Local Audit (Auditor Panel Independence) Regulations 2014

Lord Ahmad of Wimbledon Excerpts

Monday 28th July 2014 Grand Committee

Moved by

[Lord Ahmad of Wimbledon]

That the Grand Committee do consider the Local Audit (Auditor Panel Independence) Regulations 2014.

Relevant document: 6th Report from the Joint Committee on Statutory Instruments

[The Parliamentary Under-Secretary of State, Department for Communities and Local Government (Lord Ahmad of Wimbledon) (Con)]

My Lords, the regulations are among a number of statutory instruments which will put in place new arrangements for the audit of relevant authorities as set out in the Local Audit and Accountability Act 2014. Noble Lords may recall that my noble friend Lady Williams of Trafford kindly led the debate on the Wednesday before last on one of these instruments, an order delegating certain of the Secretary of State’s powers to the Financial Reporting Council. The others in the group are all negative instruments.

I do not wish to take up noble Lords’ valuable time by repeating in this debate the arguments supporting the abolition of the Audit Commission that were put forward during the passage of the Bill. However, it remains the view of the Government that the arrangements that we are putting in place, including these regulations, will create a more efficient audit system, giving greater responsibility to local bodies while providing greater opportunities for local people to hold those bodies to account. As has been said previously, this will save £730 million over the five years from 2012 to 2017—the duration of the outsourced audit contracts—and an estimated £1.2 billion over 10 years. As a direct result of this work being done by the private sector, the cost of external audit for local bodies will reduce by £30 million per annum.

Before explaining the content of the regulations, I should first explain their context. A local public body must appoint its own auditor unless it avails itself of such sector-led collective procurement opportunities as may exist in future. It is important, however, that any authority appointing its own auditor does so taking into account independent, impartial advice from a source other than itself or the auditor. For this reason, we require such authorities to appoint an auditor panel to advise on matters of auditor appointment, resignation or removal, and to advise on the maintenance of an independent relationship between the audited body and its auditor. The panel must have a majority of independent members and be chaired by an independent member.

We already have in the Local Audit and Accountability Act 2014 descriptions of some basic associations which will render an individual not independent for the purposes of auditor panel membership. As I am sure noble Lords will appreciate, the local public sector presents us with a complex set of interrelations and personal interests, and a few definitions around independence had not been comprehensively developed in time to be included in the local audit Bill. The regulations being considered today reflect the further consideration and full public consultation on the detail in the form of draft regulations. We considered it important to consult fully the relevant sectors to ensure that the regulations are proportionate and workable. That consultation took place in autumn 2013.

Respondents to the consultation were broadly content with the measures. Of those expressing a contrary point of view, one respondent argued that back-bench councillors—those not in cabinet in those local authorities running under executive arrangements—should be considered independent for auditor panel membership. However, as all members of an authority have responsibility for appointing the auditor, the Government consider that they cannot be independent from that decision.

Another respondent recommended a shorter, two-year expiry for the period of non-independence due to association with bodies specified in the draft regulations. However, it is the Government’s view that five years is an appropriate period for the effect of those associations to have expired. Among the consultation responses, there was an appetite for guidance on the practical application of definitions of independence. We will consider this with the sector.

More generally, before the introduction of what became the 2014 Act into Parliament, we consulted widely both on the broad policy approach and, in more depth, on the proposed framework, through the publication of the draft Bill. Noble Lords may recall the parliamentary pre-legislative scrutiny committee that provided detailed scrutiny of the draft Bill. During its passage through Parliament, we also provided draft regulations on several key provisions in the Bill, including a draft of the regulations we are considering today.

These subsequent provisions on independence will provide some further definitions of links or associations that would render a person not independent for the purposes of the auditor panel. Persons who have commercial links with the relevant authority to be audited, and persons who have links with a prospective or appointed audit firm, will be added to the existing definitions in the 2014 Act. This is a straightforward measure, to avoid any predominating conflict of interest in the deliberations of auditor panellists.

Persons who are, or have been in the last five years, members of an entity connected with the authority to be audited, where the connected entity is also a relevant authority under Section 2 of the Act, will also be added. For example, an integrated transport authority is an entity connected with a passenger transport executive. This measure is necessary because the connected entity will also have relevance to the accounts of the authorities with which they are connected, as the connected entity’s accounts are consolidated into them. As a connected entity that is a relevant authority may have members, it is necessary to exclude them as well as officers and employees.

For the Greater London Authority, that means persons who are, or have been in the last five years, members or officers of a functional body of the GLA—for example, the LDA or the London Fire and Emergency Planning Authority. Similarly, for a functional body of the GLA, that means persons who are members or officers of the GLA or who have been in the last five years. Just as members or officers of the GLA cannot be considered independent for membership of the auditor panel, the close relationship these functional bodies have with the GLA must also necessarily render their members and officers non-independent as regards the auditor panel.

It is important to note that the links or associations I have just described, and those described in Local Audit and Accountability Act 2014, need not necessarily disbar a person from being on an auditor panel. In fact, persons with those associations might well have just the kind of expertise that would be useful to the panel in its deliberations. The effect of these regulations on such individuals is only that they must not chair the panel or be counted towards the independent majority required on the panel. The independent view must dominate on these panels, even though that view may have drawn on the input of those who are not independent but provide expertise in their opinions. I commend these regulations to the Committee.

