China has instituted mandatory auditor rotation for SOEs. China’s Big Four banks have now all selected new auditors, and the result will shake up the accounting profession in China. The Big Four banks are the biggest audit clients in China, and they rank among the largest banks in the world.
The process began in 2010 when China Construction Bank fired KPMG for having the temerity to ask a for a fee increase. PwC replaced KPMG, and since PwC has not served a full five-year term it was not replaced in this cycle. The other three banks all selected new auditors:
Deloitte and PwC are the big losers, and KPMG is the big winner. Deloitte finds itself without a big bank. I have heard that Deloitte had poached a number of partners and staff from ICBC’s former auditor E&Y in anticipation of winning the bank, so it is a major blow to Deloitte since not only do they not have a bank to audit, they have a lot of bank auditors to pay. PwC replaced the giant BOC with ABC, but gets RMB 100 million less in fees. PwC will also lose CCB in three years when it comes up for rotation. I am sure Deloitte will be pulling out all stops to win that one. E&Y may have had a pyrrhic victory with BOC. The fee was slashed from RMB 215 million to RMB 148 million. I can’t imagine the audit will be very profitable at that fee. KPMG’s win at ICBC gets them back in the bank business; I bet they learned their lesson about asking for fee increases.
Supporters of mandatory audit rotation argue it will improve audit quality by improving auditor independence. I am skeptical about that claim. It is going to take a considerable effort by the auditors to get their arms around these massive engagements. While a fresh set of eyes might help, I think those eyes are going to pretty worn out just figuring these banks out.
Most alarming, however, is the reduction in fees at each of the banks (other than CCB which appears to have frozen PwC’s fee). Not only do the new auditors have to figure out these banks, they have to do it with an average fee reduction of 22% on the three banks than rotated auditors this year. That level of fee reduction is going to result in reduced audit quality, reduced partner income, or both. Probably both; I am glad I am retired from the Big Four.
Shareholders of these banks can ill afford these fee reductions. Audit fees on Chinese banks appeared too low even before the latest reductions. For comparison, Bank of China is nearly identical in size to Citicorp. Citicorp’s audit fee is US$68.8 million (RMB 433 million) nearly three times the RMB 148 million that E&Y will collect on Bank of China.