German accounting firms become more client-facing

The Wirecard scandal rocked Germany’s accounting profession in 2020 and damaged its credibility. The Government has moved quickly and passed the Financial Market Integrity Strengthening Act (FISG), which was considered a milestone for the accounting profession as it strengthens the auditor’s independence. But has it gone far enough?

“FISG itself is probably not really solving some of the key issue that it supposed to address,” said Michael Jetter, partner for RWT Crowe GmbH. “Some measures introduced by FISG, such as further restrictions on providing non-audit services and stricter rotation rules have only limited effect on increasing audit quality. Additionally, some say that FISG went too far in some aspects, such as increasing auditor’s liability in the non-PIE segment.”

Andrea Bruckner, member of the executive board, BDO Wirtschaftsprüfungs­gesellschaft AG, goes further and claims the FISG has done little to boost confidence. “The measures in the area of audit regulation do not affect the quality of the audit,” she said. “The increase in quality assumed as a result of external and internal rotation is not evident. On the contrary, the combination of external (10 years max.) and internal (5 years max.) rotation increases the quality risks, as the special demands on the auditor and the companies associated with an initial audit are considerable. However, it is to be welcomed that the FISG has enshrined in law the responsibility for monitoring the quality of the audit by the audit committee or supervisory board. The mandatory establishment of an audit committee by all PIEs is also positive.”

Industry experts also feel that when the FISG was drafted, not enough attention was paid to the kind of responsibilities that supervisory bodies should carry should they fail to spot fraud, or even to punish it where it was found. Christoph Brauchle, certified public auditor at Ebner Stolz, a Nexia International member firm, pointed out that the FISG could have taken a more stringent approach to situations where there are known cases of fraud but the supervisory bodies did not properly fulfil their duties. He also feels it was a mistake that the stock exchange supervisory authority has not been made responsible for delisting companies whose corporate governance systems are not suitable for the stock exchange.

Despite the lack of teeth in the new Act, there were concerns that it was going to add to the burden of regulation for SMEs and lead to fewer of them participating in the auditing market and this seems to be the case. “We believe that the law went too far with regard to auditors,” said Brauchle. “It is apparent that the smaller audit firms are withdrawing from the market. In addition, there are fewer and fewer people within the Big 4 and the Next 6 who want to audit PIEs. We assume that a maximum of 10 – 15 audit firms will remain that audit PIEs. In addition, audits are no longer attractive for smaller firms, especially with one or two partners, due to the increase in insurance premiums.”

Ironically, this withdrawal of SMEs from the auditing market is adding further risk to quality. “Separating auditing and tax consulting does not necessarily lead to higher quality,” said Jan Schmeisky, partner at Menold Bezler, an MGI worldwide member firm. “The fact is that more and more small audit firms are withdrawing from traditional auditing and focusing on consulting topics.”

However, Frank Jockers, international contact partner, assurance and advisory at PrimeGlobal member firm RGT, is confident that new regulations that apply to capital market-oriented companies but have an indirect effect on non-market-oriented companies, should bolster confidence in German auditing. “There have been a number of key changes,” he said. “For instance, auditors may not audit and render consulting services to a client at the same time. Companies are now required by law to implement an adequate risk management system. And BAFIN (Bundesanstalt für Finanzdienstleistungsaufsicht) may immediately perform its own audit if violation of accounting regulations seems probable.

Schmeisky does not want either the industry or its clients to focus too much on regulation, and instead, he wants them to trust German firms to deliver on the quality they promise. “Wirecard was an isolated case,” he pointed out. “We should not draw conclusions about the market as a whole from this one case. We have the same challenges as many other colleagues worldwide in the MGI network. Fee pressure and client demands in the audit business in Germany remain very high. At the same time, we have challenges in recruiting and retention. We need highly qualified and motivated young people who see auditing as a meaningful activity. In the end, we are the ones who create confidence in the capital markets.”

There are signs that consolidation in the market has led to some relief in fee pressure for the remaining firms. Jetter feels that after a long period of constantly decreasing audit fees in the non-PIE-market, the trend is reversing. Development is driven by a mixture of what he describes as ‘dramatically’ growing recruitment issues and increasing regulatory, compliance and quality management costs. Staff recruitment in Germany, as in so many other countries, is the hot topic, while customer demand is stable, and in some instances, growing.

“In the last 12 months, the market has changed completely,” said Brauchle. “The cause is the brutal shortage of staff. In particular, larger medium-sized companies are no longer being served by the Big 4 so that they can serve their large PIE mandates. In the PIE segment, companies with inadequate corporate governance or a bad reputation find it very difficult to get an auditor. All companies are raising their prices. What would have been unthinkable in the past is that clients are increasingly asking whether we - as auditors - have the time and capacity at all.”

Regulation, staff retention and economic pressures have led to a constant consolidation process amongst German accounting firms. “Joining a bigger group or network helps smaller firms to solve those issues,” said Dr Christian Gorny, board member and CEO of ETL Global. “Through synergies and existing infrastructure they are pooling specialist technical or industry know-how, as well as shared services in the context of HR, IT, communications and financing. We expect further consolidation of smaller firms into bigger groups or networks over the next twelve month and actually expect it to gain more speed and volume as pressures increase. In addition, we still see a lot of firms lead by the baby boomer generation who are now implementing their succession plans and handing over their businesses to the next generation.”

While everyone we spoke to when putting together this report saw a rise in customer demand in areas such as tax consulting, auditing and ESG reporting, crisis management is going to be at the heart of customer relations. “Due to the pressures brought by the events of the last three years, more and more businesses face unique challenges,” said Michael Thelen, certified tax adviser at KBHT, an Allinial Global member firm. “The need for a consultant who offers foresight, while knowing about the makeup of each business, is becoming more important. With inflation, crumbling supply chains, covid-related work shortage and more regulations in place, many businesses continue to suffer. Guiding them through this prolonged crisis, offering them advice on how to deal with liquidity issues and priming them for a successful future are some of the most important jobs in the accounting industry currently.”

Thelen pointed out that with the war in Ukraine ongoing and no predictable end in sight, energy prices remain at an all-time high and will drive inflation, unless political measures lead to more stability in the market. Crisis management will be the top priority for many clients, with some of them already struggling to survive. This will have lasting effects on audits as well. “For auditors, the provisions regarding liability within the FISG act will take effect starting in 2023, which will lead to big changes in the market, especially for small and medium-sized firms,” he said. “ESG reporting and its audit necessities will be a matter for the mid-tier firms to look after.” Another big impact coming down the line for all German businesses is the German Supply Chain Due Diligence Law (Lieferkettensorgfaltspflichtengesetz, LkSG), which was enacted in 2021. It means that companies based in Germany will in the future be legally obligated to meet their responsibility to respect human rights and basic environmental standards in their direct supply chains and, for the first time, outside their own business operations, once a certain number of employees are reached (2023: from 3,000 employees; 2024: from 1,000 employees).

But while troubled times are ahead, Stefan Prechtl, international liaison partner for Crowe Kleeberg GmbH, sees no slow down in customer demand. “We believe that growth (including growth in the audit services) will continue over the next 12 months,” he said. “Staff shortages will continue to be a big challenge. From a regulatory perspective, Germany is replacing the German Auditing Standards with ISA’s for the next audit season 2023, so this change might have an impact in the next 12 months as well. The professional bodies, however, do not see any dramatic impact coming from this ISA introduction.”