International Accounting Standards and European Public Limited-Liability Company (Amendment etc.) (EU Exit) Regulations 2019
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Lord Henley
That the Grand Committee do consider the International Accounting Standards and European Public Limited-Liability Company (Amendment etc.) (EU Exit) Regulations 2019.
Relevant document: 17th Report from the Secondary Legislation Scrutiny Committee (Sub-Committee B)
The Parliamentary Under-Secretary of State, Department for Business, Energy and Industrial Strategy (Lord Henley) (Con)
My Lords, these regulations, which were laid before the House on 31 January, aim to address failures of retained EU law to operate effectively in the field of accounts and reports of UK corporate bodies. They also address certain other deficiencies arising from the UK’s exit from the EU.
The international financial reporting standards, abbreviated to IFRS, are a set of international accounting standards used by multinational companies to produce their annual accounts. They are required or permitted in over 125 countries, including all EEA countries and 15 of the G20 countries.
EU Regulation 1606/2002, known as the IAS regulation, requires that all publicly traded companies in the EU use IFRS, as endorsed and adopted by the EU, when preparing their consolidated accounts. In the UK, the Companies Act 2006 also permits other UK companies to produce their accounts in accordance with these standards. In total, approximately 15,000 companies in the UK use IFRS.
Once the UK leaves the European Union, the EU framework for adopting IFRS will no longer apply. These regulations provide for the continued use of IFRS by implementing a national framework that provides continuity and clarity to UK business, and they aim to provide such continuity and clarity by bringing the European framework for adopting IFRS into UK law. This will ensure that UK-registered companies will not have to change their processes for preparing annual accounts.
The powers to endorse and adopt these international standards for use in the UK will be transferred to the Secretary of State. These transferred responsibilities will be bound by process and scrutiny. Furthermore, assessment criteria consistent with those in the European regulation will apply to all new endorsement decisions in the UK. They are that the standards provide a “true and fair” view of an undertaking’s financial position and that their adoption is conducive to the,
“long-term public good in the United Kingdom”.
The regulations also specify that, for all new endorsement decisions, the Secretary of State must consult stakeholders with an interest in the quality and availability of accounts, and that the final decisions will be published. The Secretary of State will be required to lay a report each year before Parliament detailing the carrying out of his responsibilities.
Further, the regulations provide for subdelegation of the endorsement and adoption powers to a designated UK body. A subsequent affirmative SI will transfer these powers to a new UK endorsement board. We currently expect this board to be hosted by a subsidiary of the Financial Reporting Council. As such, it will benefit from the FRC’s existing operational processes, such as HR and premises. The FRC’s role will be limited to monitoring governance and due process of the endorsement board. It will have no role in the process for adopting standards.
As the Committee will be aware, a comprehensive and detailed report of the independent review of the FRC, making 83 recommendations, was published in December. The Government welcome and share the review’s vision for a new regulator with a new mandate, new leadership and stronger statutory powers, and will take swift action to deliver that. The FRC’s role in relation to the endorsement board will be transferred to the new regulator once it is operational.
Throughout the development of these regulations, the Government worked closely with businesses and regulatory bodies. Informal consultations were carried out with companies, their advisors and investors. In addition, a dedicated stakeholder group also helped inform decisions about these regulations. Stakeholders were strongly in favour of both establishing a UK framework for the continued use of IFRS and the requirement for consultation before an international standard is adopted for use in the UK.
The regulations also make amendments relating to societas Europaea companies, or SEs: a Europe-specific type of public limited liability company that will not be able to register in the UK after EU exit. Regulation is already in place to convert automatically existing UK entities on exit day into a new corporate form—a UK societas—to ensure that they have a clear legal status. The amendments in the regulations relating to these entities do three things. First, they preserve a particular employee involvement provision to maintain employment rights wherever practicable. Secondly, they apply the Overseas Company Regulations 2009 to SEs registered in other member states. This will ensure that UK branches of entities registered in other member states are treated in the same way as UK branches of any other overseas company. Finally, they make a number of minor consequential amendments to other legislation, such as replacing references from SEs to UK societas to ensure that the UK has a functioning statute book on and after exit day.
