this month under the above title, and gave a clear answer to the question - ‘Yes’. In his opening address on the second day of the conference (the day devoted to the audit profession) the Commissioner for Internal Market and Services, Michel Barnier, made it clear that “things will not stay stagnant” and that “the status quo is no longer an option”. His remarks were very encouraging because much of the pre-conference ‘chatter’ suggested that the lobbying efforts of the dominant firms had persuaded the EC to soften their proposals for change. But, in fact, the opposite was the case. Not only did Commissioner Barnier make it clear that he was “never convinced that markets should be left to regulate themselves” but he also confirmed that all the options outlined in the EC Green Paper remain under consideration. Further, most of the discussion groups commented on some aspect of the domination of the audit market by four firms – even though only one such discussion was devoted to this subject.

I was pleased that Commissioner Barnier referred to the need for international cooperation and for this matter to be put on the G20 agenda. He confirmed that whilst he is still open to ideas and the “means to the end are open, it is now time for action”.

Recognising the problem of dominance by four firms is a much needed step in the right direction. Hopefully this time we will get some concrete actions to prompt the much needed change – an early statement confirming that ‘Big 4 only’ clauses will be outlawed would be a great first step.

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One of the more interesting speakers…

Jeremy Newman — Wed, 16 Feb 2011 14:15:00 +0100

… at last week’s EC Conference on the future of audit was Jules Muis, a former partner in one of the four dominant firms and then a vice president and controller of the World Bank. He provided an interesting perspective and was less predictable than might be expected from someone of his background (ie a partner in one of the dominant firms).

Subsequent to the conference one of my colleagues sent me the following article by Mr Muis - slightly irreverent but hard hitting and saying many of the things that I suspect others think but are not sure how to express.

For example: “In 2004, facing a sceptical audience… Jules Muis ventured… ‘A major financial crisis is an accident waiting to happen… The accountancy profession has lost touch with the language of finance.’… According to Muis, the emergence of ballooning bubble economies and a disjointed financial architecture, as well as unaccountable regulatory and oversight bodies, all set the scene for a crash.”

And: “An audit profession too rules driven and too chicken to use anything else besides clean opinions… Dozens of banks keeled over, or stayed alive only because of taxpayer support, and auditors did not issue a single qualified audit opinion…”

His comments on regulation are significant as we consider yet further regulation of many businesses, including the accounting profession. For example: “Regulators allowed themselves to be ideologically held captive by the in vogue deregulation mode, with no effective accountability constructs—not even for systemic risk”.

There is much more, and I recommend the article to you, but the lessons are clear – the audit profession needs to change to be more relevant and regulation needs to change. The challenge is to ensure it is the right change to help create a more dynamic market, and not to reinforce the current, unhealthy model.

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There is a Credible Alternative

Jeremy Newman — Thu, 10 Feb 2011 00:38:39 +0100

Ahead of the European Commission’s conference on the future of auditing today, and following the publication of its Green Paper entitled ‘Audit Policy: Lessons from the Crisis’, I was delighted to issue a statement jointly with my counterparts from Grant Thornton, Mazars and RSM. This is the first time the four firms have issued a joint statement and shows how important this matter is to all of us in the profession and how important it is that there is a strong, and united, voice to balance the extensive lobbying of the four dominant audit firms and to provide support for the EC and their agenda for change.

The statement welcomes this European Commission initiative and its review of the audit profession and confirms that these four of us believe that, however uncomfortable change can be, ‘no action’ is not an option in a market place currently dominated by four accountancy networks. We all strongly believe that intervention is necessary to achieve change – to counter the regulatory environment that has allowed this unhealthy position to develop.

The four firms – BDO, Grant Thornton, Mazars and RSM – each act for some substantial companies and we have all invested in developing our capabilities. We are keen to invest more – but can only do so if there is a free market. Current restrictions, such as ‘Big 4 only’ clauses and general institutionalised bias, need to be addressed. Everyone accepts that these distort the market and are inequitable yet, so far, nothing has been done to deal with them.

Our firms look forward to actively participating in the next steps of this key project for the EU. The EU has an important role to play and the capacity to contribute to enhancing global financial stability and fostering economic growth.

We all have a responsibility to learn from the recent financial crisis and to accept that ‘no change’ is not an option for any of us, however uncomfortable that might be.

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