Structural separation an ‘untenable’ risk to audit quality: KPMG

KPMG Australia’s submission to Treasury’s options paper on regulating accounting, auditing, and consulting firms in Australia says the firm supports a strong, effective regulatory framework that promotes audit quality, auditor independence, and accountability.

It also acknowledged that public scrutiny of KPMG has surged following allegations of audit misconduct at the firm by a whistleblower, and subsequent examination of how the whistleblower was treated after they raised the allegations. It also noted the heightened public and policy focus on governance, culture, accountability, and conflict management across professional services firms.

“KPMG acknowledges the failures that contributed to this issue, and the shortcomings in how we as a firm responded to them,” the firm said in its submission.

“In response, there has been significant change to leadership, sanctions applied, and material governance change is underway.”

While several submissions supported mandating the structural separation suggested in Treasury's options paper to manage conflicts of interest, KPMG said many of the other reforms outlined in the paper would better address the relevant policy objectives without needing to move to operational or structural separation.

Treasury's paper said this option would require reporting entities to obtain audit services only from firms that do not offer non-audit services. It said this would address any real and perceived risk that a non-audit services culture could impact audit quality.

However, KPMG said that a “blanket” prohibition on all non-audit services to audit clients could result in adverse outcomes for audit entities, audit committees, investors, and capital markets. It said some services are closely linked to the audit, required by law or regulation, requested by regulators, or involve assurance over information that is important to investors and other stakeholders.

Such cases may require services to be delivered by the statutory authority due to its existing understanding of the entity and its reporting environment, the firm said.

“KPMG supports stronger restrictions on non-audit services where those services create actual or perceived threats to independence, including management responsibility, self-review, advocacy, or other conflicts that cannot be appropriately safeguarded,” the submission read.

“However, restrictions should distinguish between prohibited services and a limited category of permitted audit-related, assurance, statutory, and regulatory services that can be provided subject to appropriate safeguards.”

Further, KPMG’s submission said that there is limited evidence that structural reforms like the separation of audit and non-audit functions would improve audit quality or outcomes for investors, companies, and capital markets.

“Audit quality reflects the combined influence of governance, culture, ethical decision-making, professional standards, investment in training, quality management systems, technology and specialist expertise, as well as the effectiveness of the broader financial reporting ecosystem, including regulators and clients,” the submission read.

Alongside this, it said structural separation could risk reducing access to specialists for complex audits in areas like taxation, cyber security, technology, climate reporting, valuations, actuarial services, and data analytics. It also said this could increase compliance and operating costs, and reduce the ability to deploy specialist capabilities to support complex audits.

“This may affect firms’ ability to invest in innovation, technology, and quality improvement initiatives, which could ultimately have implications for audit quality, audit costs, and market capacity,” KPMG said.

The firm said it supports stricter governance requirements for audit firms, including stronger board oversight, requirements for independent directors, more transparency, and clear accountability mechanisms.

It added that any framework should be accompanied by appropriate ASIC supervision and enforcement powers, and build on existing governance practices through a principles-based governance code for large professional services firms.

At the KPMG hearing into its ethics and professional accountability, its latest chairman, Michael Ebeid, was questioned about his independence, and he revealed that his previous work on the KPMG subcommittee was not remunerated.

However, it said partnership caps or a mandatory authorised audit company model could potentially bring high cost and disruption to delivering audit services to the capital markets. If it is enforced, these reforms should include appropriate transition relief and implementation arrangements to minimise market disruption, the submission said.

“We recommend the government consider alternative options that more directly support audit quality, public confidence, and accountability,” it said.

Former chairman Martin Sheppard admitted at the hearing that there is a “difficult tension” between partner-directors and independent directors on the firm’s board, and that there is no framework for governance partnership.