[Lord McKenzie of Luton (Lab)]

My Lords, I thank the Minister for his very full introduction of these regulations, which we will not oppose. It seems a long time ago that we debated the issues of auditor panels when we were considering the Local Audit and Accountability Bill, as it then was. Like the Minister, I do not propose to revisit some of the debates we had at that time, and certainly not at this hour. The Minister was right to focus on a sentence in the Explanatory Memorandum about local government containing,

“an extremely complex set of interrelations and personal interests”,

and on the importance, therefore, of these regulations containing independent definitions. Some of our discussions have been around the need for audit powers for authorities that had audit committees and around how the two would work together. We certainly accept that the audit committee could be the audit panel if it satisfied the independence rules, but many audit committees would not satisfy them because it is not uncommon for the chair to be an opposition member. Perhaps the Minister can say whether there has as yet—it is, of course, early days in this area—been any evidence of audit committees being reconfigured so that they could satisfy the audit panel requirement.

We discussed at the time the prospect of the audit panel being a sub-committee of an audit committee, again on the basis that its members would satisfy the independence requirements. Nothing in these regulations would appear to prevent this, and perhaps the Minister can confirm that. It was acknowledged that the definition of “independence” was incomplete when we debated the Bill, and was still incomplete when the legislation passed to the other place. The additions made by these regulations, as has been explained, amend the definition of independence to exclude someone with commercial links to the authority or prospective auditing firm, someone who is or has been a member of a connected authority, and persons who have been members or officers of the GLA or a functional body of the GLA. We support these changes to the independence requirements.

I have some questions for the Minister, and I promise that I will not press the matter of the definition of a “close friend”, which featured previously. I am sure that the Minister will have much more comforting views on that than the Secretary of State, who we teased at the time. None of these regulations precludes individual members having to identify an interest that may crop up. What is their obligation in this regard, in the event that there may be an issue before the audit panel of which an individual member would have to recognise a potential conflict of interest, as would happen in relation to any other committee of a local authority? Can we be clear on members’ obligations to declare an interest and where that leaves them in terms of their ability to vote on the business before the audit panel at the time? What is the position for non-elected members who might find themselves in the same position? What is the position when a majority of members of the panel satisfy the independence requirements, but one or more independent panel members are absent from a meeting? Can the meeting still proceed with its business?

Taken together, these changes produce robust criteria for independence, which are to be welcomed. Whether this is sufficient to ensure that a diverse range of audit providers will ensue from the whole process, I am not sure. Whether it adds to a sense that there is an appropriate level of expertise available to audit panels and local authorities remains to be seen. However, I should like to focus on something that is as much a drafting point as anything. As the Minister said, someone cannot be treated as independent when they have been an employee or partner of a current auditing firm. The same rules apply for a prospective auditor of the authority, who is defined as,

“a person who has made a bid, which has not been declined or withdrawn, for a contract of appointment as the authority’s local auditor”.

I can see that on day one, if you have been a member or a partner of firm A, you cannot be on a particular audit panel if firm A is auditing the local authority until five years have elapsed. It is the prospective bit which is more difficult because you would not necessarily know at the point of appointment whether or not somebody is going to bid to be an auditor. I am not quite sure how that works. Indeed, I am not quite sure about the concept of somebody making a bid to be an auditor which is then not declined or withdrawn. I am a bit out of date on these things but I think that is not how the process of appointing auditors generally works. Invitations are generally issued to a range of firms. I do not necessarily oppose the point, but I would welcome an explanation of how it will work in practice. Those are the only questions I have for the Minister.

[Lord Ahmad of Wimbledon]

I thank the noble Lord, Lord McKenzie, for his broad support for these measures. I am getting into a bit of a habit of saying that to the noble Lord across the Chamber or, indeed, the Committee. He raised some pertinent points, and he will appreciate that the effects will become much clearer as these changes bed down.

The noble Lord rightly commented on audit committees. Many councils have audit committees, but, conversely, not all local authorities have them. It is up to them whether they do so and we do not require them to have audit committees. However, the Act allows bodies to use the existing audit committee as their auditor panel provided—this is the key point—that it is independently chaired and has a majority of independent members. Where the audit committee does not have a majority of independent members, the body will be able to set up a small independent panel. We know that 31% of existing council audit committees include an independent member—indeed, 15% have two or more.

The noble Lord asked about conflicts of interest as regards an auditor panel. This will be detailed in the guidance which will be issued. He also asked how these committees are configured. It is too early for me to comment on that but we know that many committees already have independent members under the existing set-up. The noble Lord asked various questions about conflicts of interest and about what happens when an independent member is not present, even though he or she is a nominated member of the committee. As he knows as well as I do, the same rules apply to any council committee—namely, if it is inquorate, a decision could not be taken. The key issue here is that of independence. If the independent member is not present, the committee would not fulfil the criteria which have been laid down, and it would be inquorate.

[Lord McKenzie of Luton]

Can I just clarify that to make sure I understand? I think that I do. The Minister is defining “quorate” for these purposes in terms of a committee having the requisite number of independent members present.

[Lord Ahmad of Wimbledon]

That is exactly what I was stating. On the more general issues about conflicts of interest, the individual member has a responsibility in this regard. In both local government and the national Parliament, where there may be a conflict of interest there is a responsibility on the individual to reflect whether that conflict of interest has occurred.

The noble Lord asked a specific question about the auditors to be appointed. That is something that I need to think through. I will write to him with the details of that point. I hope that I have dealt with the questions that he raised.

Motion agreed.