A de minimis impact assessment of the regulations estimated low overall costs to business. The IFRS-related changes were estimated to have an equivalent annual net direct cost to business of £2.4 million per year. The estimated impact for the SE-related changes was £10,400 per year. Both figures are under the £5 million threshold necessary for a full impact assessment.
I commend these regulations to the Committee and ask the Committee to support and accept them. I beg to move.
Lord Hodgson of Astley Abbotts (Con)
My Lords, I begin by congratulating the Minister’s team—it is always said that the British Civil Service is the best in the world. They must have realised that their Minister might take a bit of incoming over the FRC tonight, as they produced this headline for the front page of the Financial Times: “FRC to make way for stronger accounts watchdog after a string of audit failures”. To get that on the front page of the FT just as we are to discuss the FRC as a possible delegated body is above and beyond the call of duty.
I need to declare some interests. I have served in the City for most of my life and remain a director of a number of limited companies, which are listed in the register of your Lordships’ House. I am also a member of Sub-Committee B of the Secondary Legislation Scrutiny Committee, which considered these regulations. I am coming back to have a second bite at the cherry, having had a go under the noble Lord, Lord Cunningham.
I will make a couple of points. It is easy—my noble friend, in his emollient style, flows so easily over the issues—to think that accounting standards are humdrum and commonplace. In fact, their exceptionally wide-ranging implications are felt in every part of our corporate system. They have an impact on directors and their boards and companies; if you serve as a company director, the two great things your lawyers and accountants always tell you about is trading while insolvent and maintaining capital. Failing to do that exposes you to some nasty and unpleasant risks and penalties—quite rightly. On the other side, they are for investors who need a clear basis on which to decide whether to invest their money in a particular venture.
Years ago, I was sitting where the noble Lord, Lord Stevenson of Balmacara, is now sitting, leading the Opposition on what became the Companies Act 2006, to which my noble friend referred in his opening remarks. We spent quite a bit of time on the Section 393 “true and fair” view, which is a statutory requirement. If there is to be a clash between international standards and UK law, UK law must prevail because it is the law of this country. In those circumstances, how will we determine the final arbiter of what is true and fair?
I will give the Committee a brief example because although it may seem quite simple to decide what is true and fair, it is exceptionally difficult. Revenue and recognition have been a problem behind a number of companies recently—notably Carillion—where you have a long-term contract with an assured client, perhaps the Government. Let us say it is a 10-year contract. You will have to put in some additional work in year one to provide the systems that are going to last the 10 years. Boards and auditors will argue fiercely about how this should be done. Some people would say that to show that you would make a loss in the first year of a 10-year contract, when you will make additional profits in the next nine, is not a true and fair view from the investor’s point of view. A true and fair view can be conservative and restrictive, or neutral, or positive and expansive. Of course, in the case of Carillion, it was positive and expansive and they recognised too much revenue early on.
These concepts go to the heart of our corporate governance and systems—and the public trust in and have confidence in those systems—so these are not just economic decisions; they have big political implications. I would argue that while the Secretary of State may appropriately delegate some of the detailed powers, he or she needs to retain an overarching power to ensure that the system works properly. Noble Lords on the Committee will have seen the ABI briefing, which says:
“We disagree that the Secretary of State should delegate all his functions to the Endorsement Board. Firstly, we think it would be counterproductive and secondly, we think it inconsistent with the aims of the Withdrawal Act … We strongly urge that, in the House of Lords debate on this SI, assurances are sought from the responsible minister that the new SI will provide for active political oversight of the Endorsement Board by the Secretary of State”.
