Statutory Auditors and Third Country Auditors Regulations 2016

Baroness Hayter of Kentish Town Excerpts

Monday 13th June 2016 Lords Chamber

These regulations are the produce of tired thinking. It is a shame that the profession and its regulators have not been able to think more creatively about the real issues and, instead, have fallen back on the old policy of, “If in doubt, stick in another regulation”. They represent missed opportunities: a missed opportunity to improve the competitive nature of the audit market; a missed opportunity to focus reform on the areas that need it; and, above all, a missed opportunity to think of better, more focused and more meaningful ways in which to measure the performance of British industry and commerce, on the success of which our country’s prosperity depends.

[Baroness Hayter of Kentish Town (Lab)]

My Lords, following that speech, I think that the Minister will be delighted to know that we welcome these regulations, and particularly what they seek to achieve. I am a little surprised that, today being 13 June, they come into operation on 17 June—so we are cutting it fine. Nevertheless, the content is important to improving audit, and is another welcome initiative by the EU, further proof of how our membership of the EU enables us to develop rules across the whole of the EU, which will ensure that the public can be assured that company accounts really mean what they say. We particularly welcome the increased oversight of the auditing of quoted companies, credit and insurance firms, all of which are vital to the health of UK plc. I think even the noble Lord, Lord Hodgson, would agree with that. We especially welcome strengthening the independence of auditors from their clients, including independent members having to form a majority of an audit committee. We strongly welcome the audit firm rotation, with at least 10-yearly public tendering, and an upper limit of 20 years for appointments, and we welcome the restrictions on the supply of non-audit services, including at certain points tax, legal, and internal audit functions.

The questions that I shall pose to the Minister are about the governance of the competent authority—the FRC; the delegation to, and recall back from, an RSB; and the potential exclusion from membership of an accountant from a professional body. First, I recognise the detailed work that the FRC has undertaken in preparing for these regulations, and in preparing itself for 17 June. However, could the Minister confirm that involved in that planning were not only the regulated community but representatives of the wider community, which particularly depends on high-quality auditing—consumers, investors and employees?

That brings me to the second question about the FRC—its future accountability and governance. I note that in its response to our Secondary Legislation Scrutiny Committee, BIS said that the Government and the FRC are likely to review the current accountability framework. Will the Minister confirm that in any such discussions and review the Secretary of State will take seriously the need to include these wider interests of consumer, investor and employee representatives in the governance of the FRC? I should perhaps say that, although it is quite out of date, I used to chair the FRC’s actuarial stakeholder group. This wider input to professional, ethical and enforcement standards remains important, and I would like to build it into any such review of governance.

When we look at BHS or many other examples, we are often left wondering what on earth the auditors did not see or did not choose to report. A proper audit might have led to different outcomes. It is essential that in fulfilling its bigger and, indeed, powerful role, the FRC will work not simply with its regulated community—that is, the audit firms and the RSBs—but with these wider interests who are dependent on high-class auditing for the future of their jobs or their investment or, indeed, for the purchase of goods and services in their role as consumers. Will the Secretary of State consider their interests in looking at future governance?

Secondly, in relation to the delegation from the competent authority to an RSB and the recall of those delegated powers, the regulations define what cannot be delegated from the competent authority—the FRC—but allow the retention of some tasks. They also allow for some tasks to be reclaimed. Will the Minister confirm that, so that the FRC can concentrate on the systemic risks in the audit market, it will leave the other bits of the regulation of audit to the existing regulatory supervisory bodies? I assume that he agrees that the FRC should really concentrate on the bits that only it can do and leave the RSBs to use their experiences and skills where that is appropriate.

That brings me to the part in the draft regulations that state that something can be reclaimed if the FRC considers that the RSB is unable to carry out the task. However, we know nothing about how that would be defined and what the barrier is. Will the Minister outline the governance mechanism and the criteria behind a judgment that an RSB was not able to carry out a task? Will there be transparent criteria for that decision on its competence? Will there be any appeal mechanism against such a judgment?

Thirdly, if I and others have read this correctly, an important area is the potential expulsion by the competent authority—the FRC—of an accountant from his or her professional body. I think the Minister knows that RSBs are concerned about the FRC taking power to exclude members from their professional body. The ICAEW asked whether it really was the intention to allow the FRC to exclude an ICAEW member from membership of the ICAEW or whether it was really simply for the FRC to be able to exclude a member from holding an audit licence issued by their professional body. That is quite a big difference. Our legal friends who are in the House tonight will know the difference between being and not being a member of their professional body. It would be unusual for an outside body to take away their membership of the Law Society or the Bar Council.

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[The Earl of Courtown]

My Lords, I thank my noble friend and the noble Baroness for their contributions to this short debate. I know both of them feel that effective financial management underpins the success of every business, and the quality and reliability of financial reporting in the UK is well regarded. Consequently, it will also be a priority of this Government to maintain the rigour and integrity of the UK’s audit regime. Although the regulations are largely regulatory they should place very low additional costs on business. Furthermore, compulsory retendering of audits should increase competition—notwithstanding what my noble friend said—and choice in the marketplace.

