German market starts to heat up

When the Wirecard scandal rocked Germany’s accounting profession in 2020 and damaged its credibility, the Government 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 there were criticisms at the time that it was not going far enough and yet the increased regulation would cause a lot of firms to leave the auditing market altogether. Those predictions have come true and demand for auditing services is now far outstripping supply. It has led to a boom in fees but how long can the situation go on for?

According to Jan Schmeisky, partner at Menold Bezler, an MGI Worldwide member firm, they are now in the position of having to turn down audit requests, a situation only made worse by the skills shortage.

“It’s not just us - our colleagues at medium-sized auditing firms are also having to turn down orders,” he said. “We have massive worries about finding qualified and motivated young talent. In particular, clients looking for short-term inquiries, large and complex clients, and clients in the public sector, must increasingly expect that they will receive few offers or, for example, that the audit will be significantly more expensive.”

The FISG affects SMEs and contributes to the concentration of the audit market. Small and medium-sized auditing firms are increasingly withdrawing from auditing capital market-oriented companies. The audit of annual financial statements is becoming increasingly over-regulated, according to Schmeisky. “We medium-sized companies view this development rather critically,” he said. “I cannot see that the FISG is helping to improve the quality of auditing.

FISG has also made auditing more expensive for firms. The FISG had a substantial impact on the PIE audits, but also affected the non-PIE audits. “At first, the stricter liability regulations for statutory audits led to an increase in insurance costs for audit firms,” said Michael Jetter, partner at CPA, RWT Crowe Germany. “It remains to be seen to what extent the higher liability amounts will lead to an increase in the number of cases in which claims are made against the auditor by injured parties. However, the risk of claims is likely to have increased overall as a result of the new provisions of the FISG.”

Of course, the skills shortage looms large in Germany, as it does everywhere else. Whether balance sheet preparers or auditors, the entire industry is looking for qualified professionals. The recruitment and earning opportunities are correspondingly good. This leads to corresponding fee pressure for tax consultants and auditors. Good employees also want to earn well. Clients must also be prepared to pay appropriate fees - especially if they want high-quality and intensive support, said Schmeisky. “Both employee recruitment and the retention of specialists are and will remain challenging.”

Staff shortages have boosted fee revenue, according to Dr Christian Gorny, CEO of ETL International, an Allinial Global member firm. “The skills shortage has seen audit (but also advisory) fees constantly rising and clients accepting those fee increases due to capacity shortages in the market,” he said. “Hence it is no surprise that most audit and advisory firms have generated double digit growth during the last year.”

This situation cannot continue, according to Michael Thelan, partner at KBHT, an Allinal Global member firm. “A decrease in pressure on fees is anticipated,” he said. “This trend is likely influenced by the market becoming smaller due to regulatory developments, which may lead to fewer firms operating in the space. The regulatory changes are not only affecting the market size but also the operational dynamics of accounting firms, leading to a more concentrated market environment.”

While merger and acquisition activity is quiet, Ann-Kathrin Steinroder, executive director of the ETL Global Board, has noticed a constant consolidation process going on. “The pandemic and the rising pressure on smaller players in terms of professional and technical specialisation, lack of talent in the market and dynamics of inflation and the energy crisis have clearly influenced this process,” she said. “Joining a bigger group or network helps smaller firms to solve those issue through synergies and existing infrastructure, with regard to both specialist technical or industry know-how as well as shared services in the context of HR, IT, communications and financing.”

Steinroder expects to see further consolidation of smaller firms into bigger groups or networks. “In addition, we still see a lot of firms lead by the baby boomer generation which may add more speed and volume to these processes once they start handing over their businesses to the next generation,” she said.

FISG is also putting pressure on the market to consolidate by piling on regulation, according to Thelan. “As smaller firms face the challenge of adapting to these stricter regulations, it's possible that we'll see a market 'cleanup' where only those able to comply effectively will continue to operate,” he said.

Private equity firms have also begun to take an interest in the German market and this will drive more M&A activity next year. “As private investment firms have started acquiring accounting practices, this indicates a strategic shift in the accounting profession,” said Thelan. “Firms need to scale up to meet growing demands and navigate the evolving business landscape. The involvement of private equity will potentially accelerate the pace of mergers and acquisitions in the future.”

Overall, this is leading to a potentially unhealthy situation for the German auditing market. “The German market for audit services has been under debate for many years,” said Dr Marcus Borchert, partner at Mazars Germany. “Several symptoms of the market call for action from the regulator and the administration side. Market concentration is rising. The Big4 are gaining increasing market shares. There is a ‘war for talent’ across all qualified professions in Germany, and audit is no exception. Aside from the demanding entry requirements into the profession, the continuing regulation and significant potential punishments for mistakes are certainly challenges for recruitment and retention.”

Despite the storm clouds gathering on the horizon, Jetter is confident that 2024 will continue to be a good year for the local accounting industry. “After rather slow growth in 2021, the accounting industry has shown strong growth in 2022,” he said. “The outlook for 2023 is that the 2022 development will continue.”

He predicts that demand for CSRD services will likely be growing at a faster pace. Recruitment and staff retention remains a top priority and a significant issue for accounting firms. As in prior years, IT issues such digital transformation and cyber security risks remain a hot topic.

Outsourcing is also a growing area, according to Dr Gorny, in the areas of outsourced accounting, compliance and payroll services in general, as clients are facing personnel shortages themselves.

“We are noticing a significant increase in demand for ESG consulting services - finally also in the SME sector,” said Schmeisky.  “CSRD and the ESRS have established the framework for ESG reporting. Our clients are now increasingly requesting consulting services in this area. Clients need to secure consultancy capacities in this area quickly, as consultant resources are scarce.”

The Supply Chain Due Diligence Law has not yet had a significant impact, but it is expected to in the near future, according to Thelan. “This is particularly relevant for medium-sized enterprises, which are directly obligated under the law,” he said. “While it is too early to assess its overall impact, the law is poised to bring about significant changes in how businesses manage their supply chains, especially in terms of ethical and sustainable practices.”

In general, the German economy is expected to shrink by 0.3% this year, as a loss in purchasing power due to high inflation and the tightening of financing conditions are weighing on consumption and investment, according to the European Commission.

By comparison, the German government expects the economy to contract by 0.4% in 2023.  Germany is struggling with the highest interest rates in a decade, high inflation and weakness in international trade. Declining industrial production and a shrinking construction sector are also taking their toll.

From next year domestic demand is set to improve, driven by a real wage increase. Together with recovering foreign demand, this is expected to support a pick-up in gross domestic product (GDP) growth to 0.8% in 2024 and 1.2% in 2025, according to the commission's autumn 2023 economic forecast.

The International Monetary Fund is also predicting that Germany ’s economy is projected to dislodge Japan’s as the world’s third largest economy.   Germany's nominal gross domestic product is likely to overtake Japan's this year, with the weak yen and inflation in Europe pushing up the value of Germany's gross domestic product in US dollar terms, according to a forecast by the IMF.

The figures were presented in the fund's recently published World Economic Outlook. Nominal GDP indicates the level of economic activity in a country or region, including changes in the prices of goods and services. It is often used as an indicator of the size of a country's economy.

“The geopolitical and economic conditions worldwide and in Germany are challenging for our clients,” said Schmeisky. “Both us and our clients have to keep an eye on legislation and the regulator. At the same time, we must not forget that sustainability efforts, digitalisation and automation also offer opportunities. We have a positive - albeit challenging - outlook for the coming 12 months.”