If these matters are to be delegated in their entirety, this country will lose part of its political influence in international negotiations surrounding changes in these worldwide standards. That will impede the UK Government in ensuring that future IFRS continue to reflect the interests of UK companies. That would be a strange decision for us to take in the light of us looking to hew a more independent line, post Brexit. I hope that my noble friend can reassure me and the Committee that there is a real understanding of the political implications that overarch the accounting technical implications of this statutory instrument. That is my first point.
My second point concerns the body to which any delegation may be made. I do not want to dance on the grave of the FRC, but some of the reports to which my noble friend referred in his opening remarks are absolutely devastating. The points include that the FRC,
“is not fit for purpose”,
and that it,
“has serious problems in how it recruits top staff”.
Another point states:
“A new body should have statutory funding and a clearer remit”.
Another states:
“The watchdog needs some new powers”.
One wants an assurance from the Minister that this unfortunate body, which has undergone regulatory capture in the views of many, will not have anything other than a passing interest in the establishment of the body that will enforce the regulations in the future.
It would be helpful if my noble friend could give the Committee more detail on how we will move forward. When his department wrote to the Select Committee of the noble Lord, Lord Cunningham, on which I sit, it said:
“The Department is currently working with the FRC to build capacity to set up the new Endorsement Board (EB) in time for EU Exit”.
We must be quite well on in that process, since we are only 10 or so days away from it. The Committee was also told:
“In addition, stakeholder input helped us define the extent of the FRC’s role in relation to the new Endorsement Board”.
It is important that we get some clarity on where we are in that process. We really do not want stuff to be set in concrete at this point. We need to know how the FRC will slide away and how the new endorsement board will be set up in the next two or three weeks.
Inevitably, particularly tonight, our focus is on Brexit and associated issues. However, this statutory instrument and its successor, which will bring the endorsement board into being, will have serious long-term implications for our corporate governance, the way our companies operate and the confidence of investors in our corporate system—all of which have come into question in recent years over a series of failures and scandals. We need to learn from that and plot a better course for the future. I look forward to hearing from my noble friend how the Government anticipate that being done.
Lord Stevenson of Balmacara (Lab)
My Lords, I declare my interest as a retired fellow of the ACCA. Although I have not practised as an accountant very much during my membership—very little, in fact—I retain an interest in the processes of accounting and the impact it has on business and the economy as a whole, which have been so well described by the noble Lord, Lord Hodgson, and the noble Baroness, Lady Bowles. Both have contributed a great deal to the debate, which leaves a number of very uncomfortable questions for the Minister to try to respond to. I am afraid we will probably not get to the bottom of them today. They have set out an agenda, particularly the noble Baroness, for work that needs to happen over the next few months if we are to get the best out of the current changes.
I will put another review on the table as well, which we have not yet had an opportunity to discuss in our House. I hope there will be an opportunity to do so in the not too distant future. Very significant changes are being made through what appears to be a process of correspondence and speech-making between the new chair of the CMA and the department, under which what looks like a substantial shift of public policy on competition issues will be introduced to put consumer interests at the heart of much competition policy—a change which I would welcome.
This would be a significant change in the powers and abilities of the CMA to investigate and to seek out remedies where malfeasance has been found, and a completely different sense and sensibility relating to the work that has previously been done under the CMA on investigations more generally. I say that because it seems a rather important leg of the various bodies involved in a broader conception around how public trust is to be generated in economic operators. One could also add that a similar responsibility towards consumer interests and consumer focus is needed for the regulatory powers in financial services, for which the Minister will be aware we have been arguing for some time, if we are to get the best out of that system. That has been much discussed in the context of whether there should be a duty of care on financial organisations dealing with consumers, a matter to which we will no doubt return.
By way of introduction, I align myself with the two speeches that have already been made, and will ask three questions on the Explanatory Memorandum. I will preface those with the point made very strongly by the noble Baroness, Lady Bowles, but raised also by the noble Lord, Lord Hodgson, that it is the cruellest of misfortunes for those who have been responsible for designing this new structure that they are trying to find analogues for the existing system in Europe, which has run and operated our overall structure for reporting on public accounts and public bodies, when the whole of that structure is being completely refigured through the FRC review and the consultation now going through. The question that concerns me most is about the structure being proposed. The Secretary of State takes on, broadly speaking, the responsibilities of the Commission, but the political control is reduced to a situation which we find more commonly in Britain than in other countries—about which the noble Baroness, Lady Bowles, has been fairly critical—where the devolved responsibilities are to a body that is being created out of nothing and allocated to a body that is in transition and will not have proper supervisory powers. There is a real problem in this, particularly since, as we read in the recent consultation about the independent review of the FRC, about a third of the recommendations are in category three. As the Minister will know, this relates to reforms that will require primary legislation and have wider ramifications, and therefore require deeper consideration and wider consultation.
I do not understand how the Government think they can get away with a process changing the nature and function of an important construct that relates to a whole economic activity and the accounting process underpinning it in terms of public trust—and do so when they are signalling that they will not be in a position to do it until they get primary legislation ready, let alone through, at a time when it seems impossible to legislate on anything except Brexit. I will leave the Minister to respond to that if he can.
My questions in response to the points raised so far are relatively straightforward. First, in paragraph 7.5 of the Explanatory Memorandum, the policy intention is for the Secretary of State to delegate the function to an independent endorsement board when it is constituted satisfactorily in 2019. Am I right in assuming that this is what is referred to in the Chapter 1 recommendations on the need for a statutory authority, which will require primary legislation? If so, can we have more information about the timing? It does not seem likely that it will be finished this year, let alone in time to enforce the work. I would be grateful for a comment on that.
Secondly, paragraph 7.6 makes the point that the instrument enables the Secretary of State to revoke the delegation to the endorsement board if he or she wishes. Is that right? I do not regard that as good law. It is certainly not parliamentary language. Can we have some examples of the sort of issues that might be raised? The only example we have here is the endorsement board being deemed unsuccessful—but by whom and under what criteria? Do we have any principles under which that judgment can be made? If so, what are the processes under which it will happen?
Thirdly—I have already touched on this point—the principles of financial reporting are taken without question as providing a “true and fair” view of undertakings and a position “conducive” to the long-term public good. These are familiar words. They are contained in the IFRS and apply in the UK GAAP but they are not without some difficulty in terms of their overall understanding. They require judgment at the local level in terms of the individual accounts and in the round about whether the processes were correct. The instrument places an obligation on the Secretary of State to consult those with an interest in the quality and availability of accounts. In pursuit of my concern that the consumer and the broader public interest require a much broader cut through this, can the Minister confirm that the consultation process will include not just the Big Four and the accounting professions, and look genuinely at the wider stakeholder interests?
Lord Henley
My Lords, I thank all three noble Lords for their interventions, which were based on considerably more expertise than I have. I hope they will be tolerant of my response. If I fail to answer any questions I might have to write to them.
It might be helpful if I remind them of the purpose of these regulations. As usual they have the words “EU exit” in them. They are designed for a no-deal exit and ensure that the IFRS can continue to be endorsed and adopted for use by UK-registered companies after exit from the EU. They are laid using powers under the EU withdrawal Act 2018. It is again worth reminding noble Lords of the constraints within that Act and that the powers within it would not allow the Secretary of State to go wider into some of the other matters that are of concern to all three noble Lords. That is why, as I made clear earlier, that there will be a further SI later on.
We have been talking about Kingman who, as we know, published his report on 18 December. We also know that my right honourable friend the Secretary of State issued his initial consultation on the recommendations on that only yesterday and that the closing date for responses is 11 June. No doubt all three noble Lords have copies of that. I think I saw a tweet from the noble Baroness, Lady Bowles, on it today, so I presume she has seen a copy. I regret that we are not in a position to debate it today, but there will be many other opportunities to debate it and to feed in responses in due course.
To some extent, that deals with the initial concern from the noble Baroness about whether the FRC is a suitable body to host the new endorsement board, in light of Sir John Kingman’s report and the response that will have to be made to that. As I said, there are the constraints of the EU withdrawal Act. My right honourable friend is trying to deal with the deficiencies so that we can get on with the eventualities, should there be a no-deal Brexit.
I shall say something about the consultation on the Kingman review. It is important and we are grateful for the very comprehensive review he gave. We think the recommendations are well-considered, far-reaching and transformational. As noble Lords know, the Government published our initial consultation on those recommendations, highlighting our approach in taking forward the review’s recommendations. The Government welcome and share the review’s vision for a new regulator with a new mandate, new leadership and stronger statutory powers and intend to move as fast as possible on this. I would say move swiftly, but the noble Lord will have to be tolerant because the process to implement reforms and overhaul the sector must be gone through. In the interim, until the new regulation is in place, the Government will work with the FRC to take forward 48 of the review’s recommendations, including addressing issues such as lack of transparency and shortcomings in the enforcement activities. Further detailed consultation on those measures will follow.
Lord Hodgson of Astley Abbotts
One of the words that worries me is “hosting”; this relates to the question raised by the noble Baroness, Lady Bowles. Are we just getting a defective organisation—Sir John Kingman’s review makes it clear that it is defective—to be the handmaiden or midwife of this new organisation? What does hosting mean? Does it mean that all the staff are the same? Will there be an independent unit within the FRC? This may be too detailed for this discussion and I would be perfectly happy if my noble friend wrote to us. However, for the reasons we have explained, and in order to have the public’s trust, it is important that it must be seen to be independent and not infected with the problems of the FRC.
Lord Henley
I take my noble friend’s point. In my opening remarks, I tried to make clear that the FRC would host it purely in terms of human resources and other such matters. It will be an independent body to which my right honourable friend can delegate powers. Some noble Lords—I think it was my noble friend and the noble Lord, Lord Stevenson—asked about this. My right honourable friend will retain overarching power to ensure that that endorsement function operates well. If he retains that overarching power, he can revoke designation and retain overall control.
The endorsement board will be required to report annually to the Secretary of State on carrying out its functions. Sitting with the FRC is a matter of convenience in terms of HR and such matters, but it does not mean that its staff has to come from there. If there is anything more I can say, it might be best if I wrote to my noble friend and copied the letter to other noble Lords. I want to make it clear that the board will be made up of independent members. Its chair will be independent and it will not be part of the FRC. Having used the word “hosting”, I am trying to think of some appropriate metaphor but I cannot offhand. I hope that my noble friend will understand what I am getting at.
Baroness Bowles of Berkhamsted
I have a couple of comments. The Minister referred to this being done under the withdrawal Act, and that is quite correct. There is no problem with the way in which Regulation 7 and things around it operate. That is a copy-and-paste job and exactly what the withdrawal Act provides for. I do not think that that Act requires there to be any delegation or sub-delegation. It enables such things to happen but does not require them. But it is in there and at this stage we are unlikely to resist the statutory instrument going through.
However, given everything that has been said, the next statutory instrument, which is also affirmative, will have to contain constraints and requirements ensuring proper, not-captured behaviour for there to be the confidence to allow it to go through. There is no problem with the Secretary of State doing an endorsement. There are people who can assist and advise, and the Secretary of State can perfectly well organise consultations and those kinds of things, so I would not consider delay of the next stage sacrosanct. Given the whole situation, the nature of this debate and the concerns from all who have spoken, I hope that that message about the next stage can be taken to the Secretary of State. I would be very unhappy about trying to pass something in the next month or so without there being many more safeguards.
Lord Henley
At this stage, all I can say is that I note what the noble Baroness has said. Regarding when the next SI will appear—whether it will be in the next month or so—I cannot say, but I will certainly keep her informed and let her know exactly what our thinking is.