Although the application of the requirements to auditors of LLPs goes beyond the minimum requirements of the audit directive and regulation, it will implement the recommendations of the Competition and Markets Authority and meet the understandable desire of users and preparers of accounts for consistency in financial frameworks.

My noble friend and the noble Baroness, Lady Hayter, asked a number of questions. I will deal first with the questions asked by the noble Baroness. In her first question she asked whether the regulated community was involved in planning but also representatives of the wider community—consumers, investors and employers. As I said in my earlier speech, the Government have conducted two full public—I emphasise “public”—consultations on implementation. Respondents included representatives of companies and investors who are also effectively the consumers of audit services in this context. I am not aware at this stage of interest from any employee representatives but the ability for representations to be made in both consultations was there at that point.

The noble Baroness also asked about the need to include wider interests such as consumer, investor and employer representatives in the governance structure of the FRC. As part of current discussions relating to the status of the FRC as a public body the Government and FRC are likely to review the current accountability framework and to consider whether changes are needed following the implementation of the directive and regulation. I am sure that interest from these groups will be considered where it is expressed. It is fair to say that the interests of investors in particular are of great concern to the FRC and all its work.

The noble Baroness also mentioned leaving the regulation of audit to the existing regulatory supervisory bodies. The experience and skills of the professional bodies are vital to the quality of audit and accounting in the United Kingdom, which is why the United Kingdom successfully made the case in Brussels for their continued involvement in audit regulation. However, we also support independent oversight of the profession as envisaged by the directive and regulation. The FRC therefore has had to have power and discretion to reclaim tasks from the RSBs where necessary.

The line in the EU reforms is between PIE audits, where inspections, most investigations and enforcements cannot be delegated, and other audits, where these tasks can be delegated. The regulations place the FRC as a competent authority in charge of delegation decisions. We do not want to tie its hands unduly. The FRC works closely with other regulatory authorities such as the Financial Conduct Authority and the Bank of England to identify areas of risk. We would expect any such areas of concern to be identified through consultation. This would all be subject to a direction from the Secretary of State which will oblige the FRC to work on the basis that it will delegate all tasks wherever possible.

The noble Baroness also asked whether I could outline the governance mechanism and criteria behind such a judgment and whether there would be any transparent criteria upon which any RSB competency would be judged. The FRC will delegate tasks on the basis that it can update from time to time the conditions which it will set when making the delegation. We will expect any conclusion that an RSB is unable to carry out tasks for a particular type of audit to be based on whether these conditions are met. The conditions will be set out in written delegation arrangements, which the FRC is currently discussing with the RSBs.

The noble Baroness also asked about an appeal mechanism for an RSB against such a judgment. There is no prescribed appeal system, but if the RSB considered that the FRC had acted unreasonably, it would have recourse to judicial review.

The noble Baroness also asked whether there would be some form of continual review of this matter. There will be continuing discussions on these regulations between the FRC and the Government.

My noble friend Lord Hodgson, with all his experience—

[Baroness Hayter of Kentish Town]

If the Minister is moving on from the points that I made, the one that he has not addressed is about the power which appears to be given to the FRC to expel a member from their professional body. If he does not have that information in front of him, maybe it will be possible to at least give an undertaking that discussions on that will take place, because clearly it is a key concern for the professional bodies.

[The Earl of Courtown]

My Lords, I thank the noble Baroness, but I thought that I had covered that issue. Rather than repeat what I said, I will write to her and put a copy of my response in the Library.

As I was saying, my noble friend, with all his experience in business, made some important points. Perhaps the most important question that he asked, right at the beginning, related to the Alternative Investment Market of the London Stock Exchange and public interest entities, and I hope that my answer will satisfy him. The definition of a public interest entity does not include companies unless they are banks or insurers that have securities listed only on the Alternative Investment Market of the London Stock Exchange. These companies will not be required to retender or rotate auditor appointments, or to be subject to any of the statutory provisions on audits of PIEs introduced by the regulations or to the provision of the EU regulation. Nor will they be subject to the FCA’s or PRA’s rules on audit committees.

My noble friend asked why these regulations do not apply to the small number of companies that pose a systemic risk. This was a source of concern in the negotiations in Brussels, where the list of criteria for a company to qualify as a PIE was reduced considerably. The definition of a PIE focuses on an EU-regulated market, not the AIM, and that may illustrate the concern in Brussels to apply some harmonisation across this area.

My noble friend also mentioned enabling more entry to the PIE audit market for mid-sized firms. The prohibition of restrictive clauses in, for example, loan agreements will help to achieve this, as it will not be possible for third parties to require other audit firms to be excluded from tenders.

I think my noble friend made a number of other points and if I have missed any, I will of course respond to them in writing, ensuring that the noble Baroness has a copy and that a copy is placed in the Library.

Finally, the Financial Conduct Authority has amended its rules to reflect changes to the framework in the directive on audit committees. The directive also requires rules on audit committees to be applied, for the first time, to unlisted banks, building societies and unlisted insurers—something the Prudential Regulation Authority has already done in respect of its rules. As noble Lords will note, overall this represents an extensive package of changes, of which these regulations are an important part. I commend them to the House.