India could create its own Big Four audit firms as envisioned by the PM: Here’s what it’ll take

His call could not have been timelier. India aims to become a developed country by 2047, which requires sustained gross capital formation (GCF) at a minimum rate of 35% of GDP. In this journey, the strength of the country’s institutional framework, including auditing practices and audit assurance, assumes significance.

Investors expect not just world-class corporate governance, but also top-notch assurances on financial statements of the quality level that the world’s Big Four audit firms are perceived to provide.

Despite a large talent pool, India lacks homegrown audit firms comparable to the Big Four. Deep fragmentation of the profession is a key reason. Data from the Institute of Chartered Accountants of India (ICAI) suggests that as of October, India had over 102,000 registered chartered accountancy firms, of which 72,696 were sole proprietorships, 27,442 partnerships and only 2,129 limited liability partnerships (LLPs). Together, they employed about 183,642 professionals, thus averaging only 1.8 CAs per firm.

The Big Four are not limited liability companies (LLCs), but a network of independently owned, legally separate member firms, often structured as LLPs. In India, some major domestic firms operate under a network arrangement with one of the Big Four.

Apart from their brand strength, the Big Four bring to the table scale, a higher level of learning and cutting-edge auditing tools that leverage technology and databases. This gives them an advantage in securing the audit work of big companies, albeit by employing Indian CA talent. They have access to patient capital; even private equity funds are allowed to invest in these firms.

Hence, the real issue in raising a homegrown Big Four is not a lack of talent, but the absence of entrepreneurship needed to upscale a fragmented sector that primarily comprises sole proprietorships, with access to frontline technology and capital key concerns as well.

In this context, the ministry of corporate affairs has published a paper on establishing ‘Multi-Disciplinary Partnership Firms,’ encompassing auditing, accounting, cost accountancy, actuarial and legal disciplines. An important issue in bringing auditing (assurance) and non-auditing disciplines under one umbrella is the potential ‘conflict of interest’ between auditing and consulting services. This could compromise audit independence, which lies at the heart of the auditing function. Laws and regulations across the world have been designed to mitigate this conflict.

The Big Four, which have historically evolved to offer both auditing and consulting services under the same brand, have been at pains to demonstrate that their services for these functions are independently managed and have no conflict. Yet, in numerous instances, regulators have sanctioned them on this ground. In India, Section 144 of the Companies Act prohibits auditors from offering specified non-audit services, including management advice. This is an important consideration in evolving any model for an Indian Big Four.

Given that we have no dearth of high-quality talent, the evolution of our own Big Four must address at least three enabling factors: a legal framework for the achievement of scale, availability of cutting-edge audit tools and access to capital that would enable talent recruitment as well as retention.

In India currently, only individuals and LLPs are permitted to practise auditing, since the Chartered Accountants Act of 1949 prohibits companies from this profession. This acts as a legal-structure constraint on the development of large Indian audit firms. The CA legislation should permit companies to enter the profession (as many other countries do). Audit practice should be ownership-structure agnostic, with an organization taking the form of a partnership, LLP, private or public company.

A feasible option for consolidating the sector would be to let smaller firms band together to form a network under a holding company or protected cell company (PCC) structure—a corporate form that exists in many jurisdictions. PCCs allow multiple, legally separate ‘cells’ with ring-fenced assets and liabilities to operate under a single corporate structure.

The holding company, or PCC, can raise capital, acquire or develop technology at par with the Big Four’s proprietary tools, leverage data analytics, hire high-quality talent and build an umbrella brand. Individual member firms, like the network partners of the Big Four, may even retain their old names, which would address the ‘loss of identity’ feared by many.

The ICAI should play a major role in fostering the rise of an Indian Big Four and developing or acquiring high-end auditing tools and technology. It can charge its members a user fee. The ICAI should also proactively pursue the recognition of Indian CAs by foreign jurisdictions on a reciprocal basis. This would help them globalize.

Along with aiding the evolution of large homegrown firms, the ICAI should also support the implementation of international standards for group audits, enabling large and small audit firms to co-exist in a complementary yet professionally rewarding manner. High-quality auditing infrastructure would go a long way towards inspiring greater trust among international investors.

The need for domestic auditing firms cannot be overemphasized in the context of a Viksit Bharat. As Mark Carney, Canada’s Prime Minister, famously said in his address at the World Economic Forum in Davos this year, “If you are not at the table, you are on the menu.” Coordinated action by the ICAI, government and CA firms could help India fulfil the PM’s vision.

The authors are, respectively, former chairman, Sebi and LIC; and former deputy comptroller and auditor general and member, National Financial Reporting